7/20 Kelly Letter Topics
⇒ Weekly market review
⇒ Ban on Naked Shorting
⇒ Evidence of Inflation
⇒ GOOG Misses
⇒ China Getting Cheaper
⇒ U.S. Needs New Bubble
⇒ Protecting AAPL Gains
⇒ Dividend Stock Income
⇒ MSFT's Online Obsession
⇒ AMD Share Price Cycle
⇒ On Vacation
I hope you enjoy this day with your family and friends as much as I do. The whole Kelly clan is together in Colorado for a white Christmas complete with turkey, wine, and lots and lots of presents.
I expect volatility around the sub-prime induced credit slowdown to continue for the next few months.
BCA Research monitors the relative performance of bank stocks, the yield curve, credit spreads, consumer confidence, market leverage, private debt, and new bond and equity issuance to come up with a U.S. Financial Stress Index. It moves on a scale from -2 (little stress) to +2 (great stress).
For perspective, the S&L crisis of 1989 pushed the index over +2, the Long-term Capital Management implosion of 1998 sent the index to a little under +1, the dot.com meltdown of 2000 saw the index approach +2, and the current sub-prime fret has the index approaching +2 again.
Lest you think this is cause to skip Christmas and say "Crappy New Year!" at midnight on December 31, just look back at how the stock market has done since those other stressful times.
The S&P 500 has gained 434% since the S&L crisis, 55% since the LTCM implosion, 43% since the middle of the dot.com meltdown, and 82% since the end of the dot.com meltdown. Read market history and you'll note that the ballyhooed "end of the modern financial system" never was. It isn't this time, either.
BCA says the Fed is behind the curve on lowering interest rates to stave off further credit trouble and recession. Joining BCA has been a chorus of analysts attacking the Bernanke Fed.
Conversely, Briefing.com president Dick Green wrote last Monday:
The criticism of the Fed is way overdone.
The Fed started cutting the fed funds rate in September. That was the end of a quarter in which real GDP rose at a 4.9% annual rate. The numbers are adding up to an increase in fourth quarter real GDP as well. If a recession hasn't yet started, that means it comes in the first quarter of 2008 at the earliest. The Fed would therefore have started cutting rates at least four months before the recession started.
The Greenspan Fed, often blamed for having kept rates too high too long ahead of the 2001 recession, left the fed funds rate at 6.5% through the end of 2000. The first rate cut was to 6% on January 3, 2001. By then, the recession had already started as first quarter real GDP posted a decline. The fed funds rate did not get down to the current level of 4.25% until May of 2001, well after the recession had begun.
The Bernanke Fed has thus moved faster than the Greenspan Fed did in 2000-2001, and from a lower fed funds rate target, to get rates down before a recession started.
Regardless of whether the Fed is behind or ahead, it looks likely to lower rates further in the medium term.
The market wants lower rates right now, not in a few months. That impatience will sweat volatility everywhere you look until rates get where the market wants them. They will get there, however.
Too, credit worries will fade as they always have in the past, lower interest rates will stimulate the way they always have in the past, and even the overkicked dead horse known as housing will get back on its feet and remind everybody surrounding it that it never did account for more than 5% of the U.S. economy.
The short term will remain rocky while we wait for the Fed to catch up, but there's hope on its heels.
Would you like to win a free signed copy of the 2008 edition of The Neatest Little Guide to Stock Market Investing? Now's your chance!
Simply refer eight new people to my free email list shown at the top of any page on this site. If you're one of the first five people to do so, I'll mail a signed copy of the book directly to you from where I'm spending Christmas in Colorado.
Note that you can't type their email addresses in for them. They need to come to this site and enter their own addresses in the field.
How will I know you've referred eight people? Newcomers to the list will receive a note asking them for the name of the person who referred them. When I get eight notes back with your name in them, you qualify. If you're one of the first five, you win! If you're not, you still win my admiration and gratitude.
I'm doing this because I want to expose more people to my unique approach to investing, get the word out about the 2008 edition, and reward my regular readers with a Christmas gift.
Can't wait to win a copy? Why, you could always buy one:
I'm proud to announce that the 2008 edition of my bestselling Neatest Little Guide to Stock Market Investing will be on sale everywhere books are sold beginning tomorrow!
It's a thorough update that includes:
My Maximum Midcap strategy, an innovative investment program that consistently outperforms the market
Real-life examples of successful investment strategies
Tips from master investors like Warren Buffett, Peter Lynch, and Bill Miller
Meticulously updated resource lists
A ten-year retrospective on the famous IBM Value Line scenario that lets you decide what you'd do based on the information at hand, then check your own performance with current data
Updated examples throughout
Concise summaries of all key points to help you remember
A comprehensive index
About his section, Bill Miller wrote, "Jason Kelly captured my investment methods well, and better than most who have tried to describe what I do."
Beginning tomorrow, I'll provide you with a chance to win a free signed copy mailed to you directly from where I'm spending Christmas with my family. For today, here's an excerpt from the book:
How about clothing? Like me, you might enjoy watching people in public places such as a shopping mall. What are they wearing? One year, I noticed kids wearing Tommy Hilfiger clothes more and more frequently. It didn't take a genius to know the clothing was from Hilfiger because the name was emblazoned across the front of every T-shirt and sweatshirt. I went into the department stores and looked for racks of Hilfiger clothing. Much to my intrigue, I found entire sections of the stores devoted to Hilfiger. In a local Macy's, "Hilfiger" hung in huge gold letters against the wood paneling and throngs of kids stood under the sign holding shirts up to each other for first looks. That's darned interesting to an investor, wouldn't you say? I checked out the company's numbers and recommended Hilfiger to friends in spring 1993. A buddy picked up shares at $10.50 in July. At the end of 1996, he sold them for $48.
I have a more recent clothing story for you. My mother and sister visited me in Japan in May 2006. My mother wore a pair of Crocs sandals that she raved about the entire visit as we walked around Tokyo and flower parks near my home in the countryside. She told me that Crocs were invented in Colorado, where we're from, and that everybody back home had a pair. When my friends in Japan saw the sandals, they asked about them, tried them on, and wondered if I would buy some for them on my next trip back to the States. An actionable tip? You bet. Shares of Crocs were less than $25 that May. In February 2007, they broke $58 for a gain of more than 132 percent in just nine months. I have a feeling Peter Lynch would love this story.
Food, clothing, and other necessities are good places to start looking for companies. Once you've exhausted them, think about where you spend your discretionary dollars, that is, for things you don't absolutely need. Perhaps you love home movies and notice that some companies just won't go away. One might be the place you rent videos, maybe Netflix. You could have bought it split-adjusted for less than $5 in fall 2003 and sold it for almost $40 in January 2004. Another might be the movie company Disney. If you decided back in October 1990 to get more out of Disney than a mouse cartoon and a few rollercoasters, you could have purchased its stock for $8 and sold it in January 2007 for $35. That's a 700 percent gain in a little more than one year with Netflix and a 338 percent gain in a little more than 16 years with Disney, both of which you would have found by just vegging out on home movies. Who says couch potatoes can't get ahead?
Now that financial stocks have cratered, homebuilders have been burned to a crisp, semiconductor companies have fizzled, and the Fed has shown itself to be clueless yet again, what do you think is the smart way to play this market?
I don't like the phrase "play the market" to begin with, but really despise it when coupled with "this market." It makes it seem like we need to adjust the way we invest based on what's happening this second, which implies that this second is different than all other seconds. Neither is true.
I invest the same way regardless of what's happening, and anybody worth anything in this business will tell you the same thing. If you're still following the ever-increasing volume of market commentaries as if they'll help you get ahead, you're either a slow learner or wet behind the ears. The dime-a-dozen commentaries that clutter blog aggregation sites around the internet are so fickle that you might as well be getting your financial guidance from a kindergarten class that just finished a case of Twinkies.
Almost nothing matters to long-term results except earnings. Nothing will keep you safer at night and wealthier in the end than buying future earnings at a discount today. Patiently sifting through stocks and indexes for future earnings on sale is what I always do. I don't stop doing it because some guy with a blog and a webcam snapshot of himself posts a rant on why Federal Reserve Chairman Ben Bernanke chose to cut rates by a quarter-point yesterday instead of a half. The internet is a blessing in so many ways, but its having given a bullhorn to an army of idiots is not among them.
May I point out that Ben Bernanke graduated from Harvard College summa cum laude with a B.A. in economics, then received his PhD in economics from MIT? He served on the President's Council of Economic Advisers and was a member of the Federal Reserve's Board of Governors before President Bush appointed him Chairman. I think he's well aware of the implications of monetary policy. I think he understands inflation risks. I think he knows that credit markets need to remain healthy. I would go so far as to say he knows economics better than most bloggers out there, who tend to offer their economic opinions during lunch breaks at work in unrelated fields.
So, let it be known that I don't think the Fed showed itself to be clueless yesterday, nor do I think the word "again" is appropriate because the Fed hasn't shown itself to be clueless anytime in the last good many years.
As for financial, home building, and semiconductor sectors being down, yes they are and as ever The Kelly Letter is searching for value in them, along with other sectors and other countries.
"This market" is like every other market. You'll notice after years of waiting for the market to be just right that it never is. You'll realize after sitting out too many supposedly impossible rallies that the stock market really does rise twice as often as it falls, and that the trouble of the moment is just another twist on what was the trouble of the moment a year ago, three years ago, and even 30 years ago.
Markets fluctuate. Media sensationalize. Investment services spew articles showing there's a 51.09% chance of a certain stock rising today because it has done so that percentage of the time every day after it lost the amount that it lost yesterday -- as if such trivia is helpful in any way.
Find value. That doesn't always mean cheap. It means buying a future earnings stream at a good price today. It might be a high price to those who don't understand the earnings. That's why we have to find the bargains. They're not obvious.
Dell has one of the worst reputations in the business for customer support. Does this affect sales? Well, how did Dell manage to slide so much? Where are the repeat customers?
Perhaps Dell will learn. Michael Dell is young, familiar with the business (he's no John Scully at Apple in the 90s trying to figure out what canning Pepsi had to do with personal computers), and is not an idiot such as Steve Ballmer. There is hope, but should you buy based on hope alone?
Microsoft has languished for years between $20 and $30 and they have no competition, just bad products and worse management. The competition in the laptop market is fierce and low prices don't seem to be the answer, at least not judging from Dell's performance.
Desktops are not a growth area or even a replacement area in the retail market, so where is Dell going to make a breakthrough? Cost cutting, improved productivity, and all the MBA buzzwords are well and good, but do lower prices alone sell enough units?
Will I buy Dell? No.
I'll address this point by point.
Customer service from all computer makers has been dismal for years. Longtime readers know the saga my office went through a year ago when upgrading to all new equipment from HP. Total disaster. It took six months to get things working right and I'm not sure it would have ever come together if not for a colleague's brother-in-law who happened to work in HP's level two tech support. When I asked him why nobody at level one thought to move us up the ladder after their solutions failed, he just shrugged and apologized, and said it happens all the time.
For a good laugh, consider that HP is a J.D. Power & Associates Certified Support Provider, a designation they repeat every minute or so while you sit on hold for ages waiting to be given ideas such as checking to see if the computer is plugged in. If you care to read more, check out the articles I wrote last April.
I'm not defending any bad customer service provided by Dell, but rather pointing out that dissatisfaction with product support looks to be endemic to the PC industry. I happen to know from other mails from Luigi that he uses a Mac and will undoubtedly point out that Mac users are mostly satisfied and tend to not know anything about Apple's customer service because they never need it. True, but not pertinent here.
I happen to have heard from a number of people that Dell has pretty good customer support. I've heard of the company delivering replacement machines to remote locations such as the Rocky Mountains where a friend of mine works from home exclusively on Dell machines. Another friend in Los Angeles told me of Dell sending a tech support person the next day when the toll-free help line couldn't fix the problem. I'm sure every PC company has good and bad customer service stories.
On this point, let's just say that Dell is no worse than anybody else.
As for shares of Microsoft languishing between $20 and $30 for years, they did until achieving a decisive breakout above $30 in October. I know because The Kelly Letter owns shares and we were waiting for Vista earnings, Xbox successes, and online inroads to finally pay off in Redmond, and they have. I expect that continue.
Luigi's point, though, was that if monopolistic Microsoft could fail to produce much stock performance for years, what hope can competitors-in-every-direction Dell have? He says low prices aren't the answer and hints that industry growth overall is limited.
I agree that low prices aren't the answer. Design, branding, and distribution are the answers. This is the main reason I'm interested in Dell's turnaround. Dell has shown that it finally understands that computers aren't commodities, any more than jeans or handbags or portable music players despite all of them appearing to be so.
Anybody can make jeans, but you want to wear Levi's. Anybody can make a handbag, but not like Vuitton's or Hermes's. Any electronics company can make a portable music player, but whose can touch the iPod?
Design matters. The brand of a well-designed product can take market share from competitors, creating a growing company even within a stagnant industry. If Dell makes computers that are far cooler than machines from other PC companies, it will be able to charge more and still sell more than its competitors.
What Dell would need to do is get widespread distribution to be sure people see its products and want to buy them, then pack that distribution channel with cool new products that create product lust. Let's see if Dell's doing that.
On Friday, the company announced that it will begin selling its XPS and Inspiron notebook and desktop computers at more than 900 Best Buy stores in January. That's in addition to the 3,000 Wal-Mart stores already carrying Dell's machines. If we add Bic Camera in Japan, Carrefour Group and Carphone Warehouse in Europe, and Gome in China, Dell's number of retail outlets worldwide jumps to almost 10,000.
That's a pretty big retail push and should get Dell positioned to roll out slick new designs. Sexy brands combined with retail presence could finally be the spark needed to reignite the shares.
In response to the same article that inspired Luigi to write, I received this email from John Q. Pope in Dell's Digital Media Group:
We wholeheartedly agree with your assessment that design and branding can make a difference. We've bolstered our design efforts considerably over the past few months and the market feedback on our new XPS consumer products has been very positive.
He mentioned a $4.5 billion marketing deal with WPP Group and then showed off Dell's all new World of Warcraft notebooks. Have you seen these things? There's one for the Alliance team and one for the Horde team. They're amazing, and you can get yours starting today.
Don't miss that site. As one French comment reads, "C'est une bombe!" It's the beginning of the new Dell we need to book the profits we want.
We're counting down the months to Dell's iPod moment.
I wrote on Nov. 27 that my Maximum Midcap strategy had declined 20% since its October high, and that its five-year price history suggested it was ripe for a recovery.
Since then, the strategy has gained 13% and is now up 14% for the year. My Double The Dow strategy is up 10% since then and 15% for the year. These are excellent performances in absolute terms, but also in relative terms compared to the Dow (+9%) and the S&P Midcap 400 (+10%).
Since Dec. 31, 2002, here's what $10k in each strategy and the Dow has grown to become as of Friday's close:
$30,732 Maximum Midcap $22,553 Double The Dow $16,209 The Dow Jones Industrial Average via the DIA ETF
That gives Maximum Midcap an annualized return for the past 5 years of 26%, which is better than 99.998% of all mutual funds. Of the 0.002% of funds that did better, most focused on Latin America and India.
Kelly Letter subscribers invest more in Maximum Midcap at the end of each month, a simple technique that boosts performance even beyond that shown above by automatically buying more cheap shares than expensive ones.
That's just dollar-cost averaging at work, but the technique is particularly well suited to volatile investments that rise over time. These leveraged strategies are precisely such vehicles, combining extreme volatility with assured recovery.
As the market dashes hither, thither, and yon, it's good to have a winning strategy that keeps cooking along no matter what the pundits say about impending recession, credit crunches, and other fears of the moment. I've dismissed all those fears, and that boldness has paid off.
Why don't you join us for a month and see if this calm approach to superior performance over time can help your portfolio?
It's been a lousy year for First Marblehead, and the last two-month span has been the worst time of all. It's not hard to see why. That's the time period when the entire financial services sector came under fire from sub-prime fallout.
FMD has no exposure to sub-prime, but it is in the debt securitization business. Instead of packaging mortgages, it packages student loans. Analysts are worried that as buyers of mortgage securitizations become gun shy, the entire asset category will lose its appeal. That could mean that FMD will have trouble securitizing student loans this quarter and possibly next.
Last week, FMD was downgraded by FBR. Yesterday, it was downgraded by Sandler O'Neill analyst Michael Taiano. Mr. Taiano said that a prolonged liquidity crunch could threaten FMD's business structure by limiting its alternatives and compressing its profit margins. Other analysts, even those who haven't downgraded the stock, have lowered earnings estimates for next year.
Longtime FMD bullish analyst Tom Brown disagreed with FBR's recent worries.
A look back at FMD's stock price history is instructive. The company has experienced a boom-bust cycle that's now clear. From November 2003 to February 2005, the stock rose 248%. It then fell 71% to give back all the gains by October 2005. From there, it rose 296% by January of this year and then again fell 65% to today's close at $19.93.
That's quite a price history. The rising times were characterized by an interest in the firm's impressive control of 20% of the student loan securitization market, strong growth, and solid profit. The down times, oddly, were characterized by the same healthy business attributes but one kind of worry or another.
The first plunge came when the company's former CEO Daniel Meyers was caught up in a scandal where he'd exchanged $32,000 in gifts with Kathy Cannon, who at the time was a senior vice president in Bank of America's student loan division. Mr. Meyers resigned and BofA chose to not automatically renew its contract with Marblehead, presumably to distance itself from the scandal.
A Goldman Sachs analyst said that the non-renewal was a huge negative and that "the visibility on FMD's outlook is poor."
The company, however, never missed a beat. The scandal disappeared, BofA renewed, and the stock price got back to climbing on the high rates of growth.
In August 2006, FMD reported a 65% surge in profits. CEO Jack Kopnisky said, "Fiscal year 2006 was one of the strongest years in First Marblehead's history, as revenue, earnings and EPS all exceeded our expectations."
That positive trend continued, even to this day. Good news has been plentiful this year: FMD authorized a stock repurchase in April, boosted its dividend 67% in June, announced a $1 billion securitization in June, was called a "screaming value" by Motley Fool analyst Philip Durell in August, and beat earnings estimates that same month.
However, in the background were worries that some of Marblehead's clients would get into the student loan securitization business themselves, thereby lowering the firm's profits. None of the clients did so. All said that they would not.
Now, we face the third time FMD shares have been battered by analyst worries about something that may or may not happen. There have been no business hiccups. Not one. Analysts are making projections about business trouble ahead, as they've done in the past, but they were wrong before and could well be wrong again.
We're always looking for the best places to put new money to work. Yesterday, we had a chance to double down on a technology stock that we've owned since March. Even back then, we bought it at a price 66% lower than it had been a year prior. We'd watched it during half that descent and were tempted to buy at prices that were 25% lower, 35% lower, and 45% lower than the high. We waited longer still and then finally bought at 66% lower than the high.
In retrospect, we were still too early. Yesterday, the stock fell through the level 75% below its high and 32% below our initial purchase. We, however, are in familiar territory here and rubbing our hands together with glee. Let me explain.
Two years ago, The Kelly Letter began building a position in a different technology company. It's one of the biggest and you definitely know it by name. We began buying at $25, a price that was 29% below the high it reached ten months prior.
The stock fell further and we had a chance to buy it at $17, which was 32% below our initial buy price. Since that last purchase, the stock has risen 55%. We're still holding on for more.
We do this all the time. We watch hundreds of stocks with solid business plans, reliable management, and other factors to indicate that they are good companies. What we wait for is something to depress the stock price. Many times -- most of the time, in fact -- the lower price is warranted and we steer clear. About 15% of the time, though, the market missed part of the story or the stock price is unduly depressed and we think we have an edge by buying the low prices.
Then, we build a position. Notice that we don't need to get the bottom exactly correct. We strive to, and we want to, but even when we're 32% early we can still do well if our initial thesis is correct. In the case of the stock we doubled down on yesterday, I'm as convinced that the thesis is correct as I was on the other stock I described, the one that's now 55% higher than our last purchase.
If you think this approach is one that would appeal to your way of investing, why not give the letter a try? It's only a penny to see what we're doing for the next month. If you like it, stay. If not, cancel.
The worst that could happen is that you'll have a chance to buy yesterday's stock at a much better price than the letter paid, and to profit that much more on the eventual recovery. And make no mistake about it: this stock will recover.
The Kelly Letter bought Dell at $29 two years ago. So far, we're down 15%.
When we bought it, Dell was trading at a price 31% lower than it had been 11 months prior, and looked to have established a bottom at around $30. Since we bought it, the stock has traded in a rough range from $30 to $22. At Friday's close of $24.54, it's currently in the bottom third of that range.
Dell shares fell 13% on Friday, following the company's 3Q earnings results. Profits were up, but by a penny less than expected and margins were down.
Michael Dell said that his company is enjoying "solid progress" in its turnaround. He said the firm expects to be a leading consumer brand, grow overseas, and make enterprise IT easier. He wants designs that create "product lust" the way Apple's do.
There were several positives to help us feel good about holding shares. To me, the report was typical of a company still in turnaround mode, with nothing frightening at all.
The company will begin buying back stock next week, an excellent vote of confidence in its future. Costs continue coming down. Retail partnerships are growing, a necessary step to compete with HP. That combined with Dell's plan to roll out compelling new designs should yield good results.
Michael Dell said in the conference call: "So with nearly 10,000 stores by year-end, we'll soon be at about 27% of the top retail doors globally. It's all about increasing a customer's opportunity to see, feel, and experience Dell products."
Also, notebook sales are roaring back to life. That segment is important because it's the public face of a computer company. It's where the logo is most often seen, the hardware that people notice in airports, and what shows up most frequently in movies, music videos, and other mainstream fare. It's at the heart of the "it's cool because cool people are using it because it's cool" cycle that consumer goods depend upon.
Michael Dell said: "We'll lead in the next generation of wireless, including WiMAX and 4G. We're shortening our development cycles and bringing products to market 40% to 50% faster, and as I've already mentioned, fantastic reviews on our latest new notebook products. When placed side-by-side against our competitors, our notebooks are second to none in performance, design, quality and simplicity."
I've long written that the vast majority of computer users have no idea what's inside, or care anymore. As with a car, the exterior is more important than the engine. Any modern computer can get anybody's work done these days, with the same keyboard, the same screen, and the same set of capabilities.
That leaves only price as a differentiating factor, right? That's what many analysts contend. They say that computers are commodities and that selling commodities is a crummy business. It's a losing proposition for all concerned because prices drop to rock bottom and every company loses.
However, introduce the concepts of branding and design and suddenly not all electronic goods are the same anymore. Ditto cars, whiskeys, and handbags. Any portable music player can play music, but you'd rather have an iPod. Any car will take you to the grocery store, but you'd rather show up in a Benz. Any whiskey tastes like whiskey, but you'd rather have Jack Daniel's or Suntory Hibiki (in my neck of the woods, at least). Any purse will carry a wallet, but you'd rather have a Louis Vuitton.
I believe Dell is creating the next must-have line of consumer electronic goods, a category in which I place the computer. That's the good news.
The bad news is that its turnaround is taking a lot longer than I expected, and I think solid results are still at least a year away. Between now and Dell's "iPod moment," there will be more disappointments like we saw on Friday.
Chief Financial Officer Donald J. Carty said as much in the conference call: "...we are going to continue to incur one-time costs as we restructure to improve productivity and execution, reduce headcount where appropriate, and invest in infrastructure and acquisitions. In addition, our near-term results could be adversely impacted by a slower decline in component costs than we saw earlier in the year and a seasonal shift in mix to U.S. consumer and international regions."
The Kelly Letter will not look to double down on Dell anywhere over $24, and probably not until $20. I'm hoping for some disappointing results again that knock the price lower as those who don't understand what Dell's doing dump the shares.
This is a common technique in the letter. We often build positions in turnaround stocks and average down once or even several times as the price finds a bottom. Eventually, the price heads back up and, as Bill Miller says, "lowest average cost wins."
While the letter is just watching Dell for the right time to buy more shares, we have an active order in place to buy shares of a company that's down 30% since we first bought. The last time we bought more shares of a company that was down 30% from our initial buy price, it recovered dramatically and is now sitting on overall gains of +27%.
Care to join us and see how to take advantage of good companies at sale prices? Give the letter a shot for a month. It's only a penny, and just $5.48 per month if you decide to stay. Cancel at any time and the monthly payments stop immediately. You probably won't cancel, though. A full 85% of people who try the letter keep receiving it.
