Tuesday, April 26, 2011

Housing is “a decline” away from a double-dip

Most recent S&P/Case-Shiller Home Price Index (just released for February) indicates that we are currently at the April 2009 lows as 20 out of 21 (except for Detroit) surveyed metro areas have experienced home price decreases. This means that if we have another month of index declines, technically we’ll be in the “housing double-dip.” This doesn’t necessarily mean that we will have a double-dip in the overall economy and that U.S. GDP will decline, but growth is certainly likely to be further subdued as consumers’ confidence wanes.

Declining home prices combined with sustained high oil/gasoline prices can definitely create an environment susceptible to a substantial sell-off in equity markets in the summer/fall timeframe, depending on when evidence of this pressure on consumers will become evident to markets. It’s unclear how light summer volume will contribute to market volatility: last two summers have presented us with a largely sideways action although, oddly enough, during both there was an uptrend in May/June, sharp drop-off in early July, and strong uptrend through the fall. More likely that not this is a coincidence, but considering mounting pressure on the consumer, this sell-off could very well be triggered during the same timeframe.

Wednesday, January 12, 2011

Stock Analysis: Microsoft (MSFT) - Part 2

After going through more of a fundamental analysis in Part 1, now it's time to analyze where Microsoft stands in terms of its historical valuation versus S&P 500 and versus its own competitors.

Below is a snapshot from Morningstar.com showing how MSFT's valuation mutliples in terms P/E, P/B, P/S, and P/CF have changed over the past 10 years.


In general, you can see that it has commanded a higher P/E than S&P 500 until 2008 when it became on par with it and then even went lower. Of course, you could argue that this downward trend may continue because more and more investors have come to a realization that MSFT isn't a "growth" stock anymore. However, I would take that point and go a step further. Indeed, I think that this a transition period in terms of mutual fund ownership. My hypothesis would be that growth investors are selling off their stakes but value funds have not opened their arms to this stock yet, hence the compression in P/E multiples. With a dividend yield being a respectable 2% right now and a earning yield of 8%, this seems to be quite a value-type of a stock. It really doesn't make sense for MSFT to be valued lower than the S&P 500: its 5-yr earnings growth forecast is slightly higher (11.1%) than the S&P (10.8%), its AAA credit rating is better than 99% of other S&P stock components, its sitting on a huge cash pile, which can potentially create move value than is currently expected. And that's just the "low-hanging fruit" comparison of MSFT vs. S&P 500 (don't get me started on MSFT's superior profits margins and ROE, which even when reasonably compressed due to market pressures are still way better than your S&P 500 company) - my point is that MSFT by itself is a far better quality stock than the average S&P 500 stock, so at the very least it should trade at the same P/E as the index, if not at a slight premium. At this time, Microsoft's forward P/E is 10.5 while S&P 500 is commanding a 14.8 multiple. This would imply that if the company meets its earnings forecast, the stock would have rise by 40% just to be on par with the index in terms of the P/E multiple, which would mean that its price could reach $39-40 per share once that happens. This is not inconsistent with the fundamental analysis done in Part 1 where I came up with an intrinsic value of $41.50/share for Microsoft. In all honesty, I'm not sure how likely the company is to reach its intrinsic value in the next 12 months, but I do believe that its far more likely to trade in the $33-35/share range than in the current $25-28/share range.

Brief review of the competitive valuations (below) doesn't really tell us much either way. Again, I used Morningstar's peer information and those are the metrics they had readily available. Also, Apple, IBM, and HP weren't considered to be MSFT's peers by Morningstar, but I've added them to the lineup since Apple seems to be one of the major competitors in the consumer products segments (and of course the OS), while IBM and HP are, like Oracle, converging in the business services segment along with the Microsoft. So, P/S and P/B doesn't seem to be very telling for this industry. P/S ignores profitability, since these aren't start-ups, I'd say that's kind of important. P/B, on the other hand, would need to be adjusted for all the intangibles these companies have. In this industry, there is a huge amount of acquisitions beings done and goodwill amounts are quite substantial. Therefore, the picture is distorted there. So, we are back to the P/E ratio. In my view, the most telling point here is that only Novell, which has plenty of its own issues, has a lower P/E than MSFT. HP is close at 12.2, but that's at least in part due to the recent top management turmoil. By the way, the reason P/E listed here is higher than the one I've mentioned earlier is because Morningstar appears to be using trailing P/E in the peer analysis, while I was focusing on the forward-looking P/E in my discussion.

Competition Valuation Analysis Market Cap ($ in billions) P/S P/B P/E
Microsoft (MSFT) $245 3.9 5.2 12.0
Apple (AAPL) $308 4.8 6.5 22.2
IBM (IBM) $184 2.0 8.3 13.4
Oracle (ORCL) $157 4.9 4.6 23.0
HP (HPQ) $99 0.8 2.4 12.2
Citrix Systems (CTXS) $13 7.2 5.2 48.0
Computer Associates (CA) $13 2.9 2.4 16.0
Compuware (CPWR) $3 3.0 2.8 27.0
Novell (NOVL) $2 2.6 1.6 6.0
Average: $114 3.6 4.3 20.0

Bottom line appears to be that Microsoft is currently undervalued versus its S&P 500 in general and its industry peers in particular. Furthermore, it has mostly positive potential catalysts on the horizon - corporate upgrade cycle will boost OS and Office sales, increased adoption of the successful Windows 7, increased Xbox profitability (up seems to be the only direction it can go at this point). Even improved search market share and smartphone adaption of Windows 7 are other possible positive catalysts as they are currently deeply discounted due to previous failures. I'm definitely bullish on Microsoft, but its perennial undervaluation is definitely an obvious risk. Nevertheless, I'm convinced that positives will outweigh the negatives in this stock and that it will reach mid-30s range by the year-end at which point I would probably cash-out.

Monday, January 10, 2011

Key Reasons People Miss Buying Big Winning Stocks - "How to Make Money in Stocks"

1. Disbelief, fear, and lack of knowledge. New, unknown companies are the future super stocks.

2. P/E bias. Contrary to conventional wisdom, the best stocks rarely sell at low P/Es.

3. Not understanding that the real leaders start their big moves by selling near or at new prices highs, not near new lows or off a good amount from their highs. Investors should be buying stocks that are on the way up, just making new prices highs as they break out of a proper base or price consolidation area.

4. Selling too soon, either because they get shaken out or because they are too quick to take a profit, and psychologically having a hard time buying back a stock at a higher price if necessary. They also sell too late, letting a small loss turn into a devastating one by not cutting all their losses at 8%.