Monday, July 27, 2009

Perspective 2009 - 7 /26 / 2009

Its an interesting time for market pundits. On the one hand we are in the midst of a terrific market rally. But on the other hand there is really not much to base this rally on. It is the opinion of at least one pundit that the low of this market in March represented the gamblers / speculators worst case US economy valuation, and that recent highs represent these same gamblers / speculators view of a perfect year end US economy value. What we do not have is the rush of value based institutions and I wonder, do any still exist?

More troubling, A few months back we witnessed consistent "surprise" earnings to the upside, and a resulting market surge. Talking heads stated "The economy is showing signs of improvement", "Green shoots" and other knee jerk responses. But the truth is a bit more mundane.

In March and April the earnings surprises were based upon 2 key items:

1) the standard inability for industry and market analysts to accurately predict anything at all and instead heading their statements with negativity - "It's better to miss low than miss high". This concession to their fallibility combines with their refusal to recognize that CFO's of Fortune 500's are far superior to them in managing their businesses for the benefit of market valuation, and

2) the Fed had given all banks the opportunity to operate with virtually no cost of capital. Meanwhile the failed financial sector heavily infused with low cost government capital declined to lend to any new emerging businesses, or even new divisions of established businesses in favor of refinancings to businesses which did not need the assistance and the calling of loans from companies who did. That equates to some profitability gains for established companies as interest payment go down. But no growth capital for companies or divisions that need it - more on this later.

The Fortune 500 responded to this environment through the only methods available, by cutting costs (firing hoards of folks and eliminating expansion investing) then delaying the payment of current costs (increasing payables for example) and the results nearly across the board were lower revenues but higher earnings. Of course the esteemed analysts somehow did not anticipate the bottom line results. Thus the "surprise".

However we recognized this well ahead of the pack, and began looking at the companies who use these practices as a daily business method and were thus among the first to "surprise" to the upside. Our bellwether value companies - Dell, GE - both purged themselves of costs and balance sheet losses during the market's slide, leaving themselves with only one way to go, up, based upon fully disclosed and real value. I expect many of you disagree with my position on Dell and GE citing the continued negative press that seems to circle these two giants. But amid all the negativity take a look at their trend lines since March. Why does that trend line exist? Its called value. Sure there are companies whose shares have fared better on a percentage basis. But DELL and GE are our true value players. Limited volatility, tons of liquidity, tons of cashflow and assets, and excellent financial officers and management. They are big and mature.

I'll add one opinion on GE, I do not believe that the dreaded real estate investment write down that prevents its shares from breaking out will have impact on this company's share value at its current position. And once GE has inched its way above $15.00 there will be a rebound in another GE division which will offset the effects of a writedown of real estate assets. And then while no one is looking, GE will readjust its real estate valuation to proper (lower) levels and no one but the best analysts will catch it. More importantly, no one will care.

That's how its done in the big leagues value investors. And to me it is the most important reason to be a value investor. The mature value building companies can really do have magic bullets, cash, diversification of revenues, assets, and very agile financial departments who understand how to protect the value of their equity.

Which leads us to the recent earnings reports. More "better than expected earnings". It's my belief that any Fortune 500's (save those operated by risk loving CEO's) has at least 18 months worth of stored profits or losses "hidden" in their balance sheets that can be deployed at any time to react in the best proper way to the equity markets. [PLEASE RE READ THAT LAST SENTENCE] If the S & P had been down for the recent 4 weeks instead of up, these same companies would be producing earnings that would be at estimates or occasionally below estimates citing one time charges or a lack luster quarter. Think of it this way, anyone surprise to the downside over the last 5 months - Nope. Shocking given the economic environment. But not shocking given the equity market's run.

Build Value Every Day

Bradford van Siclen

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