Wednesday, July 7, 2010

Large Cap Valuations/ISM Services/BOUGHT VZ at $26.74/Bought 100 MLPI at 25.9/Robert Prechter

Robert Prechter was interviewed for a NYT article and repeated his opinion that the DJIA would fall to below 1000. He recommends that individuals hold cash or cash equivalents for years to come. He did not recommend buying a goat and a shotgun, with a lifetime supply of shells. For anyone who actually believes in Prechter's forecast, you may want to get out of debt completely, buy that goat, load up on a bunch of weapons and learn how to use them, buy some good farmland, and lastly learn how to plant and grow your own crops. Personally, I do not own a firearm, preferring a good solid Louisville Slugger autographed by Frank Robinson. I do not have any debt, and I own more than enough land to grow my crops. As to the goat, I will wait for the DJIA to fall below 6000, the neighbors may complain about adding goats and chickens here at HQ, though my next door neighbor has a dog that resembles a small black bear and probably eats like one-a Newfoundland.

I thought that the California state government was the most dysfunctional in the U.S. I was wrong. Illinois is worse. A story in NYT focuses on how Illinois is unable to pay its bills and unwilling to cut spending or to raise taxes. Illinois has about 5.01 billion in overdue payments. The state pension system is the most underfunded in the nation.

Another article in the NYT came to the conclusion that it would be cheaper to live in a coop apartment valued at $675,000 than a home in New Jersey costing $595,000. One major cost difference was the NY homeowner had to pay $1361 per month in property taxes (under "multimedia" click "comparing the costs"). That equates to $16,332 per year. I have been complaining about the increase on my house to over $2000 per year, and there is no state income tax on earned income.

I was also struck by the size of the house and lot in New Jersey, pictured in that NYT article, that cost almost 600 grand. It is a different world. The picture above is a new house built near HQ on an acre of land that would cost about the same or less. King's Crossing Floorplans King's Crossing - Photo Gallery

1. Large Caps For 10 Times Earnings: Andrew Bary highlighted in his Barrons column the undervaluation of America's largest and best known companies, pointing out that 13 of the top 25 companies in the S & P 500 now sell for 10 times or less 2011 estimated earnings. He references IBM, Intel, Microsoft, AT & T, Bank Of America, Exxon, and Hewlett Packard. I have already developed a strategy based on the same observations, aptly dubbed last May as the Large Cap Valuation Strategy-A New Long Term Strategy. In Item # 3 to that post in May, I discussed several of the same companies mentioned by Bary, including IBM. I also mentioned in that post JNJ and Medtronic. I have included the recent purchase of Novartis, a Swiss firm, as part of that large cap valuation strategy. The consensus estimate for NVS is $4.79 in 2011 and the price is currently around 10 times that forward estimate. I currently own MDT, INTC, GE, JNJ, NVS, MSFT, T, and XOM. I bought last week Conoco which also fits into this same theme. Bought 50 COP at 48.75/Bought 50 REPRB at 20.19/Bought 100 BAB at 25.98/Bought 40 GE at 13.88

He also mentions that another 25 companies almost made the 10 time earnings cut, and that list included Cisco, JNJ, Wal-Mart and General Electric. I recently bought 50 shares of CSCO as part of the large cap valuation strategy along with re-initiating a nibble in Microsoft. I added to my GE position last Friday. And, although I do not own shares in WMT, I discussed a purchase of WMT shares as being consistent with this strategy in Item # 1 WMT.

However, I recognize that the market does not care now whether or not it makes any sense whatsoever that these large blue chips are selling between 6 to 12 times forward earnings. In the post referenced above discussing WMT, I mentioned that it would not be surprising to see WMT fall to less than 10 times earnings. This is part of a natural progression of a long term bear market. By natural progression, I am referencing the gradual multiple compression that occurs over the course of a long term bear market as earnings continue to increase.

The Masters of Disaster who were eager to buy Cisco at 150 times pro forma earnings will not touch it now at around 12 times estimated earnings for its fiscal year ending in July 2011, just as an example of this group think process. CSCO: Analyst Estimates for Cisco Systems, Inc. Although I do not remember the precise numbers from 1982, the same kind of valuations were in place prior to the start of the long term bull market which began in August 1982.

Since I have noticed this phenomenon of multiple compression at the tail end of the long term secular bear market which started in the mid-1960s, it naturally follows that I am interested in waiting for the multiple compression to drive the multiples down to around 10 before initiating long term positions. And then I would lighten up when the earnings continue to expand and the multiples increase to over 20, and even eliminate the positions when and if multiples on these large cap stocks reach the clearly bizarre levels of late 1990s.

Some of the large cap companies will start to wither over time for one reason or another. From the late 1960s, companies that were then considered blue chip are no longer so regarded by most investors particularly those that have bankrupted or are among the living dead. Examples would include General Motors, U.S. Steel, Eastman Kodak, Citigroup, Wachovia, Lehman Brothers, Bear Stearns, Fannie Mae, Freddie Mac or Xerox. Maybe Microsoft will be added to that list in the a decade or two. The flop on the "Microsoft Kin" phone is about what I would expect. So, an investor has to realize that yesterday's blue chip may be tomorrow's dog.

2. ISM Services: The ISM service sector index released yesterday was slightly lower than expected at 53.8, a drop from the 55.4 reading in May. ISM The consensus was 54.5. This continues a trend in recent economic reports of a slowing economy that is still growing. The employment component fell to 49.7 and new orders declined from 57.1 to 54.4. Once there is a reversal in a trend, and the recent data shows a decline, there is unfortunately a tendency among many humans to forecast a continuation of the new trend until the end of days.

3. BOUGHT 100 Verizon (VZ) at $26.74 (see Disclaimer): With the VZ shares yielding over 7% at my cost, it is hard for me to see much down side in the shares. It is difficult now to find long term investment grade bonds rated A or higher yielding that much, and their interest payments are taxed at my highest marginal rates. I mentioned in a post from last Saturday that I would buy the VZ shares back which were sold last July at $31.64.

While some believe that VZ may be selling IPhones after AT & T's exclusivity ends, whenever that might be, yesterday's purchase was not based on that possibility. For one, it does not appear to me that AT & T's share price has benefitted from having exclusive rights to the IPhone. The IPhone was introduced in June 2007. On 6/29/2007 AT & T closed at $41.5 and is now struggling to move and to stay above $25.

I have noted in prior posts analyst ruminations on the impact to AT & T when and if it loses exclusivity. Item # 2 VZ T ; Item # 7 VZ, see also Barrons from last November. A recent discussion of whether VZ will get the IPhone is discussed in this video from TheStreet TV.

Possibly, Verizon's stock would perform better if and when it receives the right to sale the IPhone, but I would not make a decision to buy based on those possibilities. My thinking on this purchase is simple. When I start at a 7+% yield, I will need only a 80 cent per share appreciation in price after commissions to realize a 10% annualized return in one year. My sights are set low for VZ. The stock is ex dividend today.

4. Bought 100 of the ETN MLPI at 25.9 (see Disclaimer): MLPI is an ETN from UBS and is a senior debt obligation of UBS. I am therefore exposed to the credit risk of UBS when purchasing this ETN. UBS E-TRACS Alerian MLP Infrastructure Index - UBS Investment Bank MLPI attempts to track the Alerian Master Limited Partnership infrastructure index. The expense ratio is high at .85%. There are two similar ETNs: AMJ an ETN issued by JPMorgan Chase Capital XVI and MLPN from Credit Suisse Group. All of these ETNs have the same expense ratio of .85%. According to what I have read, the distributions are reported on a 1099 rather than a K-1 so hopefully I will avoid the hassle of filling out the K-1 form at tax time which was one of the reasons for selling LINE recently. Sold 100 LINE at 25.90 All three of these ETNs are discussed in articles found at Seeking Alpha and TheStreet.

Distributions are paid quarterly by MLPI, and the current rate is 39 cents: UBS AG (Jersey Branch), MLPI Stock Quote This gives me about a 6% yield at a total cost of $25.9. This is a link to a fact sheet on this product provided by UBS: Alerian_factsheet.pdf

This is a low expectation, placeholder type of investment.

The top 10 stocks in this ETN are:

Enterprise Products Partners LP
Kinder Morgan Energy Partners LP
Enbridge Energy Partners LP
Energy Transfer Partners LP
Magellan Midstream Partners LP
Plains All American Pipeline LP
Buckeye Partners LP
NuStar Energy LP
ONEOK Partners LP
MarkWest Energy Partners LP