As I mentioned in my previous blog entry Carnage on Wall Street and in the March investment newsletter, it was particularly difficult to find two stocks to feature in this month’s newsletter. Amongst the stocks that I considered and then rejected were Lionsgate Entertainment (LGF) and several companies in the railroad sector.
Lionsgate is the independent Hollywood studio and distributor behind Crash, the movie that won three Academy Awards including the Oscar for best picture last year. Crash is a very powerful movie peppered with witty dialogue (the scene with the two African-American guys discussing their presence in a White neighbourhood was very amusing) and I highly recommend watching it if you have not already seen it. Lionsgate is also the studio behind the gruesome but highly successful horror franchise Saw. For additional background about Lionsgate, check out this series of blog posts by Travis Johnson of One Guy’s Investments who has extensively written about Lionsgate in the past.
Lionsgate appeared interesting to me because of its large library of movies (we will get to that in a moment), its successful model of investing in low budget movies that target niche audiences, the loyalty the company inspires in producers like Tyler Perry and the heavy demand for Crank, a fast paced action movie starring Jason Statham, which was recently released on DVD. If you really want to watch some cool Jason Statham movies, check out the British comedy movies Lock, Stock and Two Smoking Barrels (you will need a lot of patience to watch this one), Snatch (you may have to watch this one multiple times to understand what Brad Pitt and the rest of the cast are saying) and Mean Machine. But I digress.
As you can see from the article titled Fox the day after tomorrow in Fortune magazine, only 25% of a movie’s revenue now comes from box office receipts, while the bulk of revenue comes from other distribution channels such as DVDs, cable and TV. Since this statistic is from early 2006, the number representing box office receipts has probably shrunk even more as additional distributions channels such as internet downloads have opened up. Lionsgate has a large library of movies and as each new channel of distribution opens up, this library becomes even more valuable. A good example of this is the recent agreement between Lionsgate and Apple to distribute Lionsgate movies through Apple’s iTunes store.
With such an interesting story, why did I decide not to feature Lionsgate this month? While Crash was nominated for 6 Oscars and won three of them last year, Lionsgate only had one nomination this year with Deliver Us From Evil, which lost in the Best Documentary Feature category to An Inconvenient Truth. Right after Crash won those Oscars, DVD sales of the movie soared, helping Lionsgate deliver stellar results in the fiscal fourth quarter last year. I am not sure the popularity of Crank or the recent iTunes deal will help Lionsgate deliver the kind of results it did last year.
Moreover with a P/E of over 30 (before the recent decline in price), the stock appeared a little pricey. The balance sheet is also not particularly strong with $325 million in long-term debt and $365 million in “other” liabilities when compared to $49.44 million in cash and $220.72 million in long-term investments. Based on these observations and the performance of Tyler Perry’s Daddy’s Little Girl, which received a dismal rating of 2.1 stars out of 10 on IMDB.com, I decided to hold off on buying Lionsgate for now.
The rise in oil prices have lead some companies to use railroads in addition to trucking companies to deliver their goods. The resurgence of coal as an energy source has also been beneficial to some railway companies and this trend is likely to continue in the future. The companies I considered in the railroad sector were Canadian National Railway Company (CNI), Burlington Northern Santa Fe (BNI) and Union Pacific Corp (UNP) but I decided to hold off on featuring them because of general weakness in the transportation sector and a slowdown in freight volumes related to the construction business.
I am glad I was able to find our March pick, Ambassadors Group (EPAX), as an alternative to Lionsgate and the railroad companies.
Since the focus of the February 2006 edition of SINLetter was a long/short strategy as applied to closed-end funds, I looked into very few stocks as potential candidates for the investment newsletter. As mentioned in the newsletter, I came across Ireland based ICON plc (ICLR) when I noticed their strong hiring activity. I also noticed that the overall job market seemed quite strong and RCM Technologies (RCMT), a consulting and engineering company I featured in the April 2006 edition of SINLetter and blogged about in November last year had a very strong January, rising 12.85% in a single month.
Based on this, I also looked into other consulting/staffing firms like Robert Half International (RHI) and Manpower (MAN) as potential candidates for this month’s SINLetter. Robert Half has some of the best gross and operating margins in its industry and the company has been growing at a healthy pace over the last few years. The fourth quarter of 2006 was no different with the company delivering a 17% increase in profits to $75.4 million and 20% increase in revenue, which topped more than $1 billion. Full year 2006 earnings increased 19.04% while revenue increased at an equal clip of 20.06%. The company is growing organically as well as through acquisitions in this highly fragmented sector. Did I mention that the company also has a solid balance sheet?
Concerns about the economy kept Robert Half down through most of 2006 and the stock closed 2006 at pretty much the same price as 2005. I am still a little concerned about the strength of the economy but a 3.5% increase in fourth quarter 2006 GDP combined with a drop in the price of crude oil have allayed some of my fears. Robert Half did not make the cut this month because I chose to concentrate on closed-end funds but it remains high on my (ever growing) watch list.
Full Disclosure: I am still long RCM Technologies and recently interviewed with Robert Half International.
Seventeen newsletters, 34 stocks and four options later, it is certainly difficult to find two new investments each month that are likely to be winners and help us deliver the kind of returns we enjoyed in 2006.
In my quest to find the two stocks for the first investment newsletter of 2007, I considered using the Dogs of The Dow theory that we used last year to pick Pfizer (PFE) but decided against it because the 2007 Dogs of the Dow happen to be the exact set of 10 stocks that were also on the 2006 list and every single one of them posted gains in 2006. The top 5 dogs from 2006 were General Motors (GM), AT&T (T), Merck (MRK), Verizon (VZ) and JP Morgan Chase (JPM) with gains of 58.19%, 45.98%, 37.06%, 23.64% and 21.69% respectively without including dividends. Considering these gains, the stocks on the 2007 list can hardly be called “dogs”.
If I were to pick two stocks from the 2007 Dogs of the Dow, it would be Verizon (VZ) and General Electric (GE). Based on my personal experience with various cellular carriers, I think that Verizon wireless is the best carrier out there and I like Verizon’s bold plan to invest $18 billion to build out its fiber-optic infrastructure.
GE’s aircraft engines division should benefit from the large number of aircraft orders that Boeing (BA) has recently received for its new 787 Dreamliner thanks to the delayed launch of the rival Airbus 380 “Superjumbo” aircraft. GE’s water purification systems have a global market and recent interest in alternative energy sources should bode well for GE’s windpower equipment business. These three divisions are part of GE’s Infrastructure business, which accounts for 29% of revenues & 33% of operating profits.
Other than Verizon and GE, the biotech behemoth Amgen (AMGN), Yahoo (YHOO) and the fitness company that makes the Bowflex line of products, Nautilus (NLS) were also top contenders for this month’s SINLetter. However I decided to pick Alvarion (ALVR) and Diamond Offshore Drilling (DO) for all the reasons mentioned in the January 2007 edition of SINLetter.
The Bombay Stock Exchange (BSE) Sensex is approaching an all time high of 14,000 and the 3,000 point correction in May appears to have been no more than a hiccup and a good buying opportunity. However the Indian stock market has more than doubled over the last two years and has in fact more than quadrupled over the last four years. Can you imagine how nervous investors would get if the Dow (DJIA) were to rise from its present level of 12,278 to about 50,000 over the next four years? However this nervousness seems to be largely absent in India because the market has been driven higher by strong fundamentals as witnessed by the 9.2% growth in third quarter Gross Domestic Product (GDP) and burgeoning corporate profits. Infosys (INFY) reported a 44.2% jump in third quarter profits and SINLetter pick Tata Motors (TTM) posted a 43.1% increase in November 2006 sales.
India’s state controlled pension plans called “providend funds” are currently not allowed to invest in the general stock market and there is some speculation that these rules might be relaxed in the future, fueling the market higher. However at these levels I am a little concerned and hence have pared back positions in IT companies like Wipro (WIT) and Infosys (INFY) from my personal portfolio and the SINLetter model portfolio while still retaining positions in Sify (SIFY) and Tata Motors (TTM).
Looking beyond India and China, I started considering a couple of companies from natural resources rich Brazil and Chile for the December 2006 edition of SINLetter. Like India, Chile has a mandatory pension program (PDF link) but allows up to 37% of funds to be invested in publicly traded companies and surprisingly up to 20% in hedging instruments. The Chilean pension program has been a role model for the rest of Latin America and the country also has the highest nominal GDP per capita in Latin America.
Apart from benefiting from the recent run-up in commodities like Copper and Zinc, the country also has a strong agricultural industry. GDP grew 6.3% in 2005 and is expected to be a more moderate 4.75 to 5.25% in 2006. The Chilean companies I was considering were the banks Banco De Chile (BCH), Banco Santander Chile (SAN) and the airline company Lan Airlines (LFL). All three are American Depository Receipts (ADRs) that trade on the NYSE.
Another option to investing in individual Chilean companies is the closed-end fund Chile Fund (CH), which is currently trading at a 1.53% premium to Net Asset Value (NAV). While the Chile Fund distributed a very large dividend last December (and hence its dividend yield of 18.9% according to Yahoo Finance), the distribution is likely to be much smaller this year. Since I am considering buying this fund in a taxable account, I may wait until after the ex-dividend date and the corresponding drop in price to pick up this fund. But I digress.
I also considered the Brazilian aircraft manufacturer Embraer (ERJ) as a potential candidate for the December edition of SINLetter. Apart from a strong Latin American market for its aircraft, Embraer’s jets are used by regional U.S airlines like Skywest (SKYW) and JetBlue (JBLU). Embraer released its long-term outlook in November and the glimpse into Embraer’s future looks promising.
While both Embraer and the Chilean stocks looked very interesting, WisdomTree (WSDT.PK) and the red hot ETF sector were more appealing to me and I decided to let Chile simmer and cook on the back burner a little longer.
With the Dow Jones Industrial Average hitting an all time record high in October and the economy showing further signs of slowing down, finding the right stocks for the November edition of SINLetter proved very difficult. This is the reason I picked only one stock and four options instead. Two of those options, the March 2007 put on IYT and the May 2007 put on NEW have done very well, registering gains of 23% and 16.67% in just two days. The other two have not traded in the last two days but St Joe (JOE) has continued to fall.
Apart from SanDisk (SNDK), the nanotech venture capital company Harris & Harris Group (TINY) and financial services company State Street Corp (STT) were other strong contenders for this month’s investment newsletter. I considered Harris & Harris because nanotech is one of the most important emerging technologies of the future and TINY offers more of a pure play on nanotechnology than the nanotech Exchange Traded Fund (ETF) PowerShares Lux Nanotech Portfolio (PXN), which includes General Electric (GE), Hewlett-Packard (HPQ) and Intel (INTC) amongst its holdings. However with no steady stream of earnings (this is a venture capital company after all), it is hard to arrive at an appropriate valuation for TINY and the stock price is likely to be driven by overall market conditions in the short-term. Since I believe the market has more downside risk in the near future, I decided to let TINY lounge on my watch list for a little while longer.
With the growing popularity of ETFs, assets under management have been steadily growing to reach a total of $363 billion in September 2006. Assets under management grew $10 billion in August and another $4 billion in September. In addition to its various business units that serve institutional investors, I was attracted to State Street (STT) because it is also one of the largest providers of ETFs. After launching the first ETF called the SPDR 500 (SPY) in 1993 and the DIAMONDS Trust (DIA) in 1998, State Street was not as active as Barclays (BCS) or PowerShares in coming out with new and innovative ETF products. However State Street launched a set of 9 new ETFs last year and is also the provider of the streetTracks Gold Share (GLD) ETF that was mentioned in last month’s SINLetter. This shift of assets from mutual funds to ETFs will prove beneficial for State Street but with a P/E of over 20 and a dividend yield that is not even a third of what Barclays offers, I decided to let State Street join TINY on my constantly growing watch list.