Vad's Best Ideas

"Millions saw the apple fall, and only Newton asked why."
Bernard Baruch

I remember taking a close look at AAPL back in October of 2007 as the stock was rapidly closing in on the magical $200 level... I liked the company products, business model, management and the only real negative noted was the hefty price... Here is a quote of my rationale from that post: "I think AAPL is a great company with unmatched products, shrewd management and loyal customers but, at the time of this writing at $171 a share, I personally do not believe that the risk/return tradeoff for this stock (not a company) is favorable. It is quite possible that given some luck and momentum, the market could carry AAPL another 5-10% higher, but at this price just as easily any negative news could easily lead to a gap down that could be quite severe"

Rereading my original thoughts on the subject it is hard not to notice that my rationale turned out to be on target (I am considering that may be I should doing this for living some day soon) and even "the original target" market cap of $120B is awfully close to Friday's price of $114B. I am not sure whether it was simply a lucky call, brilliant insight :) or merely a coincidence, but there where quite a few occasions in the last several weeks when "driven by populist pressure" (yes I even received some "hate" emails from Mac lovers) I considered jumping in and buying some shares on the way down. But every time I thought about finally pulling the trigger, my skeptical mind has intervened. And now here is the "why I didnt'" part...

First, I do think Steve Jobs is a genius. There are only few people in the technology world whose words arguably carry similar weight (Bill Gates, Steve Ballmer, Larry Page and Sergey Brin) and he probably has no equals in his ability to market products. In addition- the ingenuity of AAPL's R&D team, the "simple and brilliant" design of AAPL's products still remains an envy of the entire IT world. The loyal customers of AAPL are willingly shelling out ever larger sums of cash for never slowing flurry of newer and better products. But this is precisely where AAPL got in trouble and why it is so vulnerable today...

AAPL simply defines what "consumer discretionary" term means. It is also quite clear, unfortunately, that timing for significant growth in consumer discretionary purchases is not that great. With US economy on the way to recession or may be even already there, there is simply not enough discretionary spending out there for all the new and improved iPods and iMacs. As the anemic 5% growth rate in number of iPods sold last quarter shows -not even AAPL's unmatched innovation could force the consumers to substitute their perfectly good iPods with iTouches...And when recession fears become an acknowledged reality - iMacs (which by the way deliver most of the financial benefit) might just become another target for slowing growth. HP and Dell by the way have souped up the design of their products recently and can offer cash strapped consumers a healthy high double digit discount for the comparable performance vs Macs...

Things are a just a little brighter on the iPhone side... It is certainly true that buying an unlocked iPhone in most BRIC countries is not only a habit; it is rather a must for any "new middle class" wannabe. But AAPL's iPhone business model is quite heavily reliant on the commissions from the Mobile carriers which are not going to materialize when phones are not activated on the partner networks. It is widely acknowledged that almost 25% of the iPhones purchased, end up being unlocked on the other networks. In that case AAPL only earns one time cash payment albeit at a healthy margin. But absent major announcements from more carriers in Russia, Brazil and China, the iPhone current partners alone can't quite deliver the growth in earnings high enough to justify the still hefty multiple and still high growth expectations...

Here is another concern for shareholders- while AAPL is arguably more innovative than Microsoft it is certainly behaves as a less mature company, and I don't quite mean that in a "good" way. I personally still can not quite comprehend why would a company with $18B (15% of the market cap) in cash on the balance sheet does not deploy it in a productive way. Steve Jobs needs to swallow his pride and do the right thing- buy back stock, pay a dividend or at the least make a smart acquisition... Hint, investing in clean energy at stupid multiples like Google is not a smart way to achieve dominance in the consumer device space, but may be buying something reasonably priced like GRMN or TIVO might just do the trick..

To sum it up, absent good news on the economic front and smart capital allocation announcements AAPL is at best a good "hold" here.

P.S. Here is a re priced high level "Vad's sum of the parts valuation" for AAPL:

"PC Unit- value no more than DELL= $45B; iPod/iTouch with iTunes- value no more than the entire Sony Corp=$47B; iPhone value no more than a 1/3 of RIMM based on the number of subscribers of 3M vs 11M growing at roughly the same unit value or roughly=$16B. So even this very rough but generous new total target price comes out to roughly $108B which is now a roughly 5-7% discount to today's price.

Stay safe and cheers,
Vad www.skepticalcapitalist.com
former "Dishwasher"

Comments: View Comments |  Saturday January 26, 2008  |  Stocks: AAPL, DELL, GRMN, SNE, TIVO,

"Most of us can read the writing on the wall; we just assume it's addressed to someone else"
Ivern Ball

It has been a only few days since the event that might go down in history as a day "when Federal Reserve has finally acknowledged the existence of the former "Greenspan or now Bernanke put". By cutting rates by 75BP Fed has in effect told the investing world- "we will do whatever it takes to prevent a severe decline in the financial markets..." Whether it was a wise move is still open for debate, but one thing is clear to me personally- nominal stock price levels will be defended at all costs even if it requires "inflating" away the "real" savings.

I guess I was right to predict last Monday night, that the group of Fed governors was quite "weak in the knees" and thus was very likely to intervene with some kind of remedy to prevent another decline in the stock indices. And sure enough just 12 hours after my post, they cut rates abruptly :) While one might say it was a lucky coincidence, I think it wasn't at all surprising. What's more, this move was very typical of what we came to expect from the US Fed over the last twenty years- in the battle of fear and greed- Fed will always err on the side of greed, because battling fear is easy and makes them look smart in the short term, while battling greed is something "that Federal Reserve can not control" and is almost certain to cause some serious political pressures...

I remember how the surprise rate from Bernanke in August has for a short while forced me to question my understanding and logic of how the financial markets function in general and what role should Fed's play in the economy...

But after reading Greenspan's book my original views of benefits of less frequent interventions from the Fed have been reinforced and now more than ever I believe that US Fed has a lot to learn from ECB's Trichet... As far as Greenspans's legacy goes, even today I still have a lot of respect for him personally as well as for his deep understanding of the world economy. It is also true, that his ultra low, arguably unreasonably so, interest rate levels helped to trigger the real estate bubble... But it will be Bernanke's hasty rate cuts that are likely to determine whether US will go through a short term, mild recession or rather something more significant, something we have not seen since early 80s- a period of potentially anemic growth and stubbornly high inflation...

It is popular to say now that if Greenspan was at the helm of Federal Reserve today he would have dealt with it similarly to how Bernanke is responding. But I am not so sure -if you read his book carefully, he states clearly that situation surrounding us today is quite different from anything he had to ever deal with. The disinflationary influence of Chinese, Indian and former Soviet labor force entering the world economy has now diminished.

What's more, with the continued rapid wage inflation in these countries and rapid appreciation of "real asset" prices, these economies are now likely to cause just the opposite effect- more inflation. As Milton Friedman famously said-"Inflation always and everywhere is purely a monetary phenomenon"... Thus while it is quite simple to blame high food and oil prices for the latest inflation spike, it is simply a side effect of excess liquidity. And thus injecting more money into the economy in the face of the highest inflation level in 17 years is almost a "guaranteed" recipe for another bubble somewhere and in something...

Hence there lies an underlying opportunity. Where will this excess liquidity show up? I am going to watch the developments closely and will deliver my thoughts as they come in... :) For now, with mortgage rates closing on 5% and a potential refinancing surge only two more 25BP cuts away, Ben and Co might just succeed in slowing the declines of housing prices and potentially even lead to a short term revival of the financial sector, but the truth of the matter is simple- even if the nominal value of your house goes up, the real "inflation adjusted" value is likely to continue sliding lower. However, I am currently in the process of studying several closed end mortgage ETFs that are selling below NAV. If someone has ideas please feel free to send them over to me at skepticalcapitalist@gmail.com

But anyway, once again- enough rambling- back to stock picking. The main purpose of this blog should be helping investors make money, not arguing about Fed's actions... So here is a quick recap of what I have done last week- I sold my ultra short ETFs on Tuesday and jumped onto the long side the next day... I have bought a number my former "oversold" favorites- MGI, ETFC, GEOY, PTNR, CEL, HOLX, CTCM, RIG, CHNG. I still think that markets are likely to head lower in the next few months but with another potential rate cut in the works - this "dead cat bounce" rally might just keep us trading water in a narrow range of a 12000 +/- few hundred points for a short while...

I will do my final analysis and selection for the MSN contest this weekend, and will post my picks early next week But I still think that regardless of where the US markets head in the coming weeks- current prices for FXP (ultra short China) and EEV (ultra short emerging markets) now once again offer a good risk /reward trade off and represent a great hedge for almost any investor.

But as with any short positions- cap your losses to no more than 10% and take your gains on any double digit moves up :) You can't go broke taking profits :)

Stay safe,
Vad
www.skepticalcapitalist.com

Comments: View Comments |  Saturday January 26, 2008

"The greatest mistake you can make in life is to be continually fearing you will make one" Elbert Hubbard

Here it comes... Bloodshed and fear have finally visited the "new leaders" of the world economy. I guess it might be the right time for me to claim that I did get it right after all, but on the other hand it is also unfortunate that many of the poor Chinese retail investors are learning in a very hard way that nothing ever goes up forever...

Greed can force people to do stupid things and the "this time will be different" speech is almost always a "sure thing" sell signal. But I wonder what will all the China bulls are going to say now? I guess we might just hear another reason why the Chinese stocks are so ridiculously cheap and why was PetroChina worth more than GE and Exxon combined... One thing is a fact -Hang Seng has declined an astounding 11% in only two days and no one can say for sure just how much lower it could go...

I have been a China "Bear" since late October of 2007 and have endured some serious pain from Ultra Short China ETF (FXP) being one of the only few significant decliners in my SLO-1 fund. My rationale for being short China has been very simple-it has simply gone too far too fast. Irrational behavior of Chinese corporations making almost a third of their profits from investments in other companies, astounding real estate price gains etc just simply could not continue forever...

The real question now is how fast the pain from the stock market decline in the emerging economies would transfer to the hard issues like real estate bubbles, manufacturing overcapacity, rampant inflation and lack of sound market principle based economic foundation. I think that China is positioned somewhat better than Japan was during the last "New Deal" bubble due to the huge $1T "foreign-exchange" reserve that could be used to shore up the onslaught of "bad loans"; but driven by the recent "irrational exuberance" attached to anything with the name China in it, by the time its over -the US sub prime fiasco might just look like a joke...

The latest question of the week asked what an average investor should do when markets decline as severely as they have in the last several weeks- my answer to this question is simple- when fear takes such a firm control of the market- the safest bets are shorting and protecting principal by investing into agency bonds... As I mentioned during the last few weeks - ultra short ETFs like FXP, EEV and TWM as well as some bond fund ETFs (TLT,TIP, SHY) could just do the trick...

P.S. I am willing to bet that after looking at the Asian market declines Bernanke and Co are probably now meeting in the "war room" and trying to arrange some kind of remedy before the market opens tomorrow... Otherwise we might just see another "Black Tuesday" decline that could make some kind of history :)

Stay safe and short :)
SkepticalCapitalist.com

Comments: View Comments |  Monday January 21, 2008

"The world is round and the place which may seem like the end may also be only the beginning"
Ivy Baker Priest

It seems like we finally starting to see a healthy amount of fear in the market place and in my book it is a good sign... Dow has dropped almost all the way to the last year's low which means the "funny" gains of 2007 have been finally erased. My guess is that during the next several months there will be numerous opportunities for the long term investors to make some terrific investors. But until everyone believes that the recession is inevitable and real, markets might just continue to find another reason to sell off every week... So with the goal of principal preservation as the main goal in the short term, the question now is simply how to avoid severe losses during the next few months.

Here are some quick thoughts to consider before jumping in too heavily into some of the sectors that are widely being touted as extremely cheap by "historical measures":

- Yes, write downs in the financial sector might seem quite severe, may be even unreasonable, but given that most ABX indexes just hit the new lows last week- expect more bad news from financials. We still haven't heard from many insurers and other firms that make their living predominately by making investments into various securities. Some states and municipalities will be forced to cut costs hence more layoffs are very likely. Asset managers held up better than most other financial stocks but with markets down in double digits since October- expect similar declines in asset driven fees and even more severe declines in performance incentive fees. Hence more lay offs again...

Below is an example of a BBB rated ABX Index- we are talking 13 cents on the dollar here...

Source: http://www.markit.com/information/products/abx.html

- Decoupling of the emerging markets from the US economy seems to be a very popular theme with many people believing that even when recession in US becomes obvious emerging markets will behave differently than they have in the past. But I think one needs to look behind the hyped up stories of the booming stock markets and skyrocketing real estate prices- the truth is- boom of the emerging economies has been driven predominately by growing exports to the outside world and not their own consumers.

- Consider this simple fact reported in WSJ last week: "...In Asia, for example, exports hit 55% of the total economic output in 2005, according to the Asian Development bank, compared with 45% output in 2002. While intra-Asian trade has grown, about 60% of Asian exports are eventually consumed in the US, Europe and Japan."
So, with Japan's economy on the brink of another collapse, US economy either in recession already or almost there, and finally with European economic growth showing fresh signs of strain almost daily now, how could the emerging economies possibly hold up?

More to come in the next few days,
Vad

P.S. One more little note - For all those who actually believe Chairman Bernanke, who keeps reiterating that the US Economy will somehow avoid recession. Everyone is confident that Fed actually knows something we don't. Yes, I am pretty sure with thousands of staffers on the payroll that could be the case, but consider another fact- Fed's statements about what they think the economy is going to do are not designed to be realistic. They simply can't be too pessimistic, period! Fed's job description assumes guiding the economy out of the recessions and thus any express statements supporting the view that US economy is heading into there would make it a certainty that will end up there even quicker- so my advice ignore Fed's projections and statements and look purely at actions. Cutting rates by 100BP with inflation at 17 year high is not designed to simply "provide insurance" against slowdowns...

Comments: View Comments |  Sunday January 20, 2008  |  Stocks: BBB,

Continued from "Are we there yet?"

What came yesterday was a real shocker- not only the losses were significantly larger than expected $800M as of November 30th (could exceed $1.5B by the end of January) but the liquidity crunch got so bad that MGI had to renegotiate the debt that was put in place just a few months ago to pretty much junk rates and had to also sell over a $1.3B in securities in a "fire sale" with real losses now hitting the book and cash balances...And in addition all the equity is going to be raised at prices significantly lower than current trading price...

At the end MGI might have to give up and astounding 60-70%+ of the total equity to new investor just to stay alive...Case closed?

But what seems to be really bad, is that contrary to the common logic- it does not seem like the supposedly safer vintages are really any safer, or that the problem is only related to the residential real estate related securities, or that it is easy or even at all possible to raise relatively safe debt now, even if it is backed by an asset that consistently cash flows $200M and is growing at 20% a year...And we are talking about leverage of only 3-4 times that projected earnings stream...A year ago multiples like this were assumed to be conservative- bad news for any outstanding private equity deals out there as well as for any boought firms that did not raise debt using "covenant lite" loans...

Yes, it is possible that the lack of the initial disclosure of the details on the entire portfolio and the lack of response to the Euronet's offer have triggered the ensuing fiasco. And I do think that multiple lawsuits will follow within days and that CEO's days are numbered, but it won't really help the investors who have lost a fortune...Even I personally have lost some money after initially having large gains on this company in 2007.

I am also afraid that MoneyGram story could turn out to be a really ugly indication of things to come... Just how bad it could really get in the next few weeks is still open for discussions, but while my forecast for 2008 assumed a world wide market downturn- I now think the situation might be even worse than one could have imagined...We clearly still have some severe froth in several emerging markets (main one is China). And it is still safe to assume that any stock that has a high leverage and even, God forbid, has a lot of asset based securities on the balance sheet (think banks and investment banks) could be in for a rough ride in the months to come. Stay away from financials- even though some regional banks seem like a good deal on the surface- after the MGI's fiasco- I don't think it is really possible to reliably value any complex asset backed product right now...

And finally let's not forget- while I believe that we have already entered or might be in the process of entering a full blown recession- not everyone is pricing in the same outcome quite yet. Only when majority of market participants agree that we are going into the "R" word- the risk/return trade off of owing stocks might finally tilt into investor's favor. For now- bonds, or bond ETFs (TLT, TIP, SHY etc), short selling individual stocks and some of the safer not leveraged non cyclical and non consumer discretionary long positions could possibly offer some safety in the weeks to come...

Trade safe and cheers,
Vad (former "Dishwasher" now simply a "Skeptical Economist")

P.S. I am in the process of setting up my new blog and getting ready for the MSN contest which turns out requires a lot of writing even prior to start which means I'll probably less attention to the virtual portfolios for the next few weeks. But I'll keep posting regularly here and will share my views on any of the fun developments in the next few weeks.

P.S.S. Also don't forget to use trailing stop losses on any long positions- it always better to be safe than sorry... By the way, sell offs also mean better upside once market stabilizes so don't panic or worry - protect whatever gains you might have and have enough in liquid securities to jump in the high beta stocks once the right time comes.

Comments: View Comments |  Tuesday January 15, 2008