Sunday, November 26, 2006

Festival of Stocks Edition #12

Welcome back to the 12th Edition of the Festival of Stocks! Value Discipline is proud to host the Festival for the second time. Thank you to everyone who has submitted a post and thank you to all readers who are visiting Value Discipline. To our new arrivals, welcome and please have a look around!

We have been provided many excellent submissions for your entertainment and edification. As always, I try to add a few comments of my own. We welcome your additional insights and commentary!

A review of the past week. The Dow Jones Industrials dropped 62 points for the week ending down 0.51%, a rather surprising conclusion to the week, given the backdrop of takeover fever that seems to be closing out the year. Much of the weakness in the Dow can be attributed to Kirk "I'm just a passive investor" Kerkorian's dumping of 14 million shares of GM at $33 leaving him with a position of a" mere" 7.4% stake. This frees up $462 million just in time for Kirk to saddle up to an additional $825 offer for MGM Mirage . Why not stick to something you know, after all Kerkorian already owns 56.3% of MGM. The next time you hit the strip you will likely run into a Kerkorian property which includes Bellagio, MGM Grand, Mandalay Bay, The Mirage, Luxor, Treasure Island, New York New York, Monte Carlo, and Circus Circus. What happens in Vegas stays in Vegas and much of my activity seems to go directly into Mr. Kerkorian's wallet! GM was down 11.7% thereby costing Kirk $173 million on his remaining stake. However, MGM's 13.3% rise resulted in an incremental boost in Kirk's MGM holdings of $1.007 billion. I hope you had a good week too! Broader indices fared somewhat better than the Dow with the S&P 500 losing 0.02% but the Mid-Cap +0.73%, the NASDAQ Composite +0.59% and then Russell 200 +0.48%. Weren't all the strategists telling us that small cap was dead and big cap was the way to go?


Stock Market Beat, written by Trent, has noted a seasonal pattern in Intuit (INTU) an expectation that he had commented on a month earlier. The company has just announced a rather spectacular first quarter with revenues up 19% as a result of an early intro of a new edition of QuickBooks. Ex this, the company would have reported a 12% improvement in revenues. My only commentary is what a gorilla of a stock this has been. Even after this seasonal correction of 8% in the last month, the stock is still up 19.29% for the year. This is a great business with a ROIC of 23% on a TTM basis, the best it's been in three years. Consensus earnings growth rate for the next five years is 15.5% versus the last four quarters at 5.2%.

George of Fat Pitch Financials presents Sally is a Beauty of a Spin-Off. Sally Beauty Holdings (SBH) has just been spun off from Alberto-Culver (ACV.) George outlines why this fits the characteristics of a successful spin-off. These characteristics have been outlined by Joel Greenblatt in the past and George demonstrates their applicability to Sally. Institutional investors generally do not want a holding that is not part of an index...SBH isn't at least for now. The company is highly leveraged from inception. However, in my view, the business is fairly well insulated from economic cycles and has demonstrated consistent cash flow characteristics. Importantly, its retail stores require very little capital. The earnings growth should be strong as there is high financial leverage, there will be some de-leveraging and reduction in interest costs moving forward, and the store base continues to grow. This is a very large chain with over 3000 stores. George owns the stock, I don't...yet.

Coinstar Costs a Pretty Penny is a post by Asif Suria of SINLetter. com. Asif describes Coinstar (CSTR) as being grossly overvalued at this point. It appears that revenue and earnings are heading in two different directions; regrettably, it is earnings that seem to be heading south! The shares have been remarkable this year, advancing 49% YTD. The fundamentals provide a somewhat mixed picture.The stock is trading at a 23.9 times TTM EBIT. The return on invested capital for the last twelve months is a paltry 3.8% well below a five year ROIC of 7.9%. Free cash flow growth over the last twelve months is up by a substantial 42% and sales growth has been almost 50%. Though the stock looks expensive on a P/E basis with 2006 consensus estimates of $0.62 (P/E of 54.9 X ) and 2007 estimates of $0.95 (P/E of 35.8 X), it is important to remind oneself of the FCF picture. The company has a FCF yield of about 5.0% per TTM FCF. It is interesting to look at the huge differences that exist between net income per GAAP and the free cash flow over the last several years:

Year.....Net Income.......Free Cash Flow
05.........$22 million........$147 million
04.........$20 million........$103 million
03.........$20 million........$ 79 million
02.........$59 million........$74 million
01.........($ 7) million.......$65 million

Here is a link with Coinstar Ratio Analytics per Reuters.

Siu LI of Leopard Strategy writes about Utek Corp, (UTK) which is a company engaged in technology transfer from university research labs to a portfolio of small OTC (many pink-sheet) companies which currently number some 50 companies. In essence, UTK trades technology transfer strategic alliance agreements that it makes with researchers for shares in emerging micro-cap companies. Put simply, UTK provides a way for university research scientists to monetize their discoveries by developing alliances with emerging companies. On a trailing twelve month basis, the company has a ROIC of 31%, as compared to 2005's 13.2% and 2004's 4.1%. Free cash flow has been significantly negative. Insiders hold a 25% stake (fully diluted) The company has been under attack by some shorts and Siu LI comes to its defense in this post. At present, there are some 723,000 shares short representing about 12.3% of the float.The short position is up significantly from the prior month, 377,000. I do not know enough about this situation to comment and do not have a current position, one way or the other.

Yours truly wishes to submit Computer Programs & Services for your consideration. An interesting highly profitable business in a sector that could be a beneficiary of changing trends in healthcare spending.

Personal Financial Planning:

David B at How Do People Get Rich suggests the Top 3 Easiest Ways To Make Money. He suggests on-line savings accounts, many of which pay superior FDIC insured returns since these banks do not carry the overhead burden of a branch system. He also suggests that low cost Index Funds are a great way to invest. We all know the record of the average mutual fund manager who trails the market. Collectively, it is difficult for large money managers to beat the Charlie Ellis points out, they ARE the market! An Index fund is an "easy" way to make money over time, but I continue to believe that great active managers who are disciplined do win the battle. They are just not that easy to find. Finally, David suggests that investing in a 401-K is a great way to invest. Who can argue? When companies provide matching funding, this is free money. NEVER turn down free money! Obvious, yet many people put off retirement investing in favor of current consumption. At the risk of sounding repetitive, NEVER turn down free money!

Markets, Macros & Miscellany:

SuperSaver at My Wealth Builder is decidedly bullish with a 6-12 month point of view. He cites both political and economic rationale. My comment: As many of you know, I do NOT have any skillset as far as predicting markets. I remain optimistic on markets whenever I can find securities at bargain prices that exhibit a margin of safety and don't require exorbitant growth rates to justify their valuation. Fortunately, I can still find some excellent companies at decent prices. Good luck in your search SuperSaver! presents some terrific logic for trading. Essentially, know thyself! As Jeff suggests, study your losing trades...herein lies the cost-cutting opportunity. Keeping your losses in check by limiting position size and pyramiding winners into positions of greater significance is the key. A very interesting read into the arithmetic of trading!

Experiments in Finance wonders about the implications of all of these takeovers. She draws a parallel to the housing market, essentially too much money looking for a place to participate but finding it necessary to accept lower returns for the privilege. Readers of Value Discipline will recognize that I share some of these concerns. It simply does not make sense that private equity capital has discovered perpetual motion; that is, bidding up public companies, paying a takeover premium, increasing leverage, paying out a dividend to themselves and their partners, and recycling the company back onto the public equity market onto the unsuspecting. Someone is going to get hurt!

The world of forex trading has been attracting a lot of trading interest. Definitely, not part of my circle of competence. However, for those whose nostrils flare at the opportunity to combine volatility with low margin requirements, may I suggest Maximum Profit Opportunities by Mark McRae at forexblog. He presents a discussion of Fibonacci numbers and their relevance to exiting a position. As many of you know, I am agnostic when it comes to technical analysis, simply not within my circle of competence, but I have always loved mathematics. For a discussion of the fascinating story of Fibonacci numbers please try this website link.

Finally, a problem for all of us in the investment business; heck, a problem for all of us period...dealing with Information Overload. Too many e-mails, too many RSS feeds, too big a stack of "research?" Paul of Paul's Tips provides some advice in dealing with this junk ( I was trying to be polite.) In fact, calling "it" information is being overly polite. Simplifying life so that we can build a reject pile quickly is so important in the investment world. Some ideas are so preposterous, so stupid, so extraordinarily expensive that we shouldn't spend five seconds contemplating such ideas. Buffett has mastered this, often being able to reject an idea within seconds. Find your circle of competence and develop it! Dwell there and ignore all the noise around you. That's the way to really enjoy your life and build some wealth.

Thank you for your attention this week. Next week's Festival of Stocks will be hosted by Frugal at My 1st Million at 33. If you have a post to submit, please send it to this convenient form. Previous editions of the Festival of Stocks are available at this link.


At 4:55 PM, Blogger Asif said...

Hi Rick,

You have done an excellent job of providing additional information about each entry that was submitted for this festival of stocks.

I was wondering how you calculated the free cash flow numbers for Coinstar. After seeing the significant free cash flow numbers you posted, I calculated them for the last three years and my numbers are significantly different from yours. In case you are interested, I have posted my FCF numbers on my blog

At 8:44 PM, Blogger Super Saver said...


Thanks for hosting. Great commentary.

The market has already made me pay for my bullish prediction :-) Today was a 158 point drop in the Dow, a 58 point drop in the NASDAQ, and a 19 point drop in the S&P 500.

At 12:07 AM, Blogger Siyu LI said...

Excellent job to consolidate the info and great commentary. Thanks for including my post regarding UTK.

My name was misspelled - should be Siyu LI.

At 8:33 AM, Blogger George said...

Thank you for hosting this week's Festival of Stocks. You did a great job.

Also, thank you for including my submission on Sally Beauty Holdings. I appreciated your comments on it. Let me know when you too are a holder of SBH.

At 3:50 PM, Blogger Rick said...

Hi Asif!

As you can see I have corrected the FCF numbers in the subsequent post. Thank you for pointing out the discrepancy!

At 3:51 PM, Blogger Rick said...

Appreciate the comments Super Saver. I suspect your horizon extends beyond one or two days! Appreciate it!

At 3:53 PM, Blogger Rick said...

Hello Siyu!

I apologize for my error in misspelling your name! As you can see, I have edited and corrected. Thank you for your commentary!

At 4:02 PM, Blogger Rick said...

Thanks George! I appreciate your commentary. I will be doing some work on Sally when I have a chance. I find the idea intriguing. There should be tremendous earnings leverage from paying down the debt. There is a huge amount of SEC documentation to read regarding SBH! Thanks again!


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