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SINLetter – May 2007
Welcome to edition 22 of Suria Investment Newsletter (SINLetter), a free monthly investment newsletter. The objective of this newsletter is to provide you with unbiased initial research and basic facts about individual stocks and other financial instruments so that you can research them further before deciding to add them to your portfolio or not. If you are reading this and are not a subscriber, you can subscribe by going to www.sinletter.com/subscribe.aspx and you will start receiving this newsletter from next month. I have provided relevant links throughout this newsletter, but if you have any questions or comments, feel free to write to me.
April Blog Entries:
Once again I did not get a chance to blog much in April as a new IT project took up a lot of my time. However the few blog entries that I did manage to write generated a lot of interest and comments. In case you missed them, you can check them out from one of the links below,
- Stocks That Almost Made The Cut: April 2007
- Imitation, The Best Form of Flattery?
- Hans Wagner’s Response
- Tata Consultancy Services Listing on the NYSE?
- The Elusive Subscriber Number 1,000
If you do not receive blog entries by email, you can still subscribe to receive blog entries by email here.
Announcing The Launch of SINLetter Forums:
The original goal of SINLetter was a website that would not only be a source of information and ideas but also a destination that would allow investors to interact with each other. Since we crossed the 1,000th sinner (er, subscriber) mark in March, I figured this would be the ideal time to launch SINLetter forums.
You already have an account created for you with your email address as your login name and you can retrieve your password by using the Request Your Password link from the Login page. After you login for the first time, please update your username and other information by using the Registration Details link in the control panel (top right hand corner). If you do not have the time to visit these forums regularly but would like to get updates, you can also subscribe by email or RSS feeds to specific forums or individual topics.
For more information about these forums check out the Welcome To SINLetter Forums topic.
While the SINLetter portfolio reached a new high in April with gains of 94.8% since inception, the monthly performance was not able to keep up with major indices that were rebounding off a correction that started in late February and lasted through most of March. Despite the dismal monthly performance of the entire portfolio, our April pick EMC Corp (EMC) did quite well, registering a gain of almost 10% in April. The monthly and “since inception” performance is tabulated below.
|Performance Metric||Dow||S&P 500||Nasdaq||SINLetter|
|Since Inception (Aug 2005)||22.97%||20%||15.02%||94.8%|
Since this newsletter was delayed by two weeks, instead of discussing the performance of stocks in our portfolio in this section like I usually do, I am going to discuss my thoughts about the market and my outlook for the next six months.
As the Dow Jones hits new highs almost everyday and the S&P 500 approaches its all-time high set in early 2000, it may appear that the shift to large-cap stocks that the “experts” have been expecting for months may finally be at hand. However, the Russell 2000 index, which represents the universe of small-cap stocks, is also close to its all-time high and well above its 2000 peak. While a large-scale shift from small-cap stocks to large-cap stocks has not yet occurred, there are other forces at play here.
While I am not a market pundit (it is hard enough to try and be right about individual stocks), I believe that the market is hitting new highs because of a variety of factors such as better than expected first quarter earnings, low unemployment, tame inflation that is very close to the federal reserve’s target rate of 2% and a perception that the fallout from the sub-prime mortgage meltdown has been contained. With most of the major indices reaching all-time highs in the face of a business cycle that appears to be at its peak and projections of an economic slowdown, it is not surprising that many market participants and financial bloggers have a negative outlook for the next few months.
I am currently not bullish on the market (I have been cautious since late last year as you can see from Hedging The Economy Through LEAP Puts) but remain neutral to mildly bearish. Unlike some people, I do not expect a market crash in the near future as I see none of the “irrational exuberance” that marked the peak of the dot com bubble or the recent real estate bubble. Even though the Dow is at an all-time high, it took the Dow almost 7 years to get past the record high it set in January 2000. If you take inflation and the depreciation of the U.S dollar into account, the Dow is nowhere near its previous peak in terms of “2000″ dollars. While looking up information about how much the dollar has depreciated since 2000, I came across this article that does an excellent job of explaining in great detail what I just mentioned in the previous sentence.
With this outlook in mind, I am currently bullish on the technology, aerospace, consumer staples and healthcare (devices and generic drugs but not big pharma) sectors. I am bearish on the financial, retail, auto, trucking, housing and commodity sectors. In short, I am mostly bullish on the non-cyclical sectors and bearish on the cyclical sectors. I realize that aerospace is a cyclical sector but I believe that the parts and manufacturing segment of the aerospace sector has outstanding long-term potential.
I would much rather leave the portfolio untouched at this point but unfortunately have to liquidate some positions (I do not believe in using margin) in order to purchase this month’s featured stocks and options.
Investors in the toy maker Mattel (MAT) have had a very good time over the last eight months as the toy maker posted better than expected results thanks to the hype associated with the launch of their T.M.X Elmo toy and strength in their Fisher-Price division. The stock is up almost 50% since we picked it up for the SINLetter portfolio in October 2006 and more than 80% over the last year. I am going to take profits by selling half our position in Mattel for a gain of 48.38%.
Mattel raised its dividend by 30% soon after I bought the stock for the SINLetter model portfolio and my personal portfolio. Hence my dividend yield works out to 3.25% and I plan to continue holding the stock in my personal portfolio.
The Power of Dividends:
It is a well known fact that stocks have historically returned around 10% a year from 1928 to 2006 (Excel Download), a period of time that includes the Great Depression, Black Monday as well as the recession following the dot com bubble. Expanding the period of measurement to almost two centuries from 1802 to 1991, stocks still gained 7.7%, outperforming all other asset classes such as real estate, bonds, cash and commodities like gold. According to Wharton professor, WisdomTree Investments (WSDT.PK) advisor and author of the book Stocks For The Long Run, Dr. Jeremy Siegel,
“One dollar invested in stocks in 1802 would have grown to $1,250,000 in 1991, in bonds to $6,920, in Treasury bills to $2,830, and in gold to $14.20. The consumer price index has risen by a factor of 10.4, almost all of it after World War II. One dollar invested in 1802 would have grown, in inflation-adjusted dollars, to $109,000 in stocks, $605 in bonds, $248 in Treasury bills, and $1.24 in gold.”
There seems to be consensus agreement that future returns from stocks may not be as high as in the past. Based on whom you ask, it could be as high as 9.27% or less than 6% as you can see from this very interesting article from Fortune magazine titled “9% Forever?”. Almost half of the historic returns of stocks come from dividend payouts and by reinvesting those dividends.
I learnt the importance of dividends while depositing dividend checks for my dad during my teenage years. He had mastered his cash flow from dividends to such a point where he could pay all household expenses from his dividend income. In case you are wondering, he achieved this more than a decade before he retired.
While the historical dividend yield from 1929 to 2003 was 4.3%, the current yield of the S&P 500 is just 1.5%. Before you jump to the conclusion that companies are returning less to shareholders, it is important to understand that during the first half of the twentieth century, large special dividends were more common while companies have now been favoring stock buybacks over special dividends or even regular dividends.
While this trend of stock buybacks has its advantages, I still prefer good old dividends as it establishes fiscal discipline by forcing the company to diligently manage its free cash flow and I get to decide how I want to reinvest those dividends.
If you consider dividend paying stocks as boring slow growth stocks without much potential for price appreciation consider the following facts from the recent article titled Five Great Yield Stocks from Fortune magazine,
“Through Feb. 28, the dividend stocks in the S&P 500 posted a 12-month total return, from price change and dividends, of 14.8 percent – beating the 8.3 percent return of the nondividend stocks.”
“In a recent report, senior equity researcher John Zbesko screened Schwab’s universe of 3,200 stocks and found that those with dividend yields above 2 percent that also met a series of additional criteria returned an impressive 18 percent per year, on average, from 1990 through 2006. That beats the 12 percent annualized gain of the S&P 500 and the 11 percent return of the Wilshire 5000 during the same period. In addition, Zbesko’s picks were 20 percent less volatile than the typical stock Schwab covers.”
It these facts are not exciting enough, ponder upon the fact that according to Professor Siegel, a $1,000 investment in tobacco maker Altria (MO) in 1957 would have been wroth $4.6 million by 2003. If you are like me and would prefer not to invest in tobacco companies, a $1,000 investment in Coca Cola (KO) would have still netted you a cool $1.05 million by 2003 provided you reinvested all dividends.
If you are convinced of the virtues of dividend paying stocks, what should you look for while trying to pick the cream of the crop (remember we don’t believe in the Efficient Market Hypothesis)? Given below are a few simple rules of thumb.
- Look for stocks that offer a better than average dividend yield. The average dividend yield of the dividend paying stocks in the S&P 500 index is about 2%. This should not to be confused with the average yield of the entire S&P 500, which includes both dividend paying and non-dividend paying stocks and is currently 1.5%.
- Avoid stocks that have an unsustainably high dividend yield. A very dividend yield is usually a sign of trouble unless the stock is actually a REIT (Real Estate Investment Trust).
- Look for companies that have a long track record of paying dividends.
- Look for companies that have a record of periodically increasing their dividends.
- Avoid companies that may appear to be close to the peak of their business cycle. This is extremely difficult to figure out even for investors with decades of experience.
- And finally look for companies that are selling at a discount to their peers (this goes without saying, but I figured I would mention it anyways).
Unilever Plc (UL) $32.53
From personal care products such as Dove, Vaseline, Ponds, Axe, Suave, Caress and Q-tips to food products such as Ben & Jerry’s, Breyers, Popsicle, Klondike (ice cream is definitely on my mind), Lipton, Ragu, CountryCrock, Skippy peanut butter, Knorr soups, Bertolli pasta and Slim-Fast, we have all either come across or used a product made by Unilever, the third largest food company in the world.
Maybe you live in India and have not heard of the rest of the brands beyond Dove, Axe, Ponds, Lipton and Knorr. Unilever through its subsidiary Hindustan Lever Limited, also makes the popular Indian brands such as Kissan, Bru, Brooke Bond, Hamam, Surf, Rin, Close-Up, Lux, Liril and Sunsilk just to name a few. The corporate structure of Unilever is not very straightforward with two parent companies Unilever NV in Rotterdam, Netherlands and Unilever Plc in London, United Kingdom. Our featured pick Unilever Plc (UL), is an ADR of the London based Unilever Plc.
If you find the corporate structure odd, just try to figure out the actual annual dividend of Unilever. Because various financial websites like Reuters, MarketWatch.com and Yahoo Finance were giving me different dividend amounts and yields, I decided to try and track down the annual dividend myself. As you can see from this page on Unilever’s website, the company usually declares two dividends called the interim dividend (usually paid around November) and a final dividend (usually paid the following June). For fiscal 2006, the company also paid an one-off dividend. The interim and one-off dividend for 2006 was 63.55 cents and as you can see from this article, the proposed final dividend is 32.04p or 63.54 cents. Hence the 2006 annual dividend would work to $1.27 and based on the current share price of $32.53, this works out to a dividend yield of 3.9%. Wasn’t that a fun exercise to arrive at a number that was so readily and accurately provided by Yahoo Finance.
So what made me pick Unilever at this point? I was originally interested in Nestle, the world’s largest food company, especially after its recent announcement to acquire Gerber from Swiss drug giant Novartis (NVS) for $5.5 billion. The fact that Nestle (NSRGY.PK) traded on the pink sheets did not deter me but when I noticed that Unilever’s dividend yield of 3.9% was much higher than Nestle’s 2.17% (source adr.com), I started taking a closer look at Unilever.
If you read through the Portfolio Performance and The Power of Dividends sections of this newsletter, you would realize that Unilever as a consumer staples company that also has a high dividend yield was exactly the kind of company I was looking for at this point in the business cycle. Unilever recently reported first quarter 2007 results with underlying sales growth of 5.7% exceeding both company targets as well as analyst expectations. The company does have a high amount of debt with over $11 billion in short-term and long-term debt when compared to just under $2 billion in cash and investments but it also generated $6.265 billion in income in 2006.
With improving operating margins and the company confident in its ability to meet its 2007 targets, I believe that Unilever can be a good long-term core holding in a portfolio. I would however use caution while starting a position in Unilever as the stock has already appreciated almost 40% over the last year.
“Unfortunately, Siegel doesn’t give us the names of the Chinese and Indian El Dorados so that we can supplement the meager Social Security payments and have sufficient savings to live a dignified life in old age.”
With a number of popular brands in India, both Nestle and Unilever along with the Tata group of companies could be considered the El Dorado’s of India that are easily accessible to US investors without using global index funds.
|P/S||0.44||Cash and Investments||$1.91 billion|
|P/E||18.91||Short and Long Term Debt||$11.36 billion|
Salesforce.com has been an amazing growth story over the last few years thanks to their web-based customer relationship (CRM) software that helped the company acquire 560,000 subscribers serving 26,000 companies (as of Feb 2007) over the last eight years. The company posted 75% revenue growth in fiscal 2006 and more than 60% top-line growth in fiscal 2007. So why would I consider buying put options on a company that appears to be doing so well? The problem with Salesforce.com becomes evident once you consider the growing competition and the actual income.
Ever since SEC rules required the expensing of stock options, the company has been posting disappointing earnings due to the number of options exercised by management and employees. This hurt results last quarter even though the company reported that Cisco had acquired 15,000 licenses and it branched into financial services software. The company reported earnings of less than a million ($0.516 million to be precise) on revenue of $144 million last quarter.
After looking at the number of options insiders had exercised last quarter and the earnings report from the quarter before that, I was convinced that Salesforce.com would report very low earnings while still growing top line revenue. Right before earnings were released last quarter, I bought March 2007 $45 put options. I sold those options less than two weeks later for a gain of 149%. I do not trade very often and this was an uncharacteristic trade for me. Moreover the position was highly speculative as I bought options expiring in a month and had I been wrong, I would have lost most of my “investment”. This was the primary reason I did not mention this trade in the newsletter or blog.
However as I look at the insider selling at Salesforce.com this quarter, I see the same pattern emerging and I think buying June 2007 put options would be a good play on disappointing earnings from Salesforce.com and as a hedge against a general market decline.
One could argue that Salesforce.com is sacrificing the bottom line in order to continue growing revenue at this point and that investors would be rewarded a couple of years down the line. Such a line of thinking would not only be ignoring the fact that management is willing to significantly hurt earnings through its options exercising practices and that competitors such as NetSuite could capture more market share. Even Microsoft through its Sharepoint software and Oracle through its Fusion product (when it is released) could put a dent into Salesforce.com’s growth. In case you are interested, NetSuite plans to go public sometime this year.
These put options are highly risky and there is a very good chance that we could just as easily lose our entire “investment” as make money on it. Hence I am allocating just 0.5% of the portfolio to this position.
Every month we add featured stocks into a model portfolio started with a cash position of $100,000 on August 2, 2005. To keep calculations simple, trading costs and regular dividends are not included. Prices reflect the closing price as of the last trading day of the previous month. However as this newsletter was delayed by two weeks, it represents the closing price as of May 11, 2007.
|Stock||Number of Shares||Cost||Current Value||Diff ($)||Diff (%)||Date Added|
|Option||Number of Units||Cost||Current Value||Diff ($)||Diff (%)||Date Added|
Voluntary Disclosure: I currently own shares of Airspan Networks (AIRN), Medifast (MED), Tata Motors (TTM), Logitech (LOGI), Intel (INTC), Suntech Power (STP), Teva (TEVA), Mattel (MAT), SanDisk (SNDK) and Alvarion (ALVR) as well as put options on Countrywide Financial (CFC) and YRC Worldwide (YRCW).
- Suria Investments, Inc. does not warrant the completeness or accuracy of the content or data provided in this newsletter.
- Suria Investments, Inc. does not comprise any solicitation to buy or sell securities.
- Suria Investments, Inc. will not be liable for any investment decision made or action taken based upon the information in this newsletter.
- We suggest you check with a broker or financial advisor before making any investment decisions.