Wednesday, July 2, 2008

CME and market

Buy and Sell Discipline -- key to buy discipline is to have some kind of disciplined view of a stock's attractiveness for purchase. It could be based on valuation, the chart pattern, earnings momentum or other factors or a combination of everything. Point is to have a plan; use factors that you are able to identify that lead to strong performance and then be consistent.

Discipline is what its called when you turn away tons of potential candidates because they don't meet your criteria for what is an attractive opportunity.

Sell discipline is also critical to investment success -- you have to know when to take profits -- to realize that an investment has either reached its peak potential or is about to have fundamental troubles or you have to be able to admit a mistake -- that your original thesis was wrong and you need to sell before you lose a lot of money. The key is to be dispassionate in your analysis -- to base your decisions on the best info available at the time without emotion -- as if you didn't have a bunch of money riding on the decision.

Key in these two processes is to understand critical factors that will impact a stock's future potential -- what are the drivers of a company's future profitability? Key metrics to follow and understand how they will change over time.

In CME's case one critical variable that I should have known was that interest rate futures made up about 50% of the daily contract volumes. Then I should have made the jump that with the fixed income market imploding it was inevitable that volumes would drop. The breakdown though was in the sell discipline -- deciding not to sell some shares when the stock was $700 and I even mentioned in this blog it was fully valued. Had plenty of chances to sell the stock for roughly what I paid for it yet didn't -- kept buying into the idea that volumes would continue to grow. Now estimates are dropping because volumes have dropped -- the PE has plummeted from 35 to around 20. I refuse to sell now because its too cheap but I'm kicking myself for not dumping some when it spiked to $440 on the buyback news.

Now in the past their volume issues have been temporary but I'm guessing the shrinking of financials will lead to a volume plateau that will keep a lid on the stock.

I still believe FDS is going to make it through this downturn without too many issues -- its that good of a business. I do plan on selling calls when it is near its high end of range -- something I just missed doing when the stock was $66 a couple of weeks ago. best not to try to top tick these things -- close enough still works.

MCO -- recent investigation into the "cover up" ratings on those european instruments resolved favorably so that removes an issue from the stock. important to realize the story is about international growth and non-ratings growth. that should allow them to grow from the 2008 base at a 10% rate, which is made easier by the fact that up to 5% of the stock is repurchased each year.

AB -- obviously in a bear market the earnings get hit as asset values drop but haven't seen anything that would lead me to believe they are in trouble like legg mason or any of the brokers/banks.

I still think sometimes about MXB (MSCI Inc.) but reality is I should have less exposure to financials -- even the non-endangered ones that I have -- because the opportunities elsewhere are so much better -- utilities, railroads, energy, technology, genetic analysis, etc.

FLIR -- impressive new contract wins adds visibility to the 2009 growth story which is boosting the multiple. Obviously I nailed this story but didn't buy enough of it. Little secret -- often times the stocks that I really like that don't seem to go anywhere but I keep adding to them -- they almost never work out but the ones I keep averaging up on -- they work out great. FLIR would be a candidate for averaging up because I don't see the stock getting back into the 20's unless we have a really bad recession.

ILMN -- wow. saw some stats on their latest product offerings -- the innovation they are producing is astounding. that should drive their growth but the expectations on that stock are huge -- even bigger than for FLIR. I have almost sold calls on the stock -- aug 95 for over $3 but haven't yet because we are so close to a potential rally -- although EVERYONE is expecting a rally so there is a high chance it won't happen until we go lower. Continue to struggle with this one given the stock's strength and its valuation but so far holding on has been the right choice.

TSRA and UEPS -- still holding pattern but nothing has changed -- sure am hoping these two don't fizzle out -- they look like incredible opportunities, which means they are likely not that good.

LH -- this one boggles my mind probably the most -- they have some risks in terms of slower volume growth and bad debt expense given the slow economy but the stock is at 13x next 12 months estimates -- in the past they have gotten as low as a 10% free cash flow yield. At that valuation it sure makes you wonder why they don't just go private. LH tries to do deals with their free cash flow but if they have none that look attractive, they buy back shares. at current values they should be able to retire close to 7-8% of the stock each year. That's a huge amount.

TECH -- last 2 quarters beaten by about 10 cents each time yet they keep saying its due to unsustainable factors so the estimates don't go too crazy afterward. will this be the third quarter in a row or are they finally going to be right that the upside was temp.

BLUD -- hoping they report earnings this week or early next -- they usually report around the 1st of the month following their quarter end -- May 30th in this case so they should be reporting now but haven't. hoping for big upsides driven by pricing. that might get the stock up towards $30. Still comparing BLUD with POWI -- blud has higher margins now but POWI's are rising. similar revenue growth prospects and similar story in that they are selling integration/automation. POWI has very little non-cash assets so their returns are huge. I don't like the fact that there is little growth in blood typing market -- its huge already. most of power integrations growth is market share but I believe their market should be growing due to growth in electricity and their ability to produce new products that can increase their served market.

S&P 500 -- looked at the chart today and what did I see? downward sloping 200 day moving average which will put downward pressure on prices until the 50 day flattens out -- see 2002's price pattern on the S&P for an example. that means hope for a rally is just to get near 1400 -- more likely the next rally takes us to 1350 or so -- basically where we were only a week or two ago.

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