I don't hold this one in SLO or real life and hadn't really looked at it until the contest question came up. I was going to pass, but thought it was worth a quick evaluation to see if it should join the team.

The first question I wanted to answer was how they make money. I know, seems like a dumb question, it's Mastercard we all know what they do. But there are several ways financial firms make money off credit cards; interest, annual fees, branding arrangements, transaction and processing fees, ATM fees, etc. and it's important to know who's doing what to evaluate the risks involved. MA's bread and butter is transaction / processing fees. Everytime someone charges a purchase on a Mastercard, MA gets a little slice of the purchase. The banks, credit unions, etc. that issue the cards collect the interest and other fees and assume the risks that go with extending credit to all of us consumers - priceless business model.

Ok, they've got a great business model. Not much risk since the card issuers are the ones actually extending the credit. Reliable source of income, millions of people Mastercharging stuff every day - and every swipe is a cha-ching for MA. But is the stock a good buy? At market close on 28 Sep, MA was trading at nearly 25 times next year's earnings estimates - well above the S&P 500. Analysts estimate the five-year earnings growth rate at about 18%, also above the market. The nearest competitor is Visa, but they're privately held so we don't have comparable metrics. The next closest competitor is American Express. AXP isn't a great comp since they do a lot more than issue cards, but it's what we've got. AXP trades at a little over 15 times next years earnings estimates, a slight premium to the S&P. AXP's estimated five-year growth rate of a little over 12% is also quite a bit lower than MA's. Comparing the trailing PE to growth rate, or PEG, ratios of the two companies, MA comes in at 1.6, AXP at a more reasonable 1.38. Tough call between these two, MA deserves to trade at a premium to AXP and it does. But, I think AXP is a little better deal at these prices.

Other
I'm not sure Mastercard can sustain an 18% annual earnings growth rate going forward. Nearly everyone in the US already has and uses credit cards, so it doesn't seem like growth here can outpace overall economic growth by very much. If anything, consumers may pull back a little as the US economy slows.

There are tremendous opportunities for growth in the rest of the world, but I don't know if it's enough to hit the earnings targets. It's also conceivable the European, Chinese, Indian or other foreign banks could develop competing credit card processing systems. I doubt those economies are going to sit still and watch a few percent of every transaction head for the US. For this SLO exercise, I haven't spent the time to research what, if any, competition MA might face overseas. At a minimum, Visa will be in the mix.

Visa is expected to come public soon. At this point, MA is the only publicly traded, pure-play credit card processing company. When Visa comes public, the supply of stock in this area goes up. Econ 101 tells us what happens to price when supply goes up.

Summary
MA is a great company with an awesome business model, but I think it's fully valued at the current price of about $148. Given a projected growth rate of 18%, I would want to see the forward PE ratio pull back to the 20 - 22 range before I'd consider buying. That would equate to a buy price range of $120 - $132 per share. This is a popular stock and prices could run. If I owned it, my sell target would be in the $160 - 165 range. It's a great company, but at this price I think there are better buys in the market.

Comments: View Comments |  Sunday September 30, 2007

... why I gave up trying to trade Mattson (MTSN). So far this week, a downgrade, an upgrade and reduced guidance. Managed to sell out on the bounce back up and recoup most of my losses.

On a brighter note, Graham Corp (GHM), a small company I found while looking for a global industrial play pulled back quite a bit today and I was able to establish a decent position. The first week of this contest did teach me a valuable lesson - I left some dry powder and more room in the position in case it's not done pulling back.

Comments: View Comments |  Wednesday September 26, 2007

RPM International's annual report for the year ending in May 2007 was recently released and I thought it was worth a review of the highlights. For those not familiar with the company, RPM is a holding company for a group of businesses producing paints, coatings, sealants, and adhesives for industrial and consumer markets.

Vitals as of Friday, Sep 21: Market cap of $2.9 billion; forward PE of 12.2, PEG of 1.15, 0.85 times sales and EV/EBITDA of 8.5 on the trailing twelve months. The quarterly dividend payout is 17.5 cents for a yield of 3.0%.

A company's history is important, but we care about the future. Frank C. Sullivan, RPM's CEO, outlines his outlook for the next three years in his opening letter. Among the highlights, "Preliminary indications suggest compounded annual growth in sales of 10 percent and earnings of 10 to 12 percent over [the next] three year period."

The company has a disciplined acquisition approach and typically does several deals a year. Over the 2007 fiscal year RPM completed six transactions for a total of $140 million. Mr. Sullivan tells us to expect more of the same going forward.

The quote I was happiest to see, "During this three year period, shareholders should expect continuing disciplined acquisition growth ... and a cash dividend that increases each year." (emphasis added)

One of the things I like about this company is that the 'international' in the name really means international. For FY 2007, total sales were $3.34 billion. Of that total, $998 million or nearly 30% came from outside the U.S. Foreign sales grew by 31% over 2006 compared to a little over 4% for U.S. sales growth. The company is growing operations in Europe, Central and South America, India and China.

There are some risks to investing in this company. Raw material prices are a concern in today's markets. The company has been able to raise prices to offset higher material costs, but there is no guarantee they will be able to continue to pass those costs along to customers.

Since RPM makes several products that are used in housing construction, the slump in homebuilding is a natural concern for the business. In a "Q&A with the CEO" piece, that question is addressed by Mr. Sullivan, "Less than 10 percent of our sales is seriously impacted by new housing starts..."

Another risk is asbestos liability. RPM is a defendant in a number of asbestos exposure cases related to products previously manufactured by RPM or its subsidiaries. The company is settling these cases and established a claims reserve in 2006 to cover the best estimate of their liabilities. RPM is also involved in litigation with some of their insurers. RPM believes the insurers improperly claimed coverage was exhausted and should have covered more of the asbestos claims. The reserve does not assume any repayments from the insurance litigation. To the extent settlements may exceed the claims reserve earnings would be impaired. If the company is successful in the litigation with the insurance companies, those settlements would reduce the need for reserves and provide a one-time increase to earnings.

I consider the stock a buy up to the mid 24 dollar range. Assigning a near market PE of 15 to the forward earnings gives it a 12-month price target of $29.

Disclosure: At the time of writing, I own stock in RPM International.

Comments: View Comments |  Saturday September 22, 2007

With Bank of America's announcement to expect some impairment from the credit crisis the day before the FOMC meeting, I decided to take advantage of the run up on the rate cut to cash out rather than wait to find out what's behind the warning. My plan is to ease those proceeds into my other bank holding, Wells Fargo (WFC). At the start of the contest, I was torn between these two so bought both. Wells has outperformed BAC over the duration of the contest so I'll just ride the stagecoach. Wells Fargo's price has been depressed somewhat due to concerns over their mortgage business. I think those fears have offered up an opportunity to build a position in a great bank at a good price. WFC consistently meets or beats earnings estimates and has clearly explained the steps they take to mitigate credit risks. In a presentation at a conference in San Francisco, the CEO stated "Given our responsible lending and risk management practices, we have not faced many of the issues others do in the industry." source At this point, I consider WFC a buy below 37. In the event it drops below 35, it'll be time to back up the truck. For SLO, I'd start selling off if it reaches the low-to-mid-40s. In my real portfolio, I'm copying Warren Buffet's approach and have a sell target of never.

Mattson Technology (MTSN) is about a half-billion dollar semi equipment manufacturer. Their balance sheet has no debt; they trade at a forward PE of 13 and PEG of 0.4. I had MTSN in the mix at the start of the contest, then traded out of it after a price run up. It dropped back below 10 about two weeks ago so I brought it back aboard. The stock price has a habit of clawing its way higher, then falling like a rock. I've had success playing that trade in stock picking games, but my one attempt in real life was a lot of effort to lose three bucks. For SLO, I'll buy small positions below 10 and trade out in the high 10's. I think this could be a $14 stock in a year of so if they continue to hit earnings estimates and deliver on higher margins. Margins and missing earnings have been problems for them in the past.

Comments: View Comments |  Thursday September 20, 2007

On Monday the 17th, GSF released its monthly Summary of Current Offshore Rig Economics (SCORE) report and the news raises a warning flag. If you're not familiar with it, the SCORE report is essentially an index of dayrates and profitability for offshore drill rigs. This month it was down 0.5%.

This report comes at the same time we're seeing record oil prices and a Fed rate cut that brings inflation and weak dollar fears to the market. These trends all support the trend of higher rig dayrates continuing. However, a big part of the bullish case for GSF and other offshore drillers is their ability to roll over rig contracts to higher day rates and the latest SCORE report may, emphasis on may, indicate that trend is abating. Add to that, concerns have been raised about rising operating costs at some of the recent conference calls for the drillers.

If GSF just continued at current earnings levels, it would be at a PE of 11.4, still well below the market. Bump that PE to a still conservative 14 and you get a stock price of 89 compared to today's close of 72.75 - looks like a no-brainer, back up the truck buy. Of course, that assumes no increase (or decrease) in earnings and current estimates are for strong earnings growth. Makes it look even cheaper.

However, I'm nervous here. The stock continues to look cheap, BUT if the drillers are starting to lose pricing leverage and their costs are going up, the stellar earnings growth could be coming to an end. I haven't sold any more either in the SLO or my IRA account, but will be watching carefully for any news and the next SCORE report. This SCORE report could just be a blip, even one or two more could be a blip. But nothing goes up forever.

To summarize, I still like the offshore drillers - particularly with a rate cut that should help stave off a recession and record oil prices that make sky high rig rates practical - but if there are more indications that they're having trouble rolling contracts over to higher and higher rates, it'll be time to sell, bank the profits and let someone else make the last few points.

To make it more complicated, GSF and Transocean (RIG) have agreed to a merger. If you like RIG and think the merger will go through, GSF has consistently been the cheaper way to buy the new company.

Assuming no additional news, I'll add to my SLO portfolio if GSF dips into the 60's; I'll start taking more off the table above 75. If it hits 85, I'll be out for SLO and for real. There's typically enough volatility with GSF to make it a good candidate for trading around a position.

Comments will be appreciated since you might help me make or save real money with this one.

Comments: View Comments |  Tuesday September 18, 2007

"So let the Fed watch begin. .... What do you expect? And what changes are you making to your SLO portfolio?"

With all the conflicting economic news, I honestly don't know what the Fed is going to do next week. High oil prices, a weak dollar and rising gold prices are sending inflationary signals, which would argue against a rate cut. The jobs reports over the last two weeks are somewhat in conflict. Last week's report was much weaker than expected, but today's unemployment claims report was better than expected, although still not great. Mortgage rates are down slightly from last week. A Yahoo poll had 59% believing the Fed will cut....

No doubt the Fed doesn't want to be seen as bailing out investors burned by the credit markets, but now they could use the weak job numbers and risk of recession as the rationale for a cut.

Meanwhile, the talking heads are reporting that a cut is a foregone conclusion and the only question is whether it'll be 25 or 50 bps. But are bank stocks telling a different story? I've got Bank of America and Wells Fargo in my SLO portfolio and they may hold a clue to the market's expectations. When the Fed cut the discount rate on Aug 17th, both banks shot up with BAC closing at 51.11 then reaching a high of 51.22 on the 24th adjusted for a dividend. WFC closed the 17th at 37.24 and reached a high of 37.37 on the 21st. Today, BAC and WFC have drifted down from those highs to 49.86 and 35.81 respectively. Similarly, the BKX closed Aug 17th at 110.17 and closed today at 104.29. While the banks fell over that time span, the S&P 500 was up from 1446 to 1484.

If the market was counting on a rate cut, the banks should trade higher leading up to the Fed meeting. So far, they've jumped on the discount rate cut and then pulled back. My plan had been to sell part of my position into a run-up before the Fed meeting, then buy back lower if there was no cut. As it stands now, there hasn't been a run-up, so perhaps the market isn't as sure there'll be a rate cut as the talking heads are reporting.

If there are no significant changes between now and the 18th, I'm not going to make any substantial changes, but will look to raise a little cash to hedge and be ready for some bargain hunting should the opportunity arise.

Sidebar - Vad dishwasher - if you're reading this, in your 'Style vs. Principle' blog entry of 12 Sep (worth reading for those who haven't seen it) you state "So in short the data for a significant series of rate cuts is not there ( I do anticipate that recession is likely to occur in the next 12-18 months one way or another)." That comment seems to be in conflict since, if data is forecasting a likely recession, a rate cut would be in order. I was hoping you could comment on why you think there'll be a recession, but the data doesn't support rate cuts.

Comments have been switched on!!! What indicators are you looking at for insight to the Fed's action? Or do you just ignore the noise since you can't really predict it anyway?

Disclosure: At time of writing I own shares of WFC.

Comments: View Comments |  Friday September 14, 2007

A few posts ago I mentioned adding a global industrial play to the portfolio and was considering GE, ABB and a few others. This morning I started nibbling at ABB. It was down a bit at the open and tripped a limit buy order. I'm going to try being more patient with this one than I was at the contest start and buy in small chunks on dips.

For those not familiar with ABB, if they generate electricity, use electricity, control machinery, or transmit power, they're a prospective ABB customer. The key factors in the decision were ABB's PEG of 0.9, strong balance sheet and the fact that it's based in Europe so provides some protection against a falling dollar. Sadly, I believe the combination of budget and trade deficits combined with the Fed's hand being forced towards easier money make a weaker dollar inevitable. ABB's home page made it clear this is a global business, listing recent big contract wins in the US, Kenya and China.

Had I been making this buy for my real portfolio, I would have chosen GE. GE's breadth of businesses provides pretty good diversification, which is attractive since I don't hold as many stocks in real life as I'm playing with in the SLO. I also like GE's higher dividend. However, for SLO I was looking for leverage to global industrial growth and ABB is more of a pure play.

While researching industrials, I ran across a small company I'd like to add. Graham Corporation (GHM) has a $150 million or so market cap and makes vacuum and heat transfer equipment used in places like refineries and power plants for customers around the world. They're only covered by one analyst, trade at a reasonable 16 times forward earnings, have almost no debt and over $5 of cash per share. Their last quarter was the definition of a blowout, 66 cents per share vs. estimate of 28. However, by the time I was entering orders, it started to run and was up nearly 9% today - great for shareholders, not so good for those who wanted to buy. I'd still like to add it, but will wait and see if it pulls back some.

Disclosure: At the time of writing, I don't have positions in any of the companies mentioned.

Comments: View Comments |  Wednesday September 5, 2007

... momentum buyers (APPL) vs. the bargain hunters (RIMM). Which approach do you favor, and why? Give us some examples from your portfolio.

A quick glance at my portfolio should make it pretty obvious that I fall in the bargain hunters camp. Nothing against momentum investors, I simply haven't got the experience to identify the momentum stocks early on or know when to jump in and out. Now that I think about it, I'm not sure I'm all that great at identifying bargains either.

My idea of a bargain stock is a good dividend payer with the yield above the historical average and/or trading at a discount to the market. In addition, there needs to be earnings growth potential to support future dividend hikes, bonus points if they have a long track record of annual dividend hikes. Stocks in my SLO portfolio that fit that template are RPM*, WFC, BAC*, BUD*, T, CVX, NVS, UL, and PSEC.
* - indicates over 25 years of annual dividend hikes.

My bargain highlight is Prospect Capital (PSEC), a closed-end fund functioning as a business development corporation in the energy area. PSEC does the annual increase one better, the payout has increased every quarter since the doors opened in 2004 and the guidance they released a few weeks ago indicates they'll continue that string later this month. Current yield is over 9% and that's without resorting to a payout ratio above 100%. If the guidance they issued a few weeks ago is accurate, the next payout will equate to over 10% annualized. PSEC doesn't rely heavily on the credit markets to raise capital, so a credit crunch shouldn't hurt them much - if anything it may be beneficial because it would limit competition for deals. There's been a lot of volatility in the share price lately, so it's been a good candidate for trading and has provided opportunities to steal shares with lowball limit buys, both in the SLO and in real life. Nearly all the assets are start-up company debt or equity, so this isn't a risk free investment by any means. However, management seems to know what they're doing and there's no sub-prime mortgage paper or housing exposure.

Portfolio notes

For the week, I did a little trading around the edges in Prospect Capital and took advantage of the run on Friday to scale back my overweight position in Global SantaFe a bit. That leaves Cisco as the only stock over 10%, and I'm comfortable seeing if it'll run before lightening up. That leaves me at about 6% cash, I'm debating whether to add a new stock or two to the portfolio or distribute among current holdings. Going to try practicing a little patience this time and see what the market offers.

P.S. I found an alternate way to get to SLO blogs. They also show up in the Marketocracy forums under InvestorPlace Blogs, not Strategy Lab Open Blogs. I tried a test and it looks like you can post replies in the forum, but they don't transfer over to the blogs. Now, I need to go get a life.

Disclosure: I have positions in RPM, WFC, T, CVX, PSEC and CSCO.

Comments: View Comments |  Saturday September 1, 2007