Stock talk for the main street investor.
Feb 25 2010

Investing In ETFs May Be Dangerous

Over the last two years the ETF market has grown incredibly fast and new products seem to emerge every week. You can invest in the Case-Schiller Housing Index, India stocks, bonds, etc. But there are products anyone who is not trading these securities regularly should stay away from.

Products offering multiples of the daily movement of an underlying like oil. The problem with this is over time they will all go to zero. It’s simple math that people fail to consider. If a stock oscillates from $10 to $11 ten times and you own a 2x multiple even though the underlying has not moved at all you will have lost 16.8% of your value.

Beware when investing in these products. Always read the prospectus of any ETF carefully before buying.

Disclosure: The Mayor does not have a position in any ETFs.

Feb 23 2010

Risk In Financials

Investing in financial stocks may seem like a low risk endeavor. For hundreds of years banks have been a relatively safe investment so it would be easy to assume this will be the case into the future.

But complexity in the financial services sector has grown exponentially over the last 10-20 years to the point where CEOs of these firms have no real way of knowing the risks their companies are exposed to. If they did understand the risks Lehman wouldn’t have failed, Merrill Lynch would still be independent and we wouldn’t be in the financial mess we’re in today.

Complex products which are relatively new to the market have created much of the mess of accounting for risk. These products are so thinly traded and hard to value that only models can be used to create an accounting value. This leads to firms valuing their balance sheets with models they’ve created themselves.

The problem with this is that a model is only as good as it’s input assumptions. Like statistics, you can make a model say anything you want. If I re-modeled all financial institutions with very conservative estimates today I could make every one of them look insolvent.

The other thing that is scary with financial institutions is the way they calculate risk. Most times assuming a daily, weekly or monthly return is somehow normalized based on previous returns. This assumption puts a 1 in 10,000,000 chance that something like the housing collapse happens. The problem is, in reality these rare events happen every 5-7 years.

So are the models wrong? I don’t know, I just don’t understand them well enough to feel comfortable with their risks. Experts with years of experience have amassed incredible losses thinking they understood the risks in financial institutions. Main Street investors shouldn’t make the same mistake.

If you do need exposure to financial stocks I would stick to conservative banks like Wells Fargo or fee based asset management firms like BlackRock (BLK) or T. Rowe Price (TROW).

Disclosure: The Mayor has no position in any stock mentioned.

Feb 15 2010

What To Do With The Dollar

As the Fed discusses how to take liquidity out of the market and stop inflation from running rampant I’d like to discuss why we shouldn’t be as worried about a weak dollar as the talking heads would make us believe.

Lets start with the case for a strong dollar. When the dollar is strong we are able to buy more goods from other countries effectively benefiting from their cheap labor and natural resources. Consumption in the US goes up, imports increase, standard of living goes up, everyone is happy.

And just like every leveraged business plan or mortgage backed security this is a great plan… until it’s not. When unemployment is hovering around 10%, people are underemployed and real wages are frozen or falling we need to shift our focus from consuming more to employing more.

What we effectively do when the dollar is strong is move jobs from the US to overseas where labor is less expensive. In recent years this has pushed not only low skilled manufacturing jobs but high skill R&D, accounting, engineering, etc jobs overseas. A weaker dollar will make these moves less attractive and bring jobs back to the US where the consumption is occuring.

US multinational companies will no doubt have a different outlook. They would see profit pressures (some would see benefits) and may raise prices or have lower margins. As this is a stock blog I must admit this wouldn’t be good for the short term stock market returns. But right now I’m more worried about Main Street’s employment issues than keeping rich investors rich.

In my opinion a weak dollar would help Main Street the most, even at the expense of Wall Street. Long term though, I think it would be in everyone’s best interest to level the playing field just a little bit. For the world’s sake it is important for the US to have a strong economy and strong employment. When we don’t, everyone is a little bit uneasy.

Feb 8 2010

Blowing In The Wind – Vestas

There are very few ways to play the growing wind market. Big turbine suppliers like GE and Siemens are so large and diverse you would hardly notice if their wind units performed well. Utilities are tied to regulated power prices and power generators usually sign long term power purchase agreements with utilities before building wind turbines effectively turning them into fixed income investments.

But there is one large player in the market, Vestas Wind Systems (VWDRY.PK). Vestas manufactures wind turbines in Europe, China and the US. They have a 23% market share, according to the latest survey. Before the slowdown in 2009 the wind market grew more than 50% in the US during 2008 and at a compound rate over 35% for ten years prior.

Vestas is projecting tripling sales by 2015 and is already on par with natural gas for cost of energy. Higher oil and natural gas prices along with a requirement to capture carbon from coal plants in 2015 will drive demand for wind turbines which provide a constant cost of energy.

New technologies like off-shore wind turbines are a growing section of the market and Vestas has installed 51% of the off-shore turbines as of March 2009. They are working on a new 3MW off-shore turbine for 2011 and a 6MW turbine is in R&D. A turbine that size could power over 1,600 homes. The reason larger turbines are important is they become more efficient as their size grows.

Operationally I’m impressed in Vestas commitment to research projecting 2,000 R&D employees by the end of 2010. They have also committed to the US market by building some of their largest plants in Colorado.

All is not rosy in the wind market though. The credit crisis and low costs for traditional energy sources has hurt demand in 2009. Anticipated government actions to spur “green” development has failed to materialize and has negatively affected Vestas business. These dynamics have caused a dramatic increase in Vestas working capital and effectively hurt their cash position.

While these concerns are real I believe it is also the reason Vestas is currently trading at a reasonable P/E ratio of 12 on their full year 2008 results. When 2010 earnings are announced on Wednesday I expect that ratio to rise slightly at current prices but improving EBIT margins, sales growth and positive future economic and industry trends make this stock undervalued.

Another company to watch in the sector is American Semiconductor. They are a supplier of wind turbine parts and have major contracts in China where wind is growing extremely quickly because of government investment. I’m watching them closely but does not have a valuation as attractive as Vestas.

I have posted a link below to an article the NY Times did on China’s growing wind industry.

Disclosure: I do not own Vestas or AMSC.

Feb 4 2010

The IMAX Explosion

I can’t believe it took me this long to look into IMAX. After I went to Avatar the weekend after opening weekend and couldn’t get into the IMAX theater there should have been alarms going off in my head. A few things surprised me that weekend.

1. There are tons of 3D and IMAX movies coming out this year. Not just Discovery type movies but real box office movies: Alice in Wonderland, Toy Story 3, Shrek Forever After, The Twilight Saga: Eclipse.

2. Demand for IMAX 3D has been off the charts. Avatar had $150 million in IMAX box office revenue thru Feb 2, an astounding number for a format with under 300 commercial screens.

3. It’s still hard to find an IMAX screen. Most theaters don’t have IMAX and in some locations you have to drive hours just to find one.

What IMAX has is a unique position in a changing movie industry. They’re a component supplier to movie theaters and movie studios which are both looking for a competitive edge. IMAX helps provide that edge with screens that are in higher demand and more technologically advanced than standard screens. They’ve also been forming joint ventures with theaters which gives them upside when IMAX demands higher ticket prices and when movies perform well.

As 3D is refined and movies become more complex the experience will play a key role in consumer buying patterns. If you’re making a decision to go out and experience a movie, wouldn’t you want a the best experience possible? Even if it costs a little more? IMAX can capitalize as theaters realize new movies and customers are going to demand the best experience possible for new high tech movies.

After the Avatar experience and seeing the movies slated for this year I’m convinced theaters will be adding a large number of screens in the next few years. Probably even more than IMAX was projecting at their last presentation in May.

With a stock price of $12.30, IMAX has a high market cap right now at about $766 million on revenues of $106 million in 2008. It’s tough for me to like the stock at that price, especially since 2008 was not a profitable year. If the stock falls a little further I’d be willing to get in. Right now IMAX is trading just over a 21 forward P/E. Not terrible if they can hit their numbers and keep a high growth rate. I’m watching results and waiting for a pullback in the stock price.

Disclosure: The Mayor does not own IMAX. I do have a limit order in to purchase at $11.45.