SINLetter - November 2006
Welcome to edition 16
of the 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 Exchange Traded Funds (ETFs)
so that you can research them
further before deciding to add them to your portfolio
or not. For those of you who are reading this and are
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month. I have provided relevant links throughout this
newsletter, but if you have any questions or comments,
feel free to write to me.
October proved to be a
strong month for all the major indices and after a gain
of almost 5.5% at one point, the SINLetter
model portfolio settled down to close the month
with a gain of 3.17%. The monthly and "since inception"
performance is tabulated below.
|Since Inception (Aug 2005)
Earnings season was in
full swing in October and a number of SINLetter stocks
reported quarterly earnings. Mattel (MAT),
which was featured in last
month's SINLetter, posted a gain of 14.87% in a
single month after reporting results that left
investors delightfully tickled and thanks to continued
demand for their new T.M.X Elmo toy. The company
managed to sell 250,000 Elmos on the first day of launch
in September and according to Toys R Us employees I
have spoken to, the T.M.X Elmo continues to fly off
Switzerland based computer
peripheral maker Logitech (LOGI)
reported the "best-ever" sales and profits in the company
history with sales up 19% and earnings up a
whopping 36%, well above analyst estimates. The company
also increased its full year forecast, which is usually
a positive signal. The stock shot up $3.16 or 14.20%
the day after results were announced and continued to
trend higher through the rest of the month. At 25.43
times this year's earnings and 20.19 times next year's
earnings, I do not find the stock grossly overvalued
and plan to continue holding half our position in the
SINLetter model portfolio while Bill
Cara waits for a pull back.
Logitech is now registering
a gain of 29.75% since we added it to our portfolio
five months ago based on the stock
split theory. Both the stocks that were selected
on the basis of this theory, have outperformed the market
by a wide margin. My decision to sell Infosys (INFY)
last month to lock in a gain of 35.21% was a little
premature as the company reported a 44.2% jump in quarterly
profits and continued its strong upward march. I am
still wary of Indian IT consulting companies based on
my outlook for continued softness in the US economy
and the high valuations that some of these companies
reported results that were in-line with analyst expectations,
posting a profit of $1.49 million or 3 cents per share
when compared to a loss of $1.34 million last year.
Revenue rose 17.9% to $30.1 million. With expectations
riding very high, the stock had run up a great deal
(up 35% from our point of entry) in anticipation of
Sify beating estimates. The stock gave up most of those
gains after reporting in-line results and is now registering
a gain of 15.78% in our model portfolio. I still find
Sify attractive and some recent initiatives such as
the launch of a new Massively Multi-Player Online Role
Playing Game (MMORPG) called A3
India and the deal
with Indian Railways to sell tickets from Sify's
cybercafes should add to earnings in the current quarter.
Sify also remains an excellent acquisition candidate
for companies like Yahoo or Google who may be looking
into expanding their presence in India. The key risk
faced by Sify at this point is a correction in the Indian
stock market, which has more
than doubled over the last two years.
The two defensive stocks
in our portfolio, Johnson & Johnson (JNJ)
and Procter & Gamble (PG),
also reported very strong earnings in October. Procter
& Gamble's 33% rise in earnings and 27% rise in
revenue is truly astounding for a company with a market
cap of over $200 billion until you realize that a large
part of that growth was not organic and was driven by
acquisitions like P&G's acquisition of Gillette
After swinging into positive
territory in the first half of October, Teva Pharmaceutical
reversed course and is now registering a loss of 5.93% in
our model portfolio. Investors did not react kindly to news
that Teva's current CEO Israel Makov plans
to retire in 2007. Management changes can have a serious
effect on a company but with Makov's decision to stay with
the company for two more years as an advisor and the favorable
conditions for generic drug manufacturers, I plan to continue
holding Teva for now. Third quarter earnings are due out on
November 7th for Teva.
After being down through
the first half of October, Gold made a strong
comeback. Gold closed the month at $607.70 per troy
ounce, a gain of $9 or 1.5%, which was also
reflected in the price of the streetTRACKS Gold (GLD)
ETF that we added to the model portfolio last month.
The current SINLetter
model portfolio is positioned well with a set of
companies that span multiple sectors, market caps and
geographic regions. However to fund the purchase of
this month's featured pick and hedge against a slowing
economy, I am going to sell half our position in Logitech
and book a profit of 29.5%.
With slowing growth in
the consumer electronics segment at Philips, I am also
going to sell our position in Royal Philips (PHG)
and book a profit of 7.1%.
Other Interesting Events:
Domestic Product (GDP) growth, a number everyone
was watching to gauge the strength of the economy, grew
only 1.6% in the third quarter following growth of 2.6%
in the second quarter and 5.6% in the first quarter
of 2006. Estimates for third quarter growth had been
2%. As mentioned in previous editions of SINLetter,
I have been forecasting a continued slowdown in the
economy or a recession in 2007. The signs pointing to
a slowdown already existed even before the third quarter
GDP number came out and I mentioned
some of these signs in the "Portfolio Readjustment"
section of last month's SINLetter. To provide further
confirmation, the consumer
confidence index dipped unexpectedly in October.
It is important to note
that with so many economic indicators out there, different
people can come to wildly different conclusions about
the economy and if Bernard Baumohl, the Director of
the Economic Outlook Group, were to be believed, the
economy is still sound and may even pick up speed next
year. I for one, beg to differ and will continue
to take defensive steps to hedge the portfolio against
a further slowdown in the economy.
The toy company JAKK Pacific
which was mentioned in the October
2006 edition of SINLetter as a competitor of Mattel
reported spectacular third quarter results with sales
jumping 27% to $295.8 million and earnings increasing
24% to $40.5 million. Investors were clearly very pleased
with these numbers, "jakking" the stock up
an astonishing 20.88% in a single day. It looks like
the toy companies are as hot as the toys they make,
if not hotter, this holiday season.
A new Exchange Traded
Fund (ETF) called PowerShares Listed Private Equity
was launched in October, which includes more than 30
U.S. public companies with investments in more than
1,000 private businesses. Based on the price movement
of two companies that I am watching closely, CMGI (CMGI)
and nanotech venture capital company Harris & Harris
I wondered if these companies were part of the PSP portfolio
and my hunch was confirmed when I looked
at its holdings. The current popularity of ETFs
as an asset management and diversification tool is clearly
driving up the price of some of their index constituents.
A relatively simple strategy that investors could use
would be to follow the filings of ETFs at the SEC and
start investing in some of the underlying constituents
of the ETF right before its launch. While some investors
are already aware of this strategy, the price movements
of CMGI and TINY lead me to believe that it is not yet
widely utilized and could still provide a window
of opportunity to nimble investors.
I am sure most of you have either
used or seen others use flash cards in digital cameras over
the last few years. The explosive growth in the use of digital
cameras and MP3 players combined with the demise of the floppy
drive has been a boon for companies that make flash cards
and Universal Serial Bus (USB) drives. Milpitas, California
based SanDisk makes flash memory cards for digital cameras,
MP3 players, the Cruzer line of USB drives and gaming cards
for use in Sony's PlayStation Portable (PSP).
So what attracted me
to this well known company that I felt was overvalued
just a few months ago? While the stock has retreated
from a high of almost $80 in January to the current
$48.10, the company has released an exciting new
line of MP3 players, acquired a key competitor
and is well positioned to benefit from the launch
of Microsoft's new operating system Windows Vista
While Apple's iPods remain
the clear leader in the MP3 market, competitors like
Sandisk and Singapore based Creative Technology (CREAF)
have been nipping at Apple's heels for years. Sandisk's
Sansa line of players have been a great alternative
to iPods for music lovers who use a subscription based
music service like RealNetwork's (RNWK)
To Go, Yahoo
Music Unlimited To Go or Napster
I personally bought a
couple of Sansa's over the last two years and could
not be happier with my player. However no player on
the market has managed to capture the "cool factor"
that has propelled the iPods to their status as a market
leader. Until now. With the release of the sleek and
highly attractive e200
series of MP3 players, Sandisk stands a good chance
of capturing market share in this highly profitable
and competitive segment this holiday season.
Beyond MP3 players, SanDisk
also stands to benefit from other emerging areas of
unveiled a 32GB flash-disk based laptop earlier
this year, which has distinct advantages over hard drives
but remains prohibitively expensive. While the possibility
of flash based laptops is a few years out, hybrid
hard drives (HDD) that combine a regular hard drive
with a 1 GB flash chip to improve performance and conserve
power are right around the corner with the release of
Windows Vista. Instead of a hybrid hard drive, Windows
Vista users can also use a feature
called ReadyBoost that can improve the performance
of the system by attaching an external flash memory
device like a USB Key. The ability to increase the memory
of a computer without having to open it up and adding
more RAM will certainly appeal to many users and is
likely to increase the sales of large USB key drives.
Sandisk has been attempting
to increase market share by significantly dropping prices
on its USB Key drives and the flash chips it supplies
to computer manufacturers. This quest for market share
along with increased R&D costs has indeed caused
a drop in margins, clearly spooking Wall Street in the
process and leading to a drop of $12.58 a share or more
than 20% on October 20th after Sandisk reported third
quarter results. While income dropped 4% to $103.3 million
from $107.4 million, revenue actually increased a healthy
27% to $1.85 billion, providing the perfect opportunity
to get into this growth stock in a moment of weakness.
With a solid balance sheet and a forward P/E of 17.24,
SanDisk could prove to be an attractive long-term investment.
SanDisk faces stiff competition from Samsung, Hynix,
Micron Technology (MU)
and Intel (INTC)
in the flash memory segment as well as Creative Technology
and Apple (APPL)
in the MP3 segment.
- SanDisk continues to benefit from the explosive
growth in the use of digital cameras, MP3 players
and USB key drives.
- SanDisk recently launched a highly attractive line
of MP3 players that work well with subscription music
services like Rhapsody.
- Windows Vista with its ReadyBoost feature and the
launch of hybrid hard drives should fuel growth in
the flash memory segment.
- SanDisk has a solid balance sheet with almost three
times the total assets to total liabilities.
- The recent 20% drop in price after the release of third
quarter results could provide an attractive point of entry.
- Net income dropped 4% in the recent quarter due
to a drop in gross margins from 37% to 32%.
- The MP3 player segment is highly competitive and
despite attempts by a large number of rivals, Apple
continues to maintain its leadership position.
- SanDisk faces strong competition from Samsung, a
company that continues to find new and innovative
uses for flash.
||Long Term Debt
Hedging The Economy Through
Preservation of capital
and risk management are two key aspects of portfolio
management as it can take many years to recover financially
and psychologically from a large loss. Risk management
can be achieved through various strategies such as diversification
across various sectors like healthcare, industrials,
technology and retail; geographical diversification
by investing in different countries and diversification
through investing in non-correlated assets (when one
asset moves up, the other is likely to move down) such
as stocks, gold, real estate and bonds. We have used
some of these strategies in the SINLetter model portfolio
but with 90% of the portfolio dedicated to long stocks,
it still remains vulnerable to the threat of an economic
slowdown or recession.
To hedge against a sluggish
economy, I have decided to add some naked put options
to the portfolio. I usually tend to avoid options as
I am not very fond of the time factor associated with
options and the possibility of a 100% loss. However
if they are used wisely, they can prove to be a useful
risk management tool. If you are familiar with options
and LEAPS, feel free to skip the next three paragraphs.
Stock options are financial
instruments that give you the right (but not the obligation)
to buy or sell an underlying stock at a pre-determined
price until the expiration date of the option is reached.
For example, if you bought Google (GOOG)
at $100 a share back in 2004 and are still holding on
to the stock after it has appreciated more than 375%,
you are most likely a very happy investor but probably
a nervous one too. To protect against a drop in Google's
stock price, you could buy an option to sell Google
for it current price of $476.39 until December 2006.
This is called a "Put" option
and for a small premium you have the right to
sell Google for $476.39 even if it drops to
$200 before the option expiration date. You can either
chose to exercise the option to sell your shares at
$476.39 or just sell the option and retain the underlying
stock (if you are convinced the drop was temporary).
The opposite of a "Put"
option is a "Call" option, which gives
you the right to buy the underlying stock at
a pre-determined price until the expiration date of
the option. For example if you think SanDisk (SNDK)
is underpriced at about $48 a share right now but would
rather not invest almost $10,000 for 200 shares, you
could consider buying a call option for SanDisk with
an expiry date of April 2007 and a strike price of $47.50
for little over $2. So even if SanDisk appreciates to
$60 in January 2007, you will have the right to exercise
your call option and buy SanDisk for $47.50, making
a tidy profit in the process. You could also just sell
the call option which would have appreciated by a few
hundred percent. For a better understanding of options
beyond this basic introduction, check out the excellent
options tutorials on the Chicago
Board Options Exchange website.
If you are like me and
do not like the short expiration dates of options (an
investment could easily go down from my purchase point
in the short-term even if my long-term hypothesis is
correct), Long-Term Equity AnticiPation Securities or
LEAPS could prove to be the right instrument as they
are options with expiry dates well into the future.
You would obviously pay a bigger premium for LEAPS but
you also have more time to determine if your investment
hypothesis was correct or not. Just like Put and Call
options, you can buy Put and Call LEAPS.
While some defensive sectors
like healthcare tend to perform well in a slow economy
or recession, stocks in sectors such as retail, travel
and transportation can be adversely affected. To hedge
our model portfolio I am going to purchase options and
LEAPS in a transportation ETF, a trucking company, a
homebuilder and a mortgage lender.
At first I decided to
just buy LEAPS Puts in the iShares Dow Jones Transportation
Average Index Fund (IYT)
as a negative call on the trucking industry but noticed
that FedEx and UPS were 11.36% and 7.3% of its holdings.
Since both FedEx and UPS have large international operations,
they may not be as adversely affected by an economic
slowdown in the US as the trucking industry. So I also
decided to buy a put option on the trucking company
YRC Worldwide (YRCW).
While investors have been dazzled by the gains in real
estate and commodities over the last couple of years,
trucking companies like JB Hunt Transport Services
and Landstar Systems (LSTR)
have quietly appreciated more than 700% and 500% respectively
over the last five years. However both JB Hunt
and Landstar have excellent balance sheets and I decided
to pick the highly leveraged YRC Worldwide instead.
To round up our put options,
I picked the Florida based homebuilder St Joe (JOE),
a company that I made a negative call on in September
2005 and that eventually decided to exit the home
building business altogether. I also decided to pick
the home mortgage lender New Century Financial Corp
a real estate investment trust (REIT) that engages in
sub-prime lending. This is an area that is likely to
face the most mortgage defaults as the housing bubble
Please note that options
are highly risky investments with the possibility of
losing your entire investment. I could also be spectacularly
wrong about the economy. Hence the amount I have invested
in these four options is relatively small. Each options
contract represents 100 shares of the underlying stock.
Every month we add the two 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 (October 31, 2006 for the November
Model Portfolio - November 1, 2006
||Number of Units
Voluntary Disclosure: I currently own shares of Airspan
Royal Philips (PHG),
Tata Motors (TTM),
VA Software (LNUX),
Suntech Power (STP),
and Mattel (MAT).
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