The Market this Week

This week the market posted significant gains on tame inflation and lower oil prices. The DJIA posted a gain of 2.6%, NASDAQ gained 5.2%, and the S&P gained 2.8%. Major individual gains on the week included Altria Group (MO), which rose 3.9% due to court rulings that investors view will give the company the needed strength to fuel its planned breakup. Also, Microsoft (MSFT) posted a 4.3% gain on the week due to plans to buy back shares under a previously announced plan (Microsoft was our stock of the week).

On Tuesday, the Producers Price Index (PPI) fell 0.3% in July, which was below expectations of a 0.2% rise. Even when factoring in energy and food prices the PPI still only managed a minimal 0.1% gain. These numbers where music to investors ears as it eased fears of overheating of the economy. Further, it re-enforced the idea that the Federal Reserve’s pause in rising interest rates will continue.

Oil was down for the week on news that the Israel-Lebanon conflict had at least temporarily ended on a cease-fire agreement. Crude was down 4.32% or $3.21 a barrel. Also, BP announced that partial use of their Alaskan pipeline was back online, which helped the decline in oil prices.

Stocks that declined this week included Wall Mart which posted its first quarterly profit decline in a decade. Dell fell 2.9% on the week on news of disappointing earnings and regulatory investigation of accounting practices.

As we make our way closer towards the mid-term elections, we can expect volatility as we have seen in the past few months. Continue to select your stocks according to Benjamin Graham’s policy of value investing looking for undervalued securities that meet your individual investing criteria. Have a productive and profitable week!

-Ben and Jon

ModernGraham.com

Using Discounted Cash Flows

One of Benjamin Graham’s greatest teachings is that when looking at the stock of a company and trying to value it, we should use the same approach as we would if we were to purchase a small business from a neighbor.  The only difference between the companies is size, so why should we as investors continually place more emphasis on the market’s speculation of stock price than the actual value?  Well, we shouldn’t.  We should only care about the intrinsic value of the company, and only purchase securities that are trading below that value.  Sounds pretty simple, doesn’t it? 

The complication comes in when we try to figure out the value of the company.  How does one go about doing that with accuracy?  Well, there are many approaches – one of which is the Discounted Cash Flow Analysis.  The idea is simple:  predict the future cash flows of the company and discount them to the present using the time value of money.  But Benjamin Graham taught us never to base our investments on predictions of the future, which are habitually wrong.

I believe that the intelligent investor can get around this prediction issue by believing another of Graham’s philosophies – the margin of error.  If you put a significant margin of error into your prediction, it becomes more reliable.  If I value a company at $35/share, but refuse to buy it unless it is trading below $26.25, I have a margin of error of 25%.  At that level I can feel more certain that I am not wrong.  

David Meier from The Motley Fool has written a nice article about using DCF, and the pitfalls against it.  The article can be found here:  http://www.fool.com/news/commentary/2005/commentary05032803.htm

Quicken.com has a very helpful tool for estimating the value of a company based on DCF.  To use it, go to http://www.quicken.com/investments/seceval/ and enter a ticker symbol.  After the evaluator comes up for the stock you enter, click on 5. Intrinsic Value.  There you can select different growth and discount rates to see how they affect the value.

~Ben

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Review of Jon’s Portfolio

Following the rules established by Ben’s portfolio, I have begun construction of my own. I am looking for approximately 15 stock’s with no more than 2 in each respected industry. Taxes will be ignored, and commissions will be $10.

American International Group (AIG) I like their business model, as insurance creates steady cash flow consistently with only periodic payout’s in claims.  Insurer domestically and abroad with a low PE and high ROE, ended 2005 with $853 billion in assets on their books, with net income over $10 billion. I purchased 105 shares at a cost of $63.01 for a total cost of $6,626.05.

Cherokee Inc. (CHKE) I was initially drawn in by the high ROIC as well dividend yield being produced by this company. There is business is the marketing and licensing of brand names and trademarks for footwear and accessory manufactures. I purchased 121 shares at $37.07 for a total cost of $4,495.47.

That ended my purchases for this week, as I will look to invest the remainder capital shortly as I find attractive companies.    

Ticker             Total Cost                   Remaining Capital

AIG                 $6,626.05

CHKE             $4,495.47

                                                            $88,878.48

 

           

 


Review of Previous Companies of the Week

Well this is the first week that we have had a previous company of the week to review, so we will be reviewing Marine Products Corp (MPX).  You can read the original write-up on Marine Products Corp. here: https://www.moderngraham.com/blog/2006/08/company_of_the_week_marine_pro.html

As of the close yesterday, the stock was trading at $8.85.  This is a 4.2% increase since we first mentioned the company (last week).  

There has been no new news on the company since we wrote about it.

We still believe Marine Products Corp. may be a suitable investment for the enterprising intelligent investor follow Benjamin Graham’s value investing strategy.

Neither of us holds a position in Marine Products Corp.  Also, please remember to read our disclaimer.

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Review of Ben’s Portfolio

Well a week has gone by since I started this portfolio.  After considering buying a few stocks today, I have decided to leave the portfolio unchanged this week.  It still is only 3 stocks – very dangerous diversification level, but I just don’t feel comfortable with any of the stocks I looked at today.  There is no reason to rush into purchases.

This portfolio will follow our modernized Benjamin Graham value investing approach, starting with $100,000 and $10 commissions.  Taxes are ignored.

The performance of the 3 stocks was pretty good this week.  They were all up.  Overall the portfolio outperformed the Dow, but not the S&P 500 this week.  I think that’s pretty good, considering I only have about 20% of the funds invested – the rest are just sitting there doing nothing.

This week’s snapshot: 

Ticker

Total Cost

Current Value

%Gain/Loss

DG $6,508.70 $6,620.25 1.71%
INTC $6,521.25 $6,806.25 4.37%
MPX $6,510.15 $6,709.05 3.06%
       
       
       
Cash   $80,458.50  
       
Total $19,540.10 $100,594.05 0.59%
       
Index Performance     Week’s Change
S&P 500     1.04%
Dow Industrials     0.47%

Company of the Week – Microsoft (MSFT)

This week I thought I’d use a little bit different approach to the company of the week.  Specifically, I wanted to bring Warren Buffett’s approach and strategy into play a little more.  So, using Robert Hagstrom’s The Warren Buffett Way, I have a list of Business and Management Tenets to consider with the company.  Hagstrom also mentions Financial and Value Tenets, but these are in essence the same as Benjamin Graham’s teachings.

Business & Management Review

1.  Is the business simple and understandable?

I believe this is a question that is dependent upon each investor’s understanding of the business.  For Warren Buffett, Microsoft probably would not pass this test, as it is a technology company and he has traditionally stayed away from technology for this very reason.  However, I feel that I understand Microsoft’s business plan, strategy, and believe it to be simple enough to be worthy of my further research.

2.  Does the business have a consistent operating history?

Microsoft has now been in business for 30 years, and has been an industry leader for over 15.  The company has not changed its approach significantly over time, but has gradually adopted new strategies and opportunities.  Overall, I believe the company has had a very consistent operating history.

3.  Does the business have favorable long-term prospects?

Long-term, I believe Microsoft will continue to be an industry leader.  Though competition is growing from other operating systems for computer servers, it is hard to imagine a world where the majority of computers do not run a version of Microsoft Windows.  The company is also pursuing other endeavors, in attempts to compete with Apple Computers (AAPL) and Google Inc (GOOG).

4.  Is management rational?

Recently, Chairman and Chief Software Architect Bill Gates announced that he will be stepping down and taking a reduced role with the company.  Current Chief Executive Officer Steve Ballmer will be increasing his control over the management of the company.  While on the surface this appears to be a change that could cause uncertainty over the future of the management of Microsoft, I believe that the approach the company is using to ease the transition will be beneficial long-term.  It is apparent that the company has been rationally preparing for this change of leadership for some time now, and Steve Ballmer’s history with the company and friendship with Bill Gates will lead to a smooth change.  You can read more about this transition in this Wall Street Journal article:  http://online.wsj.com/article/SB115405072580419987.html.

5.  Is management candid with its shareholders?

Microsoft has a very extensive Investor Relations page, located at http://www.microsoft.com/msft/default.mspx.

6.  Does management resist the institutional imperative?

I believe that the company does resist the institutional imperative.  Essentially, Buffett describes this phenomenon as when a company’s management tends to mimic the behaviors of other managers.  Microsoft in the past has tended to create its own approach to different situations, and clearly does not resist change – as evidenced by their recent announcement to enter the MP3 market to compete with Apple’s iPod.

Financial and Value Review

Microsoft has had a good financial history.  The company has had a positive net income for over 10 years, has a good current ratio, has increased EPS from 10 years ago by over 1/3, and currently pays a dividend.  Microsoft may be a suitable company for enterprising intelligent investors, but not defensive investors. 

Upon my review of the company, I have found that the company seems to be significantly undervalued, and believe there is strong potential for the company to reach $37/share within the next few years.

Jon currently holds a position in Microsoft (MSFT).  Also, please read our disclaimer.

The Market this Week

This week the market was tested by various factors that created an overall downturn. All major indices saw a decline of roughly 1% with the S&P 500 showing the lowest loss of all with a .5% loss for the week.

There were major factors that tested the market this week including the terrorist threat in Europe, rising energy costs, and continued fears of inflation. The latter two have been impacting the market for quite some time, but the former had an interesting effect on the market. The United States equity markets have become very resilient to terrorist threats and this week’s events did not change that trend. All indices produced positive gains on Thursday following the announcement in the UK that terrorist suspects had been apprehended in an apparent aviation planned attack. These events, however, had adverse effects on the airline sector still trying to recover.

Energy costs actually declined following the events in Europe as investors anticipated a decrease in air travel. The developments in the Alaskan oil fields earlier in the week, however, created turbulence that shot oil prices higher on fears of deceased supply and higher costs. British Petrolium (BP) is unsure when the pipelines will be back functioning fully, so we will have to wait and see what effect this has on oil prices, and the overall market long term.

Overall, it seems that we are stuck in the middle of fears of a slowing economy and rising inflation, but if corporate profits maintain their overall health there are still opportunities. Again, though, as value investors we are concerned with weekly events, but it does not affect our long term investing goals. We cannot be blind to current events, nor ignore them as we must continue to be as Ben Graham calls “Intelligent Investors”. Have a productive and profitable week!

-Ben and Jon

ModernGraham.com

Company of the Week – Marine Products Corp.

Marine Products Corp (MPX) is a manufacturer of powerboats.  The company was founded in 1965 under the name Chaparral Boats.  In 1986 the company was purchased by RPC Energy Services, from which it was spun-off in 2001.  Marine Products Corp immediately purchased Robalo early in 2001, and continues to operate with subsidiaries called Chaparral and Robalo.  The management is dedicated to “improvements in manufacturing efficiency, customer service, and refinement of product offerings” and has grown the company’s market share from 5.53% in 1999 to 8.7% in 2003 according to their website, http://www.marineproductscorp.com. 

A few tidbits from the company’s financial statements:

  • Total Revenue has more than doubled since 2001.
  • Net Income has nearly tripled since 2001.
  • Company has no long-term debt.
  • 5-year average growth rate in Net Income is 13.44%.
  • Current Ratio is 4.15
  • Has paid a dividend since it was spun-off in 2001.

Basic Stock information:

  • Price:  $8.49
  • PE Ratio:  13.34
  • Price-Book Ratio:  3.5
  • Market Cap:  321.47 Million
  • Dividend Yield:  2.37%

We believe this stock may be a suitable investment for enterprising intelligent investors seeking to follow a value investing strategy.  The stock appears to be undervalued, and we believe it has the potential to reach $11.58/share within the next few years. 

Neither of us holds stock in Marine Products Corp (MPX).  Also, please read our disclaimer. 

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