Glance at the Dow

I decided to put together a list of the Dow Jones Industrial Average and see how our valuation formula values each component.  I’ve listed the result below.  I also ran the test for each component to determine if it would pass our list of guidelines for the defensive and enterprising investors and calculated how the current price compares to the valuation.  Please note that by no means do we ever make any recommendations to buy or to sell and take a moment to read our disclaimer while you’re at it.

Dow Component Symbol Defensive Enterprising Value Price
3M MMM No Yes $137 $76.51
Alcoa AA Yes Yes $85 $36.60
American Express AXP No No $60 $41.53
American International Group AIG Yes Yes $15 $42.88
AT&T T No Yes $68 $35.01
Bank of America BAC Yes Yes $68 $36.74
Boeing BA No Yes $135 $76.60
Caterpillar CAT No Yes $172 $69.84
Chevron Corp CVX Yes Yes $284 $85.26
Citigroup C Yes Yes n/a $20.91
Coca-Cola KO No Yes $54 $58.85
DuPont DD No Yes $104 $45
ExxonMobil XOM No Yes $233 $82.49
General Electric GE No Yes $46 $32.23
General Motors GM No No n/a $21.96
Hewlett-Packard HPQ No Yes $71 $47.31
Home Depot HD Yes Yes $61 $25.88
Intel INTC No Yes $34 $20.07
IBM IBM No Yes $154 $113.94
Johnson & Johnson JNJ No Yes $66 $61.51
JPMorgan Chase JPM Yes Yes $130 $37.56
McDonald’s MCD No Yes $46 $52.27
Merck MRK No No n/a $41.75
Microsoft MSFT No Yes $35 $27.87
Pfizer PFE Yes Yes $47 $21.35
Proctor & Gamble PG No Yes $98 $65.80
United Technologies Corp UTX No Yes $109 $67.49
Verizon Communications VZ No Yes $63 $35.08
Wal-mart WMT No Yes $65 $49.90
Walt Disney DIS Yes Yes $63 $30.76

You’ll notice that a great deal of these are significantly undervalued currently according to our formula.  This is evidence that quantitative studies are only part of the requirements of prudent investing.  The intelligent investor must also take into account management styles and determine the likelihood of the market eventually meeting the estimated value.

InvestorGuide Stock Helper

Tom Murcko and the rest of his team at InvestorGuide.com recently created what they call their "Stock Helper" investing tutorial.  It is worth checking out at http://www.investorguide.com/stock-help.cgi

 The Stock Helper includes 10 steps to investing, though it appears that the 10 steps are also subdivided into about 10 steps each, but that is the case in real world investing.  There are 10 basic steps that can conceptually be done but when you put it into practice it often turns into 100 steps for each purchase. 

 Overall the Stock Helper seems to be a good tool for the average investor; However, we disagree with some of the methods that are mentioned and each individual investor should always learn about the actions and strategies they are considering prior to implementing them.  For example, the strategy of picking stocks at their 52 week high or low is mentioned.  As a purely technical analytical strategy, this may not be the best idea for most investors – in fact it is not the best idea for any investor in our opinion!  Each company must be analyzed thoroughly before purchase and it has been proven that most companies that are trading at their 52 week high are likely to drop from that high.

We were disappointed that the authors mentioned Benjamin Graham in the same paragraph that they were talking about using a technical analysis method, but we were pleased that the greatest investment mind of all time was included in the guide. 

Anyway, you all may enjoy reading the InvestorGuide.com Stock Helper.

Industry Review: Railroads

Industry Review:  Railroads

The last couple of weeks we have looked at eight different companies within the railroad industry.  Here, we look to present a summary of those reviews and directly compare the companies through common-sized statements.

Specifically, we looked at: 

Monday, January 8 – Jon – Burlington Northern Santa Fe (BNI)
Tuesday, January 9 – Ben – Union Pacific Corporation (UNP)
Wednesday, January 10 – Jon – Kansas City Southern (KSU)
Thursday, January 11 – Ben – Providence & Worcester Railroad Co (PWX)
Monday, January 15 – Jon – The Greenbriar Companies (GBX)
Tuesday, January 16 – Ben – Genesee & Wyoming Inc. (GWR)
Wednesday, January 17 – Jon – Canadian National Railway (CNI)
Thursday, January 18 – Ben – Norfolk Southern Corporation (NSC)

 

BNI

UNP

KSU

PWX

GBX

GWR

CNI

NSC

Defensive?

No

No

No

No

No

No

No

No

Enterprising?

Yes

Yes

No

Yes

Yes

No

Yes

Yes

Valuation

$67

$95

$26

$18

$31

$34

$71

$47

Current Price

$77.25

$95.25

$30

$19

$26.50

$26.50

$44

$52

 Here is a look at the common-sized Interim Balance Sheet for all of the companies:

 

BNI

UNP

KSU

PWX

GBX

GWR

CNI

NSC

 

9/30/2006

9/30/2006

9/30/2006

9/30/2006

11/30/2006

9/30/2006

9/30/2006

9/30/2006

Assets

 

 

 

 

 

 

 

 

Cash & ST Investments

0.27

1.98

2.64

2.08

1.57

21.78

0.25

3.09

Receivables (Net)

2.53

2.12

7.64

4.04

13.43

10.23

4.56

3.95

Total Inventories

1.47

1.17

1.78

1.79

25.59

1.06

0.9

0.61

Prepaid Expenses

Other Current Assets

1.91

4.53

0.83

0.35

0

1.7

0.82

0.88

Current Assets – Total

6.18

6.5

12.89

8.27

40.59

34.77

6.54

8.53

 

 

 

 

 

 

 

 

 

Investment In Unconsolidated Subsidiaries

2.33

0

0.41

5.03

Property Plant & Equipment – Net

87.13

89.75

53.77

91.73

38.66

49.53

89.16

80.72

    Property Plant & Equipment – Gross

118.23

    Less: Accumulated Depreciation

28.48

Other Assets

6.69

3.75

33.35

0

20.76

15.29

4.3

10.75

    Intangible Assets

30.29

0

17.37

14.35

4.3

Total Assets

100

100

100

100

100

100

100

100

Liabilities

 

 

 

 

 

 

 

 

Accounts Payable

9.14

1.83

4.06

2.84

20.29

9.15

4.5

ST Debt & Current Portion of LT Debt

2.37

1.08

4.24

0

19.43

1.49

0.67

1.86

Other Accrued Expense

2.33

7

1.02

1.02

3.04

Income Tax

0.74

0

7.75

1.05

Other Current Liabilities

0

2.56

1.15

0

0

0

7.67

1.02

Current Liabilities – Total

11.51

8.53

16.46

3.86

40.75

21.42

8.34

8.43

 

 

 

 

 

 

 

 

 

Long Term Debt

21.02

18.3

33.98

0

33.78

20.87

22.77

23.64

LT Debt Excl Capitalized Leases

21.02

18.3

33.98

0

33.78

20.87

18.97

23.64

Capitalized Lease Obligations

0

0

0

0

3.81

Deferred Taxes

25.71

26.34

6.44

12.56

3.8

6.51

21.54

25.33

    Deferred Taxes – Credit

25.71

26.34

9.6

12.56

3.8

6.51

21.54

25.33

    Deferred Taxes – Debit

3.16

Other Liabilities

9.57

6.21

5.97

8.7

1.09

6.03

6.5

5.73

Liabilities – Total

67.8

59.39

62.85

25.12

79.42

54.83

59.15

63.13

Shareholders’ Equity

 

 

 

 

 

 

 

 

Non-Equity Reserves

0

0

0

0

0

0

0

Minority Interest

0

0

2.28

0

0.11

0

0

0

Preferred Stock

0

0

9.49

0.03

0

0

0

0

    Preferred Stock Non-Redeemable

0

0

9.48

0.03

0

0

0

    Preferred Stock Redeemable

0

0

0.01

0

0

0

0

Common Equity

32.2

40.61

25.39

74.84

20.47

45.17

40.85

36.87

    Common Stock

0.02

1.9

0.02

2.39

0

0.04

1.61

    Capital Surplus

22.05

10.82

2.58

32.34

6.73

16.63

4.77

    Other Appropriated Reserves

    Retained Earnings

29.17

29.72

22.79

40.11

13.78

30.36

30.9

    Less: Treasury Stock

18.38

1.2

0

0

2.19

0.08

Total Shareholders Equity

32.2

40.61

34.87

74.88

45.17

40.85

36.87

 

 

 

 

 

 

 

 

 

Total Liabilities & Shareholders Equity

100

100

100

100

100

100

100

100

 

 

 

 

 

 

 

 

 

Common Shares Outstanding

359,060,000.00

275,962,961.00

75,832,354.00

4,531,072.00

15,971,000.00

41,536,943.00

517,700,000.00

396,891,872.00

And the common-sized Income Statement of all the companies:

 


BNI

UNP

KSU

PWX

GBX

GWR

CNI

NSC

 

9/30/2006

9/30/2006

9/30/2006

9/30/2006

11/30/2006

9/30/2006

9/30/2006

9/30/2006

Income Statement

 

 

 

 

 

 

 

 

Net Sales or Revenues

100

100

100

100

100

100

100

100

Operating Expenses – Total

Cost of Goods Sold

44.68

29.15

40.68

49.23

85.14

55.19

45.63

25.99

Selling, General & Admin Expenses

24.75

29.15

23.36

15.07

6.94

16.15

47.05

Depreciation, Depletion & Amortization

7.21

7.81

9.07

8.86

3.05

6.15

8.03

7.86

Other Operating Expenses

0

15.01

8.3

15.89

0

4.25

3.74

-10.78

Operating Income

23.36

18.88

18.6

10.96

4.86

18.26

42.6

29.88

 

 

 

 

 

 

 

 

 

Non-Operating Interest Income

Interest Expense On Debt

3.17

2.99

10.18

0

3.22

3.03

4.14

5.01

Pretax Equity In Earnings

0

0

0

0

0

0

Other Income/Expense – Net

-0.25

0.55

1.92

6.54

-0.2

11.28

-0.5

1.71

Interest Capitalized

Pretax Income

19.93

16.44

10.34

17.49

0.95

-1.85

37.96

26.58

 

 

 

 

 

 

 

 

 

Income Taxes

7.54

5.9

3.54

5.59

0.24

-7.58

12.87

9.19

Minority Interest

0

0

0.05

0

0

0

0

0

Equity In Earnings

0

0

0.77

0

0.04

0

0

0

Income Before Extraordinary Items & Discont’d Ops

12.39

10.54

7.58

11.91

0.76

-9.44

17.38

Discontinued Operations

0

0

0

0

0

0

0

0

Net Income Before Extra Items/Preferred Div

12.39

10.54

7.53

11.91

0.76

-9.44

25.09

17.38

 

 

 

 

 

 

 

 

 

Extr Items & Gain(Loss) Sale of Assets

0

0

0

0

0

0

0

0

Net Income Before Preferred Dividends

12.39

10.54

7.53

11.91

0.76

-9.44

25.09

17.38

Preferred Dividend Require

0

0

1.18

0

0

0

0

0

Net Income to Common Shareholders

12.39

10.54

6.95

11.91

0.76

-9.44

25.09

17.38

 

 

 

 

 

 

 

 

 

EPS Incl Extraordinary Items

0

0

0

0

0

0

0

0

EPS – Continuing Operations

0

0

0

0

0

0

0

0

Dividend Per Share

0

0

0

0

0

0

0

0

Common Shares Used to Calc Diluted EPS

9.31

6.83

22.03

59.21

6.49

29.41

26.76

17.13

 
In the next couple weeks, we will look at the Department Stores Sector.  Please come back for the following articles:

Monday, January 22 – Jon – Bon-Ton Stores, Inc. (BONT)
Tuesday, January 23 – Ben – Dillard’s, Inc. (DDS)
Wednesday, January 24 – Jon – Federated Dept. Stores, Inc (FD)
Thursday, January 25 – Ben – Gottschalks, Inc – (GOT)
Monday, January 29 – Jon – J.C. Penny Company – (JCP)
Tuesday, January 30 – Ben – Kohl’s Corporation (KSS)
Wednesday, January 31 – Jon – Saks Inc (SKS)
Thursday, February 1 – Ben – TJX Companies, Inc (TJX)
Monday, February 5 – Ben – Industry Review & Introduction of Next Industry

Macroeconomic Review and Outlook: Issue I

Population Growing?  Think again.

A common belief today is that our world is becoming increasingly overpopulated and that the world’s population will become an intensive burden on the human species.  This theory was initiated by Reverend Thomas Malthus in An Essay on the Principle of Population, first published in 1798.  Malthusian theory is essentially an exponential growth model based on a constant rate of compound interest (growth) applied to the world’s population.  The primary issue at stake was not whether the population would grow exponentially, but that the food supply was growing at a constant, linear rate.  Using simple mathematics, it can be seen that if the population in fact grew exponentially while food supply grew linearly, there would eventually be a food shortage.

The Malthusian model seems to have held true from antiquity to about 1950, at which time population trends started to change.  Since then, population growth has slowed due to dropping fertility rates.  In order for a population to naturally replace each individual, a fertility rate of 2.1 births per woman must be achieved.  Clearly, a couple must have two babies to replace the members of the couple, and the 0.1 accounts for babies that experience infertility, early death, or choose to not have children of their own.  (Lomborg)

Examining the trends in fertility rates over the last 50 years leads one to the conclusion that the rates drop as a nation becomes more developed.  It is theorized that this is because of the rise in costs of childcare while the economic benefits of raising children falls.  We no longer need to raise 5 children in order for 3 to survive long enough to care for ourselves when we are no longer physically independent.  Families tend to do a cost-benefit analysis (consciously or subconsciously) and determine that 1-2 children is the most beneficial.  As a result, it is reasonable to expect that fertility rates will continue to drop on a worldwide level as the underdeveloped nations become more developed (a trend that is, in fact, occurring). (Lomborg)

All in all, if the current trend holds true, the UN estimates that the world population will stabilize around 9 billion people in 2050 (while continuing to grow at a very slow pace).  If the rate of decline in fertility increases, the world’s population will peak at about 7 billion in 2050 and then begin declining.  Essentially, this all means that our frequent belief that the world is becoming overpopulated is untrue and the Malthusian theory does not hold true.

Europe currently holds many of the world’s lowest fertility rates (not surprising, given our earlier discussion of the relationship between fertility rates and economic development).  According to the CIA, Spain and Italy have a fertility rate of 1.28 births per woman, Greece 1.34, Germany 1.39, Switzerland and the United Kingdom 1.66 and the European Union as a whole is at 1.47.  With less children being born and longer life expectancies, it is a very real concern that the region will be relying on fewer and fewer workers to support the elderly.

In fact, the population aged 15-64 in Europe is expected to decline to 375 million from about 500 million by 2050 while the population over 65 will increase from 115 million to 180 million.  Furthermore, the population over 80 will increase from 25 million to 62 million!  Illustrated another way, the median age of European residents will rise from 39 years old today to 47 in 2050. (UN Database)

This change in population makeup will have serious consequences.  Specifically, two possible scenarios can be foreseen:

1)Tax rates across Europe will have to rise significantly to cover the rising costs of providing healthcare and pensions to the elderly; or,

2)Benefits provided to the elderly will have to fall, causing families to have a higher expense to care for their own relatives.

In the next issue of Macroeconomic Review and Outlook (next week), we will look in detail at both of these scenarios and possible investment strategies to deal with them.

Sources:

Recommended Reading:

Company Review – Costco Wholesale Corporation

Company Profile: Costco Wholesale Corporation (COST)

Costco Wholesale Corporation (Costco) operates membership warehouses that offer a selection of nationally branded and private-label products in a range of merchandise categories in self-service warehouse facilities. The Company buys the majority of its merchandise directly from manufacturers and routes it to a cross-docking consolidation point (depot) or directly to its warehouses. Costco’s depots receive container-based shipments from manufacturers and reallocate these goods for combined shipment to its individual warehouses, generally in less than 24 hours. As of September 3, 2006, the Company operated 487 warehouses, including 354 in the United States and four in Puerto Rico, 68 in Canada, 18 in the United Kingdom, five in Korea, four in Taiwan, five in Japan and 29 warehouses in Mexico (through Costco Mexico, a 50%-owned joint venture).
 

Business and Management Review

1) Is the business simple and understandable?

Costco is in the business of selling wholesaled goods to consumers at discounted prices over department stores. The company buys the merchandise from the manufacturer at a significantly lower price due to the volume of purchase. They then pass along the savings to the consumers who must pay a membership due(s) in order to shop from the “club”. The concept behind the business is to sell in extremely large volumes due to the low item by item margin.

2) Does the business have a consistent operating history?

Over the past five years, Costco has experienced overall positive growth even during periods of extensive expansion of the company. Earnings have fluctuated somewhat during key years of heavy expansion; however, we feel that this is necessary for the company to continue to be the powerhouse wholesaler they currently are.  

3) Does the business have favorable long term prospects?

The main competitor for Costco is Wal-Marts’ Sam’s Club division. We feel that Costco offers a greater value to their consumers and will continue to see market share increase in their favor. Costco enjoys remarkable brand awareness for a retailer and the consumer enjoys the treasure hunt atmosphere of possible savings. These factors will drive Costco to become more efficient and profitability to increase as well.  

4) Is management rationale?

We are impressed with the board of directors and the vast array of individuals it contains. We feel that the board is acting in the best interests of shareholders, and thus have management that as well is acting in the same manor. We see no reason to have concern that management is out of line in any foreseeable detail.

5) Is management candid with its shareholders?

Costco has a detailed investor relations page that has the typical detailed information one would expect from a company of this size. The page is easily found on the company’s website, and the content provided does not lack of any material information.

6) Does management resist the institutional imperative?

Given the diversity on the board of directors and the checks and balances that are in place, we see no reason to have any concern on this point. We trust that management is acting in the best interests of the shareholders of Costco.

Financial and Value Review
 

Defensive:

1) Size of firm

Costco passes the market capitalization test, with the company having a market size of over $24 billion.

2) Strong financial condition

The current ratio of the company falls below 2 at 1.22, therefore failing this test as well.

3) Earnings stability

Costco has enjoyed positive net income for the past ten years and passes this test for the defensive investor.

4) Dividend record

The company has failed to pay consistent dividends for the past ten years and fails this test.

5) Earnings growth

Costco has increased its earnings per share by one third over the past ten years, and therefore, passes this test.

6) Price to earnings analysis

The P/E ratio for Costco is roughly 22 and falls above the benchmark of 20 and as such fails this test.

7) Price to assets analysis

The P/B ratio is 2.6 and fails the test of being below 2.5.

Conclusion:

Costco fails the test of being suitable for the defensive investor with only a score of three. Although, two of the tests Costco barely failed and this should be noted.

Enterprising:

1) Strong financial condition

The current ratio is below 1.5 and therefore fails this test.

2) Earnings stability

The company has enjoyed positive net income for the five years prior and passes this test for the enterprising investor.

3) Dividend record

Currently, the company pays a dividend and passes the test of dividend payment.

4) Earnings growth

Earnings are greater than five years ago which allows Costco to pass this test.

Conclusion:

Costco passes the test for an enterprising investor with a score of 4/5.

Valuation:
Our analysis computes a fair price of $43.40 which concludes on a pure valuation approach of an overpriced security as the current market price is roughly $53.
 

Opinion:
Given the fact that the company passes the test for the enterprising investor we would allow this security to be in out portfolio, but given the inflated share price at this time we would wait for a more attractive price. An approximate ten percent decrease in share price would be place Costco in a more suitable position for acquisition.

Neither of us held a position in Costco at the time of publication.  Also, please read our disclaimer and Our Methods.

Please register and discuss this article in our forums.  Your comments help us mold our future articles.

 

 

Round Table Discussion Today

Our Round Table Discussion will begin today at 2:00 Central time. Please visit our forum to "watch" the discussion.

As a reminder, our participants are:

Rick Konrad – Value Discipline
Rick has been a portfolio manager of institutional portfolios for over 25 years. He is currently working with individuals rather than institutions and finds this much more satisfying and rewarding. His greatest joy outside of his family is training young people to become better research analysts.

Geoff Gannon – Gannon On Investing
Geoff leads Gannon On Investing, a value investing blog and value investing podcast influenced by Benjamin Graham, Joel Greenblatt, and Warren Buffett’s value investing model. Built upon the value investor insights of intrinsic value, margin of safety, competitive advantage, and protection of principal.

Doug McIntyre – 24/7 Wall St.
Douglas A. McIntyre is the former Editor-in-Chief and Publisher of Financial World Magazine. He is also the former president of Switchboard.com, which was the 10th most visited site in the world at the time, according to MediaMetrix. He has been chief executive of FutureSource LLC and On2 Technologies, Inc. and has served on the boards of TheStreet.com and Edgar Online. He does not own securities in companies he writes about. He can be reached at douglasamcintyre@gmail.com.

Overvalued Company of the Week – Boston Beer Company (SAM)

The overvalued company of the week is Boston Beer Company Incorporated (SAM), the brewer and seller of brands of beer including Samuel Adams. We will analyze using Warren Buffett’s approach for the Business and Management Review as well use Benjamin Graham’s model of valuation of a company.

Business and Management Review

1) Is the business simple and understandable?

     Boston Beer has a very simple and understandable business model, as they manufacture and distribute alcoholic beverages to liquor stores, grocery chains, and restaurants and bar’s.

2) Does the business have a consistent operating history?

     Boston Beer has had troubles in recent years as the influx of micro-breweries has taken a more aggressive approach in marketing their products and distinguishing themselves from the larger breweries. Regional micro-breweries where once localized, but they are quickly expanding as the American public’s preferences have changed. Boston Beer’s main product line, Samuel Adams, has attempted to distance itself from the larger beers including Budweiser and Miller Light, but more and more they are becoming synonymous.

3) Does the business have favorable long term prospects?

     With the above mentioned increased competition it seems that Boston Beer will struggle to maintain the niche clientele they have enjoyed in the past. However, if Boston Beer could begin to try to introduce variations of their signature product line they could begin to shorten the separation between them and the micro’s in the astute consumer’s mind.  

4) Is management rational?

     We feel there is an issue that the founder is still the chairman of the board as this may hamper the ability for Boston Beer to grow into a more mature company. Of course it is always favorable to have the influence of the founder to keep the integrity of the company intact, but at the same time it is common for them to think of the company as their “baby”. Also, the fact that he served as chairman and CEO up until 2001 further my thinking that Mr. Koch has problems with delegating control. We think the commercial aspect having Mr. Koch the spokesman of the company is a fabulous idea, but again we think that the company needs to clean house and bring in seasoned executives with proven track records.

5) Is management candid with its shareholders?

     Boston Beer is very candid as its main webpage is completely devoted to investor information. At first though I went to Samuel Adams webpage hoping for a link back to the corporate page, but was unable to find one. Overall, though, the company presents all facts publicly available nicely for its shareholders.

6) Does management resist the institutional imperative?

     From the above mentioned about Mr. Koch we wonder if Boston Beer is in fact falling victim to the institutional imperative. In our opinion the facts add up too heavily that, no, they do not resist this temptation.

Financial and Value Review

Boston Beer Company does not meet the criteria for either the defensive or enterprising investor. With a (see Our Methods) P/E ratio of roughly 42 we feel the company is overpriced given the earnings. With sales growth averaging a lackluster 4.57% over the past five years, as well net income growth of 6.72% we find the numbers unjustifiable for the high current share price. We further find that the company is selling for over 300% of its intrinsic value.

We would not feel comfortable paying more than $11.00/share for Boston Beer Company.

Neither of us held a position in Boston Beer Company at time of publication. Please review our disclaimer, and our methods.


Undervalued Company of the Week – BHS

The company of the week this week is Brookfield Homes Corp. (BHS), a homebuilder with operations in California and Washington.  As we did last week, we will be looking reviewing the company using Warren Buffett’s approach for the Business & Management Review.  We will also use Benjamin Graham’s overall philosophies to guide our Financial & Value Review.

Business & Management Review

1.  Is the business simple and understandable?

     Brookfield Homes is not in a complicated industry.  They are in the business of constructing homes and selling them to luxury and move-up buyers. 

2.  Does the business have a consistent operating history?

     Brookfield Homes was spun off from Brookfield Properties Corporation in January of 2003 in order for Brookfield Properties to strengthen its pure play strategy in the premium property business.  Brookfield Properties was founded in the 1920s and has been successful in the real estate industry throughout its history.  Since the spin-off, Brookfield Homes has experienced excellent growth in its operations along with virtually all other homebuilders.  Usually we would seek companies that have attained a more apparent consistency in their history, but we believe the history of Brookfield Properties must be taken into account.  Brookfield Homes is not a mere start-up that is only 3 years old – the company has a considerably longer history as a division of Brookfield Properties.

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

     The focus here is on the long-term.  Home prices may fall in the next year or so, but over the long term the company is sure to remain profitable.  As the target customer of Brookfield Homes is the upper-middle class, we believe the company has the potential to be resistant to downturns in the economy.  Also, the company’s main focus is on properties in California where the land value over the long-term is sure to continue to rise.  California will always be a location where people are driven to live – we cannot say the same with certainty for a homebuilder focused on building luxury subdivisions in North Dakota.

4.  Is management rational?

    We believe management to be rational.  The management is focused on the long-term prospects of the company and interests of the shareholders.  The company is working and planning over 7 years ahead, targeting properties and planning construction projects.  We believe this approach will benefit the company over the long-term, as management is not discouraged by the prospect of lower prices in the short-run.

5.  Is management candid with its shareholders?

     Brookfield Homes has an average to below-average investor relations website.  While all of the required information and annual reports are available, we have seen better and have come to expect more disclosure and candor with shareholders.  More messages directly from the management would be appreciated so prospective investors can get a better feel for the people they place their money in.

6.  Does management resist the institutional imperative?

    We believe the company’s management resists the institutional imperative.  However, as mentioned in the previous point, we would like to be provided with more information from the management to confirm this. 
 

Financial and Value Review

Upon our review, we find Brookfield Homes Corporation to be suitable for the enterprising investor but not the defensive investor following Benjamin Graham’s value investing strategy.  The company’s size, current ratio, and lack of an independent operating history of at least 10 years eliminate it from the defensive investor’s portfolio.  With a PE ratio (see Our Methods) of 7.11 and an ROIC of 16.10%, we believe this is an excellent investment opportunity.

We believe the company has potential to reach $52/share in the next few years.  We even find that if the company delivers a measly 5% growth rate over the long-term, its earnings should be valued at $43.

Neither of us held a position in Brookfield Homes Corporation at the time of publication.  Also, please read our disclaimer and Our Methods.

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Company of the Week – Westwood One (WON)

The company of the week this week is Westwood One, Inc. (WON), the radio communications company that provides News, Sports, Traffic, and other programming to numerous affiliates across the nation.  As we did last week, we will be looking reviewing the company using Warren Buffett’s approach for the Business & Management Review.  We will also use Benjamin Graham’s overall philosophies to guide our Financial & Value Review.

Business & Management Review

1.  Is the business simple and understandable?

     The company sells advertising space on its radio station affiliates across the nation in exchange for the programming it provides to those affiliates.  In the past this has been a simple business and though the landscape of the industry is changing, the overall business plan remains the same.

2.  Does the business have a consistent operating history?

     The company was founded in the 1970s and has grown over the last 30 years to be one of the largest radio networks.  Financially, the company has provided a positive net income for over 10 straight years, has grown its earnings per share over the last 10 years, and recently began paying a dividend.

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

     The last couple of years the company has faced an increase in competition with the advent of satellite radio and mp3 players.  The industry has changed, and so must the company’s approach.  During my research on the company, I discovered a past article from The Wall Street Journal.  The article mentions the problems the company is facing, and highlights the approach new President and CEO Peter Kosann is taking.  According to the article, “Mr. Kosann has cut around 100 jobs, recruited new executives and introduced initiatives to get Westwood onto new platforms, such as iPods and mobile phones.  But his biggest plan is simply trying to improve the programming lineup.”  We believe Mr. Kosann is right on target with his plan.  Technology has improved – the company must adapt itself to the changes, but first and foremost must ensure its programming is the best it can be.  Westwood One appears to be setting itself in position to move forward and resume its growth.

4.  Is management rational?

    As mentioned in the previous point, it appears that management is on the right track and is rational in realizing that its previous approach to the business will not entirely fly in the future.  With the significant changes in radio and music technology, the management must rethink its strategy.  The board of directors was wise to put a young sales executive at the helm of the company – an action that instantly injects youth into the company.

5.  Is management candid with its shareholders?

     Westwood One’s investor relations page on their website needs to be radically improved.  It only provides annual and quarterly reports, corporate governance information, and press releases.  In addition, the company profile page is very basic and does not provide any information that is not available on all financial resource websites.  However, the url of the investor relations page is:  http://www.westwoodone.com/pg/jsp/aboutus/aboutus.jsp

6.  Does management resist the institutional imperative?

    As the management of the company has only recently been hired, it is difficult to ascertain whether they will resist the institutional imperative.  However, we are optimistic that the management will resist blandly following the methods of fellow executives and be innovative into the future.
 

Financial and Value Review

Upon our review, we find Westwood One to be suitable for the enterprising investor following Benjamin Graham’s value investing strategy, but not suitable for the defensive investor.  The company is too small for the defensive investor, does not have a significant dividend history, and does not have a current ratio high enough for the defensive investor.  However, we find the company to have a PE ratio of 7.66, and a price to book ratio of 0.88. 

We believe the company has potential to reach $16/share in the next few years. 

Neither of us held a position in Westwood One at the time of publication.  Also, please read our disclaimer and Our Methods.

Please discuss this article in our forums.  Your comments help us mold our future articles.

 

Value Investing Weekly – Issue 2

ValueInvesting Weekly
Issue 2
August 17, 2006

We discussed last week about general ideas in value investing, Ben Graham, Warren Buffett, and the psychology of investing. This week we are going to discuss an example of personal experience regarding speculating and the downfalls of doing so.

My personal experience included a wonderful, well-known stock named Sirius Satellite Radio (SIRI). Allow me to explain how I became involved in this security and the reasons for doing so. In the winter of 2004, I began trading SIRI on a “tip” from a relative, and throughout the course of a few months, I netted a healthy return on purely trading on volume. I felt that it was easy enough to buy the stock in the morning watch it throughout the day, and maybe hold it overnight before getting out for a profit. I became confident of this strategy and before I had ever taken a course was convinced of technical analysis.

Following the signing of big profile broadcasters, most notably Howard Stern, I felt that Sirius was ripe to explode purely because of Stern’s listening base and the potential increase of subscribers. Further, I thought of satellite radio as this generation’s cable television. I personally subscribe to Sirius, and actually really enjoy the programming.  I purchased shares in the fall of 2005 before Stern’s debut in January on Sirius. Instead of following my previous strategy, I decided to go long on Sirius because of my interpretation of expected growth. Grant you at the time, and currently, Sirius was loosing millions of dollars each quarter in trying to acquire subscribers and spur growth of the company. They hired a top notch CEO from Viacom, Mel Karmazin, who had a proven record of accomplishment in terrestrial radio over the years. Everything in my eyes looked great and I was merely waiting for the profits to come rolling in.

Well they did not; I purchased Sirius for a price of $7.12/share, with the closing price of Wednesday (8-16-06) at $3.65/share. I have incurred a net loss of 48.95% over the course of roughly a year and a half. So the questions are “Jon why did you ever buy this stock in the first place, you should have just looked at the financial statements and seen what was going on?”, and “Why did you stay in the position for so long?”

To answer the first question, I fell under the spell of what I call the “speculation potion” by that I mean you place rose colored glasses on and view the potential of a company not seeing the disaster in the waiting. I was convinced that if I didn’t get in on this stock, I would regret it just as I did Chicago Mercantile Exchange (CME), Google (GOOG), and countless others. What I realize now that I didn’t then is that in investing you must develop a strategy and stay the course. Further, as we spoke in last week’s issue, you become an owner of the company, not an owner of the stock. In my mind at the time ownership ended on the screen of my Ameritrade account.

The second question regarded why I didn’t and still haven’t exited my position. This issue is purely psychological as I was adamantly against having a loss and decided to hold the stock until it recovered the losses. I am coming to terms with my poor investment decision and am ready to exit my position. It is similar to Alcoholic’s Anonymous where everyone stands and states “Hi I am_____ and I’m an alcoholic”, well I am standing up and stating that I am a former speculator and am seeking treatment. Just for the record, I by no means am comparing the two; I am merely using this example for comic relief.

Where Sirius will go in the future is beyond me or anyone else, currently their financial position is worse then ever. The ROE for fiscal year 2005 was (265)mil, and its Q2Y2006 EPS where (.87) down from (.83) the quarter prior. Every aspect of Graham’s investing strategies screams to stay away from this stock. Although sales are increasing extraordinary, because of subscriber growth (see article below), expenses rise linearly as well.

Ending, I hope that you all learn something from my painful lesson, do research, think logically, don’t expect to become rich overnight, and never trust other’s judgment and research.

-Jon

ModernGraham.com

WSJ article on Sirius 
Reuters article on Sirius
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