Thursday, October 22, 2009

Earnings from MS, AT & T, NYT, WBS, HBAN/The Floundering GE/Volatility Indexes

1. Morgan Stanley (own MSPRA only): Even after the crisis atmosphere lifted, there were still securities to buy. In late May 2009, I bought 100 of MSPRA at $12.88, a floating rate equity preferred issue with a $25 par value. Bought MSPRA RJZ & ADX/ COMMODITIES AS AN ASSET CLASS During any financial crisis, I would generally anticipate that the equity preferred stock of financial firms to be hit extremely hard. A few months earlier, the holders of Lehman preferred stock issues saw their investments go to zero. Owners of Freddie and Fannie preferred stock were sacrificed in the government's bailout of those financial institutions. So, even in May, I was buying equity preferred stocks with trepidation. The MSPRA is a typical equity preferred stock, in that it is senior only to common stock, has no maturity, and the dividends are non-cumulative, so there is a lot of risk involved in owning these securities. At a total cost of $13, however, the 4% guarantee of this floating rate equity preferred translated into a 7.69% yield. The security pays the higher of that 4% or .7% above 3 month LIBOR. At the $13 cost, the yield would increase to almost 11% at a 5% Libor rate at the time the computation is made as provided in the prospectus. And, the dividend is currently classified as qualified by Quantum: Preferreds eligible for the 15% Tax Rate Table - Since I have already received dividends in a taxable account, I will be able to confirm that classification when I receive my 1099 next year.

I have close to a $700 unrealized profit in this security, so I am sensitive to, and interested in MS news. The first question that I have to ask myself is whether MS has the ability to continue paying the dividend. After reviewing the earnings report, I am comfortable that Morgan Stanley will, at least for the currently foreseeable future. This conclusion will keep me holding MSPRA as one of those securities throwing off streams of income, which I then reinvest in other securities. No funds have ever been taken out of an investment account, other than to be moved to another investment account. Another key consideration for the owner of any equity preferred stock is continued payment of a dividend to the common stock holders. As long as that continues, the non-cumulative preferred dividend is safe. Once the common dividend is eliminated then the holders of the preferred stock are in what I call an enhanced danger of having their dividends eliminated too, or deferred in cases where the dividend is cumulative. Another factor that will lead me to keep a security is that my exposure to the firm is already small, which is the case with MS. My sole position in one of its securities is this 100 shares of MSPRA, so I would not be materially impacted even if it collapsed at some point in the future.

2. Volatility Indexes: The DJIA volatility index, VXD or ^VXD at YF, fell below 20 on October 12, 2009, closing at 19.92. As expected it was the first of the volatility indexes to fall below this important demarcation line for bullish and bearish action. It has been trending down since November when the VXD closed at 74.6 on 11/20/08. The VXD has now spent five trading days below 20, closing yesterday at 18.97 after hitting an intraday low of 17.61. The Nasdaq volatility index, VXN, and the one for the S & P 500, VIX, fell close to 21 yesterday, before reversing during the late day sell off. Continuous movement below 20 is critical under the VIX Asset Allocation model in classifying a market as sufficiently stable to make longer term investments, meaning investments that can be held, based on past historical patterns, for more than three years. I will generally require 3 months of continuous movement below 20 to classify the pattern as a Stable VIX Pattern.

3. Market Late Day Sell Off: Two events seemed to trigger the market sell off yesterday, both occurring at about the same time. Dick Bove reduced Wells Fargo to a sell. And, Wal-Mart announced a price cutting campaign going into the Christmas selling season. Hundreds of Millions of Dollars in Price Reductions I first noticed the abrupt downturn in WMT (owned). I did not think either of those events were a big deal, at least to me. I would think that WMT's price cutting campaign would bring more shoppers into the stores looking for bargains, then buying stuff that is not on sale. The nature of the price cuts are discussed in this Reuters article.

4. ING & Aegon Hybrids: For those interested in the continuing saga relating to the European Commission's burden sharing policy, the EC sent out this press release reminding those institutions subject to a restructuring aid investigation. The EC wants those institutions to consult it before making any transaction involving Tier 1 and Tier 2 capital transactions, which would include the hybrids.

5. Barton Biggs Column in Newsweek: Barton Biggs makes the case for an improving economy. His main argument is that the pessimists are underestimating the U.S. as the "greatest entrepreneurial engine ever created" He also argues that the rule of thumb valuation is for the market to sell at a P/E equal to 20 minus the inflation rate. He is using a $70 to $75 number for 2010. He believes the market is undervalued at 1060 using that criteria. So, just as an example, say you believe $75 is a reasonable number for S & P 500 earnings in 2010, and the inflation rate will be 2%, then multiply $75 times 18 and you arrive at 1350. Now, someone like David Rosenberg would not agree to using anything resembling a $75 number: Balancing Risk and Reward for Recent Bond Buys/ Abelson and Rosenberg Again and Again/Shiller on Improving Psychology/ Stock Hedge Rosenberg could never use a number like $75 for 2010 since that would undermine his bearish thesis. So Rosenberg uses $53 to further his bear arguments. That figure would yield a value of 954 under Bigg's formula using the 2% inflation rate and the $53 in operating earnings.

I thought that Biggs had an interesting point about the purchasing power of stocks over the last decade. As we all know, the return to 10,000 in the DJIA has just returned that average to a March 1999 level. Since the spring of 2000, equities have, adjusted for inflation, lost about one-half of their purchasing power. So in that sense, individuals are worse off being in equities than the raw numbers would otherwise indicate.

6. AT&T (own stock and bonds): AT & T reported earnings of 54 cents per share in the third quarter, beating expectations by four cents. Revenue fell 1.6% compared to the 3rd quarter of 2008. AT & T increased the number of its wireless customers by 2 million. The company also realized 9.7 billion in cash for the quarter and 25.5 billion year to date. Free cash flow was 5.5 billion during the quarter. There were 3.2 million new Iphone activations in the quarter with nearly 40% of the activations for new customers.

7. Webster Financial (WBS) & Huntington Bank (HBAN) (owed Lottery Ticket category): I am starting to cringe whenever I look at an earnings report from a regional bank. I am somewhat consoled by the fact that I bought just 50 shares of Webster at $4.58 in March. Buy of 50 WBS: Lottery Ticket/ LOTTERY TICKET PURCHASES: LINKS IN ONE POST WBS reported a greater than expected loss of 39 cents per share. Net charge-offs increased to 64.6 million in the 3rd quarter compared to 49.9 million in the prior quarter. Mortgage banking revenue declined by 2 million compared to the June quarter from decreased mortgage lending activity. Total non-performing loans were 361.1 million or 3.19% of total loans

Similarly, Huntington Bancshares, a more recently added LT, reported a greater than expected loss of 33 cents, due to 475 million provision for credit loss expenses. For the first nine months of 2009, the net loss was $6.08 a share. I do wonder sometimes how the banks select individuals for their top management positions. Personally, I think that the Board might do a better job just tearing some pages out of the local phone book where the bank is headquartered, paste the pages to a wall, and throw darts to select the bank's top 25 officials.

The bank LT category recognizes that the holding period will have to be long term, several selections will not work out, and possibly a few will recover in five or so years to somewhere near the prices prevalent in 2007.

8. MMM and GE: With its better than expected results this morning, plus the raise in the full year guidance, 3M stock rose over 2% in early morning trading to $79, recovering most of the decline in share price since the start of the bear market in October 2007. The hapless General Electric, floundering under numerous management miscues, is having trouble keeping its head above $15 per share, less than 1/2 of its pre-recession value and GE cut its dividend by 68% earlier in the year. MMM on the other hand raised its dividend in 2009. If I want to look at my holdings in GE common stock in a more positive light, I would just argue- to myself-that GE has more upside percentage potential than MMM at their respective current prices.

9. New York Times (owned as Lottery Ticket): I read the NYT everyday, and I may be the only resident in the SUV Capital who will admit to it. When I started my subscription, I was surprised about how efficiently the NYT handled it. I placed my request online one Saturday, and the paper was in my driveway before 6 a.m. on the next Monday.

Back in the dark days of the bear market, I was investing only cash flow during certain periods into common stocks. This necessitated a bunch of small purchases due to that capital constraint. Sometimes, I would do what I would call a scatter buy with cash flow received from interest and dividend payments, which entailed buying a small number of shares in several stocks all at once. These scatter buys have turned out remarkably well and demonstrates to me at least the wisdom of my approach. Since the amount of money was relatively small, and I was just reallocating cash flow, I did not fret too much about investing at a time when others were panicking and selling.

This is all leading up to a scatter buy on November 18, 2008. LATE DAY TRADES: GCI, CBL, FR, SLG, NYT, NWSA This was probably done with money received on the 15th. Six stocks were bought that day. Two were newspaper stocks, Gannett and the New York Times. The SLG buy was up about 50% in price before I sold it, keeping the other 25 shares bought at less than $15 which have tripled in price. News Corp has doubled in price from the purchase that day. CB & L Properties has more than doubled. Gannett has just about doubled. Prior to the last week or so, the only two disappointments has been First Industrial Realty, slightly under water, and the NYT that was up about a buck in price prior to today.

I look back at these decisions frequently to evaluate the effectiveness of the strategies employed during the bear market, hopefully to learn from that experience, and I have already concluded that the strategy worked during the worse bear of my investing life. Importantly, and this is a critical point, investing cash flow and reinvesting dividends during the bear market did not increase my anxiety. It turned out to be a successful strategy within a year after it started, and the gains certainly have beaten handily the alternative investment of cash earning near zero now. So, when the next bear rolls around, and it will, I will use the same strategy again.

All of this is leading up to the New York Times earnings report this morning which has sent the stock up over 16% in early trading. Excluding items, NYT earned 16 cents much better than expected.

10. Index of Leading Indicators: This index rose 1% in September, with 8 of the 10 indicators positive. (LEI)

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