• 03 Aug
    Why CAT’s 20% drop could be a value trap

    Why CAT’s 20% drop could be a value trap

    When you put a big part of your investing focus on bargains, emphasizing value-based fundamental analysis to determine whether a stock is worth your time and money, you inevitably end up filtering through a lot of different stocks, but cast most aside. I think that is useful, because being more selective helps you narrow the universe of stocks you’re paying attention to at any given time. The problem, however is that sometimes the metrics a value investor learns to rely on can give you a false sense of whether a stock really fits a good description of a good value. That can lead you to make an investment in a stock that might be down from a recent high because it looks like it’s available now at an attractive price compared to where it was; but in reality it’s a bit like trying to catch a falling knife – the only real way to avoid getting cut is to get out of the way and let the knife fall to the floor. These kinds of situations are also called value traps, because they provide numbers that lure less careful investors in and motivate them to make an investment at some of the most dangerous times possible.

    I think Caterpillar Inc. (CAT) is actually one of those traps right now. My opinion differs from most other analysts and “experts” out there, who point to the company’s solid earnings growth over the last year, and the stock’s decline in price since January of this year of more than 20% as reasons that investors should be treating the stock as a great value opportunity right now. They’ll also point to a popular valuation metric, a stock’s P/E ratio, as a clear indication that the stock is undervalued and something you should be paying attention to right now. I’ll admit that at first blush, I thought the stock might be a good opportunity, too; but the more I drilled down to really look at some of the other data points that are important to me, the more concerned I got.



    Another risk element that investors seem to be trying to shrug aside right now when it comes to stocks like CAT is the fact that while the U.S. seems to have found some sense of resolution – or at least a path to it – in trade with the European Union, the same can’t be said of discussions with China. Today, on top of existing tariffs that already amount to more than $34 billion against its single largest trading partner, President Trump proposed another $200 billion in new tariffs, prompting what seems like the customary Chinese response to retaliate in kind. The market’s reaction was pretty ho-hum; could it mean the investors are beginning to accept trade tension as a normal state of affairs? If they are, then I think it means they are becoming desensitized to that risk, and that is a troubling indication all by itself.

    Multinational stocks, and especially those with major operations in China, remain at risk if trade tensions continue as they are, or escalate even further. And let’s not forget that while the E.U. have, for now at least, agreed to hold off on further tariffs against each other and work toward compromise, it doesn’t mean that situation has been resolved. CAT is one of the companies that I think could be the most dramatically affected. That affect may not be showing up in earnings reports or sales numbers yet; but the risk that it will increases more and more with every week, month, and quarter that continues with trade affairs as they are. To my way of thinking, that puts something of a jaundiced eye on any currently glowing numbers. Just about every analyst report I’ve been able to find on CAT forecasts stable to growing revenues along with continued earnings growth for the foreseeable future, and under most circumstances I think that should be a good thing; but the thing that is setting off warning bells for me is that none of the reports I have found discuss trade or tariffs as risk factors.



    Fundamental and Value Profile

    Caterpillar Inc. (CAT) is a manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. The Company operates through segments, including Construction Industries, which is engaged in supporting customers using machinery in infrastructure, forestry and building construction; Resource Industries, which is engaged in supporting customers using machinery in mining, quarry, waste and material handling applications; Energy & Transportation, which supports customers in oil and gas, power generation, marine, rail and industrial applications, including Cat machines; Financial Products segment, which provides financing and related services, and All Other operating segments, which includes activities, such as product management and development, and manufacturing of filters and fluids, undercarriage, tires and rims, ground engaging tools, fluid transfer products, and sealing and connecting components for Cat products. CAT has a market cap of $82.5 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings grew by almost 100%, while sales growth was almost 24%. Growing earnings faster than sales is hard to do, and generally not sustainable in the long-term; however it is also a positive mark of management’s ability to maximize their business operations. Net Income as a percentage of Revenues also improved from about 6% for the trailing twelve months to more than 12% in the most recent quarter.
    • Free Cash Flow: CAT’s free cash flow over the last twelve months is more than $3.7 billion. Cash and liquid assets are also more than $7.8 billion, which does give the company quite a bit of financial flexibility; however these numbers are offset in my analysis by the stock’s very high debt to equity ratio
    • Debt to Equity: CAT has a debt-to-equity ratio of 1.59. Their long-term is more than $23.5 billion and marks CAT as one of the most highly leveraged companies in the Heavy Machinery industry.
    • Dividend: CAT currently pays an annual dividend of $3.44 per share, which translates to an annual yield of 2.49% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for CAT is $24.99 per share. At the stock’s current price, that puts the Price/Book ratio at 5.52, versus a historical average of 3.62. The historical average puts the stock’s “fair value” a little above $90 per share – more than 34% below the stock’s current price. Some analysts like to point out that the stock is trading about 32% below its historical Price/Earnings ratio as an indication the stock is undervalued, but I view Book Value, and the Price/Book ratio as a better measurement and more indicative of a company’s intrinsic value.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

     

    • Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s upward trend until January of this year and provides the reference for calculating the Fibonacci retracement levels indicated by the horizontal red lines on the right side of the chart. The stock’s decline from late January’s high at around $173 puts the stock in a clear, intermediate-term downward trend, with the stock trading near to the lowest point of that trend around $135 per share. The stock is hovering around a major support point, marked by the 61.8% Fibonacci retracement line, and if that line holds, it could give the stock some momentum to start pushing higher to reclaim its highs from earlier in the year. On the other hand, a drop below $135 would mark a clear break through support that would give the stock room to drop as far as the 88.6% retracement line around $120 in fairly short order. That’s more than $15 of near-term risk if support is broken, and about $18 of legitimate risk right now. Even if the stock does rally from that support point, it should find major resistance in the $150 range, where the 38.2% retracement line sits, meaning that a bullish investor stands to make about $12 per share if he’s right; but he could lose $18 per share if he’s wrong. That’s easy math that should make anybody hesitate.
    • Near-term Keys: If you’re looking for a good reward: risk trade opportunity for CAT, watch to see if the stock pushes below support around $135. If it does, there could be a very good opportunity to short the stock or use put options, with a target price around $120, and a stop loss a little above $136 per share. That’s a set up that offers $15 of reward, against only a couple of dollars per share of risk.


  • 02 Aug
    CSCO is down almost 10% since May – should you buy the dip?

    CSCO is down almost 10% since May – should you buy the dip?

    Cisco Systems Inc. (CSCO) is one of the most recognizable and established companies in the Technology sector. With a market cap of nearly $200 billion, they are also one of the largest, if not THE largest player in the Networking & Communications segment. They are, without question, the standard that all other networking businesses are measured and compete against. No matter whether you’re talking about wired or wireless networking, CSCO is one of the companies that not only developed the standards and infrastructure the entire Internet is built on today, but that continues to lead the way into the future, including the next generation of technology in the so-called “Internet of Things” (IoT).

    It’s ironic, perhaps that despite CSCO’s unquestioned dominance in its market, the stock has mostly languished for nearly two decades. After riding the “dot-com boom” of the late 1990’s to a peak at around $80 per share, the stock cratered when that boom went bust, dropping to as low as about $8 in late 2002. From that point it never rose higher than into the low $30 range – at least not until the latter part of 2017, when the stock finally broke that top-end resistance. That pushed the stock to a high in May a little above $46 per share as Tech stocks generally prospered.



    Recently, however, it seems that CSCO has fallen victim to the latest “Amazon rumor mill” phenomenon that has afflicted companies like CVS Health Corp (CVS), The Kroger Company (KR), and others who watched their stock price slide amid rumors Amazon.com (AMZN) was looking for a way to expand its business into their respective industry. The latest rumor is that AMZN is considering branching their Web Services unit into network switching hardware – the same technology that CSCO has dominated for more than two decades. 

    Despite the fact AMZN has provided no validation of the rumor, and in fact has given to indication they were in fact considering the move, or actually developing any such products, the mere suggestion has been sufficient to help drive the stock from that May high price to its current level a little below $42 per share. That might not sounds like much of a drop, but it does represent a 10% decline in the stock price – enough that some analysts have been recommending investors should “buy the dip.”

    I’m not sure that I agree. While I recognize CSCO’s dominance in its industry, expect it to continue, and recognize the company’s core fundamental strength, my reliance on value analysis also forces me to look at the stock’s current price in more conservative terms. It looks very overvalued right now. The company is due for its latest earnings report later this month, and that report could alter my perspective somewhat; but as of now I have to believe the stock is at a greater risk of a steeper decline than it is of staging a rebound to test its recent highs. Here’s what I mean.



    Fundamental and Value Profile

    Cisco Systems, Inc. (CSCO) designs and sells a range of products, provides services and delivers integrated solutions to develop and connect networks around the world. The Company operates through three geographic segments: Americas; Europe, the Middle East and Africa (EMEA), and Asia Pacific, Japan and China (APJC). The Company groups its products and technologies into various categories, such as Switching; Next-Generation Network (NGN) Routing; Collaboration; Data Center; Wireless; Service Provider Video; Security, and Other Products. In addition to its product offerings, the Company provides a range of service offerings, including technical support services and advanced services. The Company delivers its technology and services to its customers as solutions for their priorities, including cloud, video, mobility, security, collaboration and analytics. The Company serves customers, including businesses of all sizes, public institutions, governments and service providers. CSCO has a market cap of $197 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings grew by a little over 11%, while sales growth was more modest, at about 4%. Growing earnings faster than sales is hard to do, and generally not sustainable in the long-term; however it is also a positive mark of management’s ability to maximize their business operations. In the most recent quarter, both metrics grew about 4%. Over the last twelve months, the company also reported negative Net Income of about $1.2 billion, raising questions about their operating costs and margins.
    • Free Cash Flow: CSCO’s free cash flow over the last twelve months is more than $12 billion. This is a number that the company has historically managed to maintain at very healthy levels. It should be noted that the negative Net Income just mentioned appears to be a temporary phenomenon, and the company’s massive “war chest” of cash really makes it just a temporary blip on the radar.
    • Debt to Equity: CSCO has a conservative, manageable debt-to-equity ratio of .44. I already alluded to the company’s large cash position; at more than $54.4 billion, it is also more than twice the total amount of long-term debt shown on their balance sheet. The company also recently announced the repatriation of approximately $67 billion of cash from overseas resulting from the passage of tax reform, with plans to use the money to fund a 14% dividend hike and a $25 billion increase its ongoing share repurchase program as a clear effort to return value to their shareholders.
    • Dividend: CSCO currently pays an annual dividend of $1.32 per share, which translates to an annual yield of 3.15% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for CSCO is $9.69 per share, and this is where the biggest cracks in the bargain argument really exist. At the stock’s current price, its Price/Book ratio, at is more than 4.34, is nearly twice as high as its historical average of 2.42; a drop to par with that average puts the stock at risk of a decline of more than 43% (around $23.50 per share) from its current price. That would also put the stock at price levels it hasn’t seen since early 2016.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

     

    • Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s upward trend until early May and provides the reference for calculating the Fibonacci retracement levels indicated by the horizontal red lines on the right side of the chart. The stock’s decline from that point has followed a pretty gradual slope, which to some is a positive indication. I tend to believe the opposite is true, since gradually sloping trends, in any direction are generally easier to sustain over an extended period of time. It can also be argued that the more gradual a trend’s slope is, the more likely the trend’s momentum becomes to accelerate in the direction of that trend; at some point, more and more investors will take note of the trend and be likely to overreact to it. The stock is currently quite near to the 38.2% Fib retracement level around $40.25, with $38 or even $36 (the 50% and 61.8% Fib levels, respectively) not far out of reach. Compared to the upside if the stock reverses the short-term downtrend, you have about $5 per share in either direction, which translates to a 1:1 risk-to-reward ratio right now.
    • Near-term Keys: “Buying the dip” right now is pretty risky move, and when the potential opportunity is identical to the likely risk, it’s hard to say that’s a good decision to make. The risk: reward profile could change if the stock comes a little closer to the 38.2% retracement line, and then pivots back to the upside; that could offer a reasonable opportunity to go long in the stock or to start working with call options, with a tight stop set just below that retracement line at around $39 per share. A drop below $40, on the other hand might offer a reasonable opportunity to short the stock or start working with put options, with a closing target price in that case in the $36 range.


  • 01 Aug
    Will buying TPX let you sleep at night – or make you toss and turn?

    Will buying TPX let you sleep at night – or make you toss and turn?

    Getting a good night’s worth of sleep is important for good health – physical, mental and emotional. I’ve used the same idea throughout my investing career to help guide the investment decisions I make. If putting my hard-earned dollars into a stock is going to keep me up at night, it doesn’t matter what other people, or the market at large think about it – the smart thing for me to do is to move on and find something else. That doesn’t mean that I’m so risk-adverse that I can’t take advantage of opportunities when I see them, but it does mean that the opportunity I do choose to pursue must be clearly superior to the level of risk involved.

    Tempur Sealy International Inc (TPX) is an interesting play on that concept, if for no other reason than the fact that a good night’s sleep is what this company is all about. And a quick look at the stock’s chart shows that the stock is more than 27% below its 52-week high, but could be showing some bullish strength right now. Does that mean there is a great opportunity to be had? It’s a little hard to say definitively. There are certainly a number of positives about the business to be seen, including solid earnings growth over the past year, and an improving Book Value. There are also things to be concerned about, like a very high debt level, mostly flat sales, and a narrow operating margin. Ultimately, the value picture is probably in the eye of the beholder, so I’ll outline what I’ve found so far and let you make your own decision.



    Fundamental and Value Profile

    Tempur Sealy International, Inc. is a bedding manufacturer. The Company develops, manufactures, markets and distributes bedding products. The Company operates in two segments: North America and International. The North America segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in the United States and Canada. Its International segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America. Its brand portfolio includes TEMPUR, Tempur-Pedic, Sealy, Sealy Posturepedic, and Stearns & Foster. It offers its products in over two categories, including Bedding, which includes mattresses, foundations and adjustable foundations, and Other, which includes pillows, mattress covers, sheets, cushions and various other comfort products. As of December 31, 2016, it sold its products across the globe in approximately 100 countries. TPX has a market cap of $5.7 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings declined by about 15.5%, while sales increased at a modest rate of about 1.5%. The story is similar in the most recent quarter, as TPX saw an earnings improvement of nearly 24% against sales growth of 3.3%. The company operates with pretty narrow margins, as Net Income was about 5% of Revenues for the last twelve months. In the last quarter, however, Net Income relative to Revenues narrowed to only about 3.4%. I take this as a red flag that the company is becoming less efficient despite the acceleration in earnings growth.
    • Free Cash Flow: TPX’s free cash flow is marginal, at only $72.5 million.
    • Debt to Equity: TPX has a debt/equity ratio of 10.8, a very high number that makes them one of the most highly leveraged companies in the Household Durables industry. That is a red flag, however the company’s balance sheet indicates that operating profits are sufficient to service their debt.
    • Dividend: TPX does not pay a dividend.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for TPX is $2.90 and translates to a Price/Book ratio of 16.98. The industry average is only 2.9, implying the stock is significantly overvalued. The company’s Book Value was actually 0 until a year ago, but has improved steadily from the end of the first quarter of 2017 until now. The lack of a historical Book Value makes it a little difficult to compare the current Price/Book to anything, however we can also use the stock Price/Cash Flow and Price/Sales ratios in a similar way. The stock is currently trading a little more than 10% below its historical Price/Cash Flow average, and nearly 35% below its Price/Sales ratio. That could put the stock’s long-term target price in the $54 to $65 range, depending on how optimistic you want to be. The absence of useful Book Value information is a concern to me, however and makes me lean more to the conservative side of things, so I have to admit that I have a hard time seeing an intrinsic reason that the stock should be worth more than $54; a 10% upside is a little more limited than I would prefer to work with.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

     

    • Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s downward trend beginning in January of this year and provides the reference for calculating the Fibonacci retracement levels indicated by the horizontal red lines on the right side of the chart. The stock has shown some bullish momentum since late April, rising from a trend low of about $41 to the current level; however it has dropped back from a recent pivot high around $54.50 in just the last couple of weeks and is only a couple of dollars below the 38.2% retracement line at around $51 per share. A break above that line would be required to give the short-term upward trend any validation and a real chance to extend further. Otherwise I expect the trading range between about $47 for support and $51 for resistance to hold sway. A break below $47 would mark a short-term trend reversal to the downside and could see the stock challenge its trend low price at $41.
    • Near-term Keys: If you like to work with trend-based, momentum-focused trading methods, look for a break above $51 to confirm the short-term trend’s strength and provide a decent bullish signal to buy the stock or start working with call options. If the stock breaks down, wait for a push below $47 before trying to short the stock or start buying put options.


  • 31 Jul
    GT is up almost 14% in two days – you’d be silly to miss this opportunity

    GT is up almost 14% in two days – you’d be silly to miss this opportunity

    The longer a bull market lasts, the more people tend to think that looking for value in a stock’s price doesn’t really matter. Instead, they point to growth strategies, putting particular emphasis on growth estimates and forecasts. Forecasts usually come from a company’s management as a part of the conference calls they host to discuss their latest earnings results. They’ll provide some estimates for how much they think their business is likely to grow over the next quarter, next year, or sometimes more. Estimates come from analysts that follow those companies, and while they usually refer to management’s forecasts, they often seem to use other kinds of fuzzy math to come up with future growth numbers that really amount to nothing more than their own guesses. The ironic thing in my mind is that talking heads and other experts use these “estimates” to justify their cases for buying stocks at or near all-time highs. It doesn’t matter how high a stock has risen in the past, as long as people think it is going to keep going up.

    If that rationale seems a little silly to you, then you’re probably somebody that likes to go bargain hunting. When I talk about value investing with people, I often compare it to the kind of bargain shopping my wife likes to do at department stores. She spends a lot of time at clearance racks and likes to visit discount stores. She usually has to spend more time digging through things to find an item she likes, but she’s really good at finding nice things without having to pay full price for them. Value investing really isn’t all that different from bargain hunting, because you have to spend some time digging through lots of stocks to find something useful. Over the last few days, I’ve noticed that some of those talking heads that have been beating the growth drum forever seem to be shifting their discussions now to talks about value. That could be part of the reason that stocks like Goodyear Tire & Rubber (GT), which haven’t just underperformed the stock market but have been in steep, protracted downward trends are showing some signs of life right now.

    GT’s fundamentals are solid despite its price decline, which dates back to late January of this year and, which I think can be attributed mostly to broader concerns about the economy and trade tensions – I believe the stock has suffered a sympathetic response to the Trump administration’s steel and aluminum tariffs against the E.U., as well as auto tariffs against Canada and Mexico. The company recently released their latest earnings report, however and things look good, and the value proposition is very compelling.



    Fundamental and Value Profile

    The Goodyear Tire & Rubber Company is a manufacturer of tires. The Company operates through three segments. The Americas segment develops, manufactures, distributes and sells tires and related products and services in North, Central and South America, and sells tires to various export markets. The Americas segment manufactures and sells tires for automobiles, trucks, buses, earthmoving, mining and industrial equipment, aircraft and for various other applications. The Europe, the Middle East and Africa (EMEA) segment develops, manufactures, distributes and sells tires for automobiles, trucks, buses, aircraft, motorcycles, and earthmoving, mining and industrial equipment throughout EMEA under the Goodyear, Dunlop, Debica, Sava and Fulda brands. The Asia Pacific segment develops, manufactures, distributes and sells tires for automobiles, trucks, aircraft, farm, and earthmoving, mining and industrial equipment throughout the Asia Pacific region, and sells tires to various export markets. GT has a market cap of $5.7 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings declined by about 11%, while sales increased at a modest rate of a little more than 4%. The story is better in the most recent quarter, as GT saw an earnings improvement of 24% against flat sales. The company operates with narrow margins, as Net Income was about 1.5% of Revenues for the last twelve months. The improvement in earnings for the quarter is also reflected by an improvement in the Net Income/Revenue metric for the period, which increased to a little over 4%.
    • Free Cash Flow: GT’s free cash flow is healthy, at about $445 million. That translates to a free cash flow yield of a little less than 10%, but remains adequate.
    • Debt to Equity: GT has a debt/equity ratio of 1.18. This is higher than I prefer to see, and has increased in each of the last two quarters, indicating that GT has been taking on more debt. Over the last two quarters, the company’s long-term debt increased from around $5.1 billion to a little more than $5.7 billion. That is a red flag, however the company’s balance sheet indicates that operating profits remain healthy and more than adequate to service their debt.
    • Dividend: GT pays an annual dividend of $.56 per share, which translates to a yield of about 2.3% at the stock’s current price. This is above the industry average as well as the S&P 500 average of 2.0%.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for GT is $20.20 and translates to a Price/Book ratio of 1.19. The industry average is 1.9, and the stock’s historical average is 2.375. A rally to par with the historical average would put the stock above $47 per share. The truth is that the stock hasn’t been above $36 in almost 20 years, and so some might discount this as a useful long-term target price. I disagree with that notion, because the truth is that while the auto industry is changing and evolving with new technologies like electric and self-driving vehicles, the need for tires isn’t going to go away, or to be disrupted in a significant way. Even if you use the stock’s 20-year peak at $36 as a target price, that is still a great long-term opportunity for a stock that is just a little above $24 right now.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

     

    • Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s upward trend until March of this year and provides the reference for calculating the Fibonacci retracement levels indicated by the horizontal red lines on the right side of the chart. I already referred to the stock’s rebound in price over the last couple of days, which has made the stock one of the top performers in the market right now. Seeing more people talking about value is a good conversation for the market to have, and it could contribute to seeing the stock recover even more. As of this morning it is a little above its 50-day moving average (not shown) after having crossed above that line yesterday. That is a good indication of strong short-term momentum. The stock has strong resistance in the $28 range from previous pivots in late 2017. This is a level that is also consistent with the stock’s 200-day moving average (also not shown) at with the 50% Fibonacci retracement level shown on the chart. I’m not ignoring the resistance at around $26 shown by the 38.2% retracement line, but given the confluence of data points around $28 I think we are more likely to see strong resistance at that level.
    • Near-term Keys: If you like to work with trend-based, momentum-focused trading methods, the stock’s current price level looks like it is building to a nice trend reversal. The stock would need to break above $26 to confirm an actual trend reversal and would probably act as the best signal for a short-term swing or trend-based trade by buying the stock or using call options. The stock’s trend support is a little below $21, and if the stock breaks down below that level, its downward trend could push the stock to somewhere between $14 and $18 per share based on lows it hasn’t seen in more than five years. Bearish trades on this stock would only really be appropriate if the stock breaks below the $21 level.


  • 30 Jul
    Is Eastman Chemical a value or momentum play? 

    Is Eastman Chemical a value or momentum play? 

    A smart investor doesn’t really try to track the entire market to find new investments to make. Given the thousands of publicly traded companies on U.S. stock exchanges alone (around 5,000 on the NYSE or NASDAQ exchanges), it really isn’t very practical to think that any individual is going to be able to track them all. Instead, the most successful investors I’ve known over the years keep track of just a handful of stocks at any given time. Over the years, I’ve worked with lists as small as a couple of dozen and upwards of 100 stocks at any given time, but have never really expanded my active list (the ones that I actually check every day) beyond a dozen or so. That’s been true for me through two recessions and three bull markets, and it’s applied to my use of investing strategies that included short-term methods like swing and trend trading and longer-term philosophies like value investing.

    Working with smaller lists makes the process of tracking the market more efficient and manageable, especially if like most people, investing is just a single part of your busy lifestyle. Few people have the time to spend all day, every day watching the market from open to close, combing through one earnings report after another. The truth is that you don’t have to; if you can put together a smaller, functional basket of stocks to work with, you’ll usually find it’s more than sufficient to keep you busy while still giving you plenty of opportunities to work with.



    As a value investor, my active list stays pretty fluid. I prefer to focus my attention from one day to the next on the stocks that I know are working at valuation levels that I know I can work with. But since an undervalued stock today will hopefully not be undervalued in the future, I often move stocks out of my active list once I close a profitable position on them or they move out of a trading range I think gives me a good value opportunity. I don’t stop watching those stocks, but my check on them becomes more sporadic. That is also true when I see a stock extending an upward trend that I don’t already have an open position in. If it’s moved beyond the point that I think represents a good value, I simply put into a secondary list, which means I’ll come back to it at some point in the future.

    The interesting thing about some of those stocks is that sometimes I’ll decide to take a look at a stock I’ve used in the past at lower prices, and I’ll find that while the stock may be much higher now than it was when I invested in it previously, some of its other fundamental information – like Book Value, for instance, may have also improved significantly. In fact, they may have improved enough that the stock’s latest high price still represents a nice value. That’s an interesting wrinkle in the game for a value-oriented investor like me, because it helps to keep my active list fresh with companies I’m already familiar with, but that haven’t been a daily part of my market check for a while. It’s like coming back to an old friend to get reacquainted.

    This morning I circled back to one of those old friends. Eastman Chemical Company (EMN) is a stock I first used in late 2016 when it was trading around $65 per share. As of this writing the stock is above $101; its rise began around the same time I started paying attention to it, and after I closed the position I took in the stock (at a nice profit, by the way) it rose even more quickly, to the point that I decided to shift it out of my active list. The stock’s upward trend continued almost unabated, driving the stock to a high around $110 in the first quarter of the year before finally dropping back a bit to hover around $100 for most of this month. That drop of about 10%, and seeing the stock consolidate around its current level, prompted me to take another look at the company’s fundamentals and its value proposition. There could be a nice opportunity to work with if you prefer to work with a shorter-term momentum method; from a value-oriented approach, I would still prefer to see the stock offer a better price. Here’s what I found.



    Fundamental and Value Profile

    Eastman Chemical Company (Eastman) is an advanced materials and specialty additives company. The Company’s segments include Additives & Functional Products (AFP), Advanced Materials (AM), Chemical Intermediates (CI), and Fibers. In the AFP segment, it manufactures chemicals for products in the coatings, tires, consumables, building and construction, industrial applications, including solar energy markets, animal nutrition, care chemicals, crop protection, and energy markets. In the AM segment, it produces and markets its polymers, films, and plastics with differentiated performance properties for end uses in transportation, consumables, building and construction, durable goods, and health and wellness products. The CI segment leverages large scale and vertical integration from the cellulose and acetyl, olefins, and alkylamines streams to support its specialty operating segments. Its product lines in Fibers segment include Acetate Tow, Acetate Yarn and Acetyl Chemical Products. EMN’s current market cap is $14.4 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings  grew about 12% while revenue growth increased a little over 8%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long-term; but it is also a positive mark of management’s ability to maximize business operations. The company’s Net Income for the last twelve month was almost 15% of Revenues, with this number decreasing only slightly to about 13% in the most recent quarter. 
    • Free Cash Flow: EMN’s free cash flow is healthy, at $981 million. This is a number that has increased significantly over the past year, from about $650 million.
    • Debt to Equity: EMN has a debt/equity ratio of 1.12, implying they use a fair amount of debt. The company’s balance sheet indicates their operating profits are more than adequate to service their debt, with good additional flexibility from cash and liquid assets.
    • Dividend: EMN pays an annual dividend of $2.24 per share, which translates to a yield of about 2.21% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for EMN is $39.40 and translates to a Price/Book ratio of 2.56 at the stock’s current price. Their historical average Price/Book ratio is 2.8, implying the stock has somewhat limited upside. A move to par with its historical average would put the stock a little above $110, and right in the range of the all-time highs it hit earlier this year. That’s not horrible, but with only about 10% upside, it isn’t quite compelling enough to motivate a value-oriented, long-term investment.


    Technical Profile

    Here’s a look at the stock’s latest technical chart.

     

    • Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s upward trend until March of this year and provides the reference for calculating the Fibonacci retracement levels indicated by the horizontal red lines on the right side of the chart. The stock has significantly retraced its upward trend after hitting an all-time high around $112, and is now hovering around its 38.2% Fibonacci retracement line, which has provided a pretty solid level of support for the past month. That is a positive for momentum-based trading methods, implying a push back into the $110 area is a good possibility. In cases like this one, I also like to use moving averages (not shown on this chart) to identify a stock’s trends over different periods visually. The stock’s 200-day moving average, which is usually a very good indication of the stock’s long-term trend, is sitting right around the $93 level. That also coincides with the 38.2% retracement level if you extend the Fibonacci trend measurement over a two-year period, and with the 61.8% level shown on the chart above. Fibonacci analysts like to call that confluence; confluence means that multiple data points agree, which should improve their validity and reliability of that particular price level.
    • Near-term Keys: If you like to work with trend-based, momentum-focused trading methods, the stock’s current price level looks like a very good retracement level. If the stock can pick up bullish momentum, a push to the $110 to $112 level is a very good possibility, and a push above $112 would mark a validation of the longer-term trend and should see the stock push to even higher levels. As a value investor, I would be far more interested in the stock at around the $93 level; at the stock’s current Book Value that would offer a more attractive value argument than what exists to day, and it would fall in-line with the confluence analysis I just outlined. A bearish trade, either by shorting the stock or working with put options, is a high-risk, low-probability approach right now, without a great deal of upside to offer in exchange.


  • 27 Jul
    International Paper offers a BIG value right now

    International Paper offers a BIG value right now

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    No matter what current market conditions are, one of the biggest challenges for an investor is finding stocks that fit their investment preferences at any given time. The market ebbs and flows from high to low extremes, and those shifting conditions mean that investing strategies designed to work in one type of environment will offer up fewer choices and opportunities in another. Value investing is a great example; when the market has been declining for an extended period of time, or even in the early stages of recovery, finding undervalued stocks isn’t that hard to do. The longer a bull market lasts, however, the harder that becomes, as more and more stocks are found at or near historical highs, and at inflated prices relative to the stock’s underlying fundamentals.

    As a value-oriented investor, I’ve learned that just because there may be fewer bargains available in the late stages of a bull market (and let’s face it, we absolutely are in the very late stages of this latest bull market), it doesn’t mean that I have to change my philosophy. It does mean that I become a more cautious and deliberate buyer, and my core fundamental and value criteria become even more important, because they help me maintain my discipline and avoid jumping on the market’s bullish bandwagon at the dangerous, “irrational exuberance” stage. I’m not sure we are at that point yet, but we also aren’t very far off from it, and so my conservative approach continues to help me sleep well at night.



    International Paper (IP) is a stock that has seen an impressive increase in price since the current bull market started in early 2009 was only around $4 per share, and as of now it is trading a little above $52 per share. At first blush, that might make the stock sound more like it should be overvalued. The company has a strong fundamental profile, however, and the growth of its business over the same period lends to strong argument for the stock’s higher price. Not only that, over the course of the calendar year the stock is actually down more than 20% from its all-time high. I think there is a very strong argument to be made that at its current levels, IP looks like a pretty attractive value play right now.

    The question of trade is something that practically every business with an international profile has to grapple with, as questions about tariffs continue to linger. IP released its latest quarterly report yesterday, and the CEO indicated that to this point, the company hasn’t seen any direct impacts from tariffs. Instead, IP is a company whose risk exposure to trade tensions is mostly secondary. The simplest example, which the CEO cited, was packaged food. If IP’s customers are hit with higher costs from tariffs and uncertainty from an extended trade war, they will need less packaging products, which would then impact IP’s operations. An example that counters this logic applies to China, who the CEO pointed out doesn’t make its own fiber-based products like pulp and paper, which means they have to purchase ti elsewhere. Tariffs won’t be likely to change that reality, which means that area of business should continue to perform well.



    Fundamental and Value Profile

    International Paper Company is a paper and packaging company with primary markets and manufacturing operations in North America, Europe, Latin America, Russia, Asia, Africa and the Middle East. The Company’s segments include Industrial Packaging, Global Cellulose Fibers, Printing Papers and Consumer Packaging. The Company is a manufacturer of containerboard in the United States. Its products include linerboard, medium, whitetop, recycled linerboard, recycled medium and saturating kraft. The Company’s cellulose fibers product portfolio includes fluff, market and specialty pulps. The Company is a producer of printing and writing papers. The products in Printing Papers segment include uncoated papers. The Company is a producer of solid bleached sulfate board. As of December 31, 2016, the Company operated 29 pulp, paper and packaging mills, 170 converting and packaging plants, 16 recycling plants and three bag facilities in the United States. IP’s current market cap is $21.5 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings  grew almost 57% while revenue growth was modest, increasing only 2%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long-term; but it is also a positive mark of management’s ability to maximize business operations. The company’s Net Income for the last twelve month was almost 13% of Revenues, with this number decreasing to about 7% in the most recent quarter. 
    • Free Cash Flow: IP’s free cash flow is healthy, at $361 million. This is a significant increase from the last quarter, when free cash flow was a more modest $175 million.
    • Debt to Equity: IP has a debt/equity ratio of 1.48, implying they are fairly highly leveraged. This is pretty normal for the Containers & Packaging industry. The company’s balance sheet indicates their operating profit are more than adequate to service their debt, with cash and liquid assets of more than $1.1 billion to provide additional flexibility.
    • Dividend: IP pays an annual dividend of $1.90 per share, which translates to a yield of about 3.64% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for IP is $16.58 and translates to a Price/Book ratio of 3.17 at the stock’s current price. Their historical average Price/Book ratio is 4, which provides a strong basis for the stock’s long-term upside. A move to par with the average would put the stock above $66 per share, more than 27% higher than the stock’s current price and very near to its 52-week (and all-time) high around $67.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

    • Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s upward trend from October of 2016 to late January of this year, and provides the reference for calculating the Fibonacci retracement levels indicated by the horizontal red lines on the right side of the chart. The stock has significantly retraced that upward trend, and has used the $51 level as strong support since late March. More recently, the stock’s trading range has narrowed, with resistance around $53 and support in the same $51 price area. Its current range also sits inline with the 61.8% retracement line, reinforcing the strength of the support the stock has seen over the last few months.
    • Near-term Keys: If you don’t mind working with a little volatility over time, and can tolerate a potential swing lower, the value proposition for the stock offers a great long-term opportunity with a very attractive dividend yield to draw from right now. If you prefer to work with shorter trading periods and strategies like swing or momentum trading, look for a push above $53 before taking a long position in the stock or working with call options. A drop below the stock’s current support around $51 could mark an interesting signal to short the stock or work with put options, since the stock isn’t likely in that case to find new, significant support before reaching the $46 level shown by the 88.6% retracement line.


  • 26 Jul
    KSU is breaking out – how far can it go?

    KSU is breaking out – how far can it go?

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    Throughout the year, transportation stocks have mostly lagged the rest of the market. There are multiple reasons that just about anybody could point to – increasing fuel costs, broad-based market uncertainty and volatility related to questions about the economy’s health and rising interest rates, and certainly questions about ongoing trade tensions – but the truth is that investing in this segment this year has translated to some tough sledding. Interestingly enough, however it looks like this is a sector that is starting to move into favor. The Dow Transportation Average is up almost 2% since last Friday, and almost 5% after rebounding off of support from its 200-day moving average line earlier last week. That momentum has given a nice push to a lot of well-known, large transportation names like Union Pacific (UNP) and CSX (CSX). If this momentum holds, those stocks could keep pushing to new all-time highs, but my bet is on the smallest Class 1 railroad in the United States. I think Kansas City Southern (KSU) is a stock you should be paying attention to.

    Trade tensions between the U.S. and its allies are a concern, and the truth is that KSU is exposed to a significant amount of trade war risk, since the railroad focuses on the north/south freight corridor that connects the central  and southern areas of the United States with northern Mexico. NAFTA-related concerns have mostly taken a back seat in the national narrative about trade, as tariffs against China and the European Union have dominated headlines; but the fact is that the same kinds of questions exist for the U.S. with Canada and with Mexico. In KSU’s most recent quarterly report, however, management reported a 19% increase year-over-year in cross-border volumes. 

    Management seems to believe that trend will continue, as their CEO stated on the earnings call that he expects volume growth to continue through 2019. Yesterday President Trump announced an agreement with the European Union to halt further tariffs on each other, and to work on reducing existing tariffs – including those on steel and aluminum – and increase trade on U.S. goods like soybeans and liquified natural gas. That news didn’t include Mexico, or relate directly to questions about NAFTA, of course, but the idea that the U.S. is going back to the negotiating table with the E.U., rather than continuing to escalate trade tensions, seems to be giving the market at large some hope it will do the same for its other trading partners. That is a dynamic that I think will continue to provide some uncertainty and volatility to stocks like KSU for the time being, but more positive trade developments could also add an extra boost of bullish enthusiasm to the stock’s price activity.



    Fundamental and Value Profile

    Kansas City Southern (KCS) is a holding company. The Company has domestic and international rail operations in North America that are focused on the north/south freight corridor connecting commercial and industrial markets in the central United States with industrial cities in Mexico. The Company’s subsidiaries include The Kansas City Southern Railway Company (KCSR) and Kansas City Southern de Mexico, S.A. de C.V. (KCSM). KCSR serves a 10-state region in the midwest and southeast regions of the United States and has the north/south rail route between Kansas City, Missouri and various ports along the Gulf of Mexico in Alabama, Louisiana, Mississippi and Texas. KCSM operates a corridor of the Mexican railroad system. KCSM’s rail lines provide rail access to the United States and Mexico border crossing at Nuevo Laredo, Tamaulipas. KCSM also provides rail access to the Port of Lazaro Cardenas on the Pacific Ocean. KSU’s current market cap is $11.9 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings  grew almost 16% while revenue growth great about 4%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long-term; but it is also a positive mark of management’s ability to maximize business operations. The company also operates with healthy operating margins, since Net Income for the past year was 36% of revenues and almost 22% for the last quarter. 
    • Free Cash Flow: KSU’s free cash flow is healthy, at almost $455 million. This is a number that has increased steadily since late 2015, when it was below 0.
    • Debt to Equity: KSU has a debt/equity ratio of .54. Their balance sheet indicates their operating profits are more than sufficient to service their debt.
    • Dividend: KSU pays an annual dividend of $1.44 per share, which translates to a yield of about 1.24% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for KSU is $48.85 and translates to a Price/Book ratio of 2.37 at the stock’s current price. Their historical average Price/Book ratio is 2.98, which to provides a strong basis for continued long-term upside for this stock, since a break above its 52-week high makes it difficult to forecast new resistance levels. A move to par with its historical average would put the stock above $144 per share. That would mark a new all-time high, but given the company’s overall strength and the momentum the sector appears to be drawing right now, it also looks like a reachable long-term target price.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

     

    • Current Price Action/Trends and Pivots: It’s pretty easy to see what the broader momentum and interest in the transportation sector has done for KSU over the last several days; the stock bounced off of range support last week, and used that bullish momentum to break above range resistance around $113 this morning. Swing and momentum traders like to see this kind of break, since it can act as a very good signal for a short-term trade.
    • Near-term Keys: If your prefer is to work with a short-term trade, this could be a very good signal to buy the stock or to work with call options. The stock’s all-time high was reached in late 2013 at around $124 per share, and so that price level could provide a good target point to exit a swing or momentum trade. If you’re willing to take a longer-term view, however, buying the stock gives you the opportunity to draw its dividend and hopefully take advantage of a value-based opportunity that offers nearly 25% upside potential. Risks to either kind of a trade – short or long-term – are related primarily to lingering trade questions. It isn’t a given that yesterday’s positive news with the E.U. will carry over to Mexico or NAFTA concerns, and that means that you have to be willing to accept some price volatility if you decide to take a position in this stock. Also, if the stock starts to lose bullish momentum and drop back down, watch the $104 price level. A drop below that price would mark an important break below range support and could force the stock into an extended downward trend.


  • 25 Jul
    TTC is down 18% for the year, and consolidating. Is it a great buy?

    TTC is down 18% for the year, and consolidating. Is it a great buy?

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    One of the biggest challenges all investors face is finding stocks to invest in. It isn’t just about picking a stock out of the thousands that are available, but also trying to figure out when the time is right to make the investment. Momentum and trend traders like to try to time the swings from high to low extremes within price trends to place short-term trades, while investors with a longer time period in mind usually look at the fundamental strength of the underlying business. Value-oriented investing, which is the approach I prefer and write about, incorporates aspects aspects of both trend and fundamental analysis to determine if a stock’s current price is lower than it should be. It doesn’t mean the stock is guaranteed to go up, of course, but it does provide a pretty good way to build a case for whether a stock is worth the bother right now, later, or even at all.

    The Toro Company (TTC) is an interesting case study. This is a mid-cap Machinery company with an easily recognizable brand; if you mow your lawn, enjoy gardening or landscaping, or have to deal with snow in the winter, there’s a good chance you are familiar with their products. TTC competes with other companies in the Machinery space like Deere & Co. (DE) and Briggs & Stratton (BGG), to name just a couple. Their business has a definite element of seasonality associated with it; in their most recent quarterly earnings report, for example, the company cited a more-temperate-than-expected winter, in many parts of the country along with a delayed start to spring as factors that impacted revenues and earnings in the quarter. Even so, the company also has a diverse product portfolio that makes them an interesting player. The stock’s price is also down for the last twelve months, having hit a high price at around $73 in August of last year before dropping quickly to a range somewhere between $56 on the low side and around $62 on the high end. The stock is roughly the middle of that range right now and has been holding this sideways pattern for the past few months. 

    The stock’s current, and somewhat extended, sideways pattern marks a consolidation of price that usually gets technical traders to start paying a little more attention, since stocks inevitably find a reason to break out of consolidation ranges to establish new trends. When the stock is trading significantly below its historical levels, technical traders usually look at a consolidation pattern as a bullish indication and will start looking for a strong upside breakout signal to place a trade. As a value investor, consolidation makes me check a stock’s fundamentals to determine if there is a strong argument that the stock should move higher over either an intermediate or long-term perspective, and if the value proposition isn’t compelling enough right now, what is the price at which I think the stock is a good buy.



    Fundamental and Value Profile

    The Toro Company (Toro) is engaged in the designing, manufacturing, and marketing of professional turf maintenance equipment and services, turf irrigation systems, landscaping equipment and lighting products, snow and ice management products, agricultural micro-irrigation systems, rental and specialty construction equipment, and residential yard and snow thrower products. The Company operates through three segments: Professional, Residential and Distribution. Under the Professional segment, Toro designs professional turf, landscape and lighting, rental and specialty construction, snow and ice management, and agricultural products. The Residential segment provides products, such as riding products, home solutions products and snow thrower products. It manufactures and markets various walk power mower models. The Distribution segment consists of Company-owned domestic distributorship. Its brands include Toro, Exmark, BOSS, Irritrol, Hayter, Pope, Unique Lighting Systems and Lawn-Boy. TTC’s current market cap is $6.3 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings  grew more than 11% while revenue growth was mostly flat, posting an increase of .29%. TTC operates with a narrow margin profile of about 1%. The results are more encouraging over the last quarter, where earnings grew 150% and revenues improved almost 60%. In addition, the company’s Net Income was about 10% over the past year, but improved to almost 15% in the last quarter.
    • Free Cash Flow: TTC’s free cash flow is healthy, at a little more than $257 million. This is a number that has declined over the past year from a little above $340 million.
    • Debt to Equity: TTC has a debt/equity ratio of .48. Their balance sheet shows about $206 million in cash and liquid assets versus about $300 million in long-term debt, which a pretty good indication that the company works with a conservative debt management philosophy. Given their healthy operating margins, they should have no problem servicing their debt.
    • Dividend: TTC pays an annual dividend of $.80 per share, which translates to a yield of about 1.33% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for TTC is $5.81 and translates to a Price/Book ratio of 10.29 at the stock’s current price. Their historical average Price/Book ratio is 9.96, which provides a pretty strong argument for the fact that while the stock isn’t overvalued, it also isn’t a great value right now. I’m also not confident that under current conditions, with some early signs that steel and aluminum tariffs are starting to squeeze margins for industrial stocks, that the market is likely to start rotating into these stocks in the near future. A more compelling value argument in my mind would be made with the stock in the $45 to $46 range – which is a level the stock hasn’t seen since late 2016.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

     

    • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s long-term downward trend, and also informs the Fibonacci trend retracement lines shown on the right side of the chart. As I observed earlier, the stock is currently hovering in a range between about $56 (range support) and $62 (range resistance). That range has been pretty persistent since April of this year. In order to reverse its long-term downward trend, the stock would need to break out of that range and move above the $63 area marked by the 38.2% retracement line. A break below $56 would reconfirm the long-term trend’s strength and could see the stock drop down into the $46 to $49 range.
    • Near-term Keys: If you’re looking for a way to take advantage of the bullish side of the market with TTC, look for a strong move above $63 before buying the stock or working with call options. If the stock does break below $56, that could be a good signal to short the stock or to consider buying put options. If you’re a value-oriented investor like me, a break below $56 could be a good reason to start paying closer attention, with stabilization below $50 an area where the stock’s value proposition could become very attractive.


  • 24 Jul
    Trade war fears are driving WHR down to REALLY interesting value levels

    Trade war fears are driving WHR down to REALLY interesting value levels

    Since the beginning of the month, the stock market has shown some positive momentum, with the S&P 500 driving from around 2,700 to a little above 2,800 as of this writing. That boost seems to come in spite of trade tensions, which always seem to be lurking close by and ready to start grabbing headlines and investor’s attention all over again. Today another wrinkle seems to be making its way into the storyline, as the Trump administration appears ready to make about $30 billion in emergency aid available to U.S. farmers that have been negatively impacted by tariffs. That certainly seems like a tacit acknowledgement that a trade war is really hurting Americans, and that more pain could be coming in the near future since the administration doesn’t seem to be changing its tone or approach in any meaningful way.

    The truth is that any actual impact of tariffs – from the U.S. on another nation, or vice versa – isn’t likely to be seen on an immediate basis. The markets, however are emotional by nature, which means that they usually react as much, if not more, to the perception of news more than to its reality. That’s why the entire semiconductor sector, with massive exposure to China has seen its practically uninterrupted momentum of nearly nine years fade over the last few months and even turn bearish since early June. The same is true of industrial stocks, where steel and aluminum tariffs have muted enthusiasm for stocks in that sector despite recent, generally positive earnings growth.



    It is also true that increased globalization, facilitated by technological advancement in practically every economic sector means that most companies that have been successful at growing revenues and profits over the last two decades or more have done so by extending their reach far beyond their own national borders. That means that almost no matter what business you look at, how well-established it may be, or what its perception as a “national icon” may be, if you dive deeper into its business you’ll find that tariffs between any, or all of the nations embroiled in trade tensions is exposed to a heightened risk of increased costs from tariffs. As investors, that means it can be hard to figure out how to invest actively, but conservatively by limiting your own exposure. 

    The concern over tariffs is an important element to consider when you’re thinking about Whirlpool Corp. (WHR), which is a stock that anybody should be able to recognize easily; there is, after all an excellent chance that you have one or more Whirlpool or Maytag appliances in your own home. The company reported earnings this morning that missed most analyst’s expectations; management also lowered their profit outlook for the rest of the year and cited increased costs of steel and resin as well as freight. One of the factors that the company cited for those increased costs included tariffs imposed by the Trump administration on steel imports (although the implication from the conference call was that they were just one contributor, and not the biggest one). The news sent the stock plunging more than 14% below yesterday’s closing price. 

    The company also faces intense competition from South Korean companies like Samsung and LG, but still remains one of the largest home appliance (large or small) manufacturers and markets in the world. How does WHR shield you from trade risk, especially when they are citing tariffs as an element that is increasing their costs? While the company operates globally, it also localizes its manufacturing operations, which means that products sold in the U.S. are manufactured in the U.S., products sold in Europe are manufactured in Europe, and so on. Despite its global footprint, North America remains its largest market, with more than 54% of all sales in 2017 coming locally. By comparison, 23% came from Europe, the Middle East, and Africa, 16% came from Latin America, and only about 7% from Asia. WHR’s CEO also indicated that because the company negotiates annual contracts for the steel they buy, they hadn’t been strongly affected in the last quarter by steel tariffs; however it does raise some concern that the longer the tariffs persist, the more direct the impact will be, which appears to be a reason for the lowered profit forecast. Even so, the company remains profitable, with strong, positive cash flow, continued market leadership and a dividend yield far above the S&P 500 average, but that remains conservative from a payout ratio perspective. The bonus for a value-oriented investor is that the stock’s overnight drop really puts its price at a deeply discounted level that is attractive for those willing to work with a long-term perspective.



    Whirlpool Corp. (WHR)

    Current Price: $129.96

      • Earnings and Sales Growth: Earnings decreased from $3.35 a year ago to $3.20 in the most recent quarter. The market was expecting to see a year-over-year increase to $3.69 per share. Revenues also missed the mark, dropping to $5.14 billion versus $5.35 billion a year ago. While the market is reacting negatively to the fact that the numbers missed analysts expectations, I think it’s constructive to put the year-over-year decline in perspective; the earnings drop is about 4.4%, while revenues dropped by about 3.9%. That isn’t insignificant, especially if you think about it on an annualized basis and consider that the global economy has generally been healthy. Don’t make the mistake, however of attributing the drop just to trade war concerns. Other factors that had an impact, for example was a trucker strike in Brazil that impacted WHR’s business in Latin America and could continue to show softness until its general elections in October are settled, as well as sales declines in the EMEA portion of their business.
      • Free Cash Flow: WHR’s Free Cash Flow is healthy, and their balance sheet indicates they have good liquidity, with more than $1 billion in cash and liquid assets to supplement healthy operating margins.



    • Debt to Equity: WHR has a debt/equity ratio of .80 as of the quarter prior. Long-term debt has increased since the end of 2017 by about 10%, and so I expect this number is going to go up somewhat. Their balance sheet however implies that operating margins remain healthy and more than adequate to service their debt, with good cash and liquid assets to provide additional flexibility.
    • Dividend: WHR pays an annual dividend of $4.60 per share, which at its current price translates to a dividend yield of about 3.54%, well above the S&P 500 average of 2%. Its dividend offers an attractive yield for patient investors who would be willing to hold the stock and wait for its trend to shift back to the upside.
    • Recent Price Action: The stock has been trending lower for the past year, hitting a high in July of last year at about $200 before tapering lower from that point. Its current price marks a 23% decline from its 52-week high, and therein lies the opportunity. The stock hit a trend low point in late June at around $142 before rebounding a bit. The stock plunged overnight due to the pre-market earnings call to its current level as the market is reacting in an extreme way to the earnings miss and the lowered forecast. The acknowledgement that tariffs are playing a role seems to simply be adding fuel to that fire for now, but from a value standpoint it’s really just creating an even better value proposition. Given the company’s strong fundamental profile, its current price could be considered a good value. It is now trading only about 1.7 times above its latest Book Value, while its historical average is about 2.6. That puts a long-term price at around $191 – near to its 52-week highs. Adding to its value argument is the fact that at its current price, it is trading at less than ten times forward-looking earnings, while the average for stocks in the S&P 500 Index right now is 17.1.


  • 23 Jul
    HAS beats Street estimates, but its 12% overnight jump is a Red Herring

    HAS beats Street estimates, but its 12% overnight jump is a Red Herring

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    Before the market opened this morning, toymaker Hasbro, Inc. (HAS) released its report of second quarter results, and the numbers prompted the market to push the stock up in a big way early in the trading session. After closing a little below $94 on Friday, the stock opened Monday’s trading session at nearly $105 per share and pushed as high as $107 in the early hours of the day. The report must have been really great, right? Well, not so fast.

    One of the interesting things about the stock market is watching the way it reacts to company reports. All things being equal, when a company can demonstrate that their business is growing, their stock should go up, and when it is shown that business is contracting, the stock should also go down. Of course, all things are not equal, and that means that the market, being an emotional animal, treats stocks differently. Sometimes the market’s immediate reaction is about something entirely different than whether a company’s business is growing or shrinking. Hasbro’s price action today is a pretty good example.

    Analysts and investors alike like to try to predict what a company’s report is going to look like. They analyze and measure all kinds of information and data and try to make their own educated guesses about what is going to happen. With HAS, one of the factors that everybody has been trying to account for is the effect that the collapse of U.S. toy store Toys ‘R’ Us, which of course was one of the toymaker’s biggest customers would have. Analysts had anticipated a drop in revenue of a little more than 14% versus the same quarter in 2017, and earnings to decline by more than 45%. Revenues actually declined by 7%, less than half of what was expected, and earnings only dropped by about 9.5%. Seeing both of those numbers come in better than expected led the market to respond with high enthusiasm. Clearly, the market seems to be treating the news as an indication that the effect of the liquidation of Toys ‘R’ Us was much less than expected.



    I’m not saying that the news in this case isn’t positive; being able to minimize the impact from a negative event like a major customer’s complete and utter collapse is a mark of strong management. But does it justify sending a stock 12% above its current price in a single day? That’s where my red herring reference comes into play. The market has always seemed to prefer to draw any kind of silver lining it can from news to drive a stock’s price higher, but the problem is that immediate boost often puts average investors at a disadvantage and increases their risk. The people that stand to benefit most clearly from that early surge, of course, are the investors that were already holding shares of the stock; but the probability any chance the stock will keep going up is less likely to be about emotion and more about the stock’s fundamentals.

    One of the short-term risks about jumping into a stock that is making a big overnight jump based on a news headline comes from the size of that overnight jump. If you’re an investor or trader that had the good fortune to buy HAS at any point in the last month or so when the stock was languishing in the $85 to $94 range, seeing the stock jump up more than $10 per share overnight would certainly be exciting; it would also automatically make you think about selling your shares back to the market to lock in that gain. That is exactly what I think a lot of folks are going to be doing in the next day or so; and while it isn’t a given that is going to drive the stock lower, the odds that it will drop are much greater than that it will keep going up. I’ll quantify exactly how much downside risk I think there is in that scenario later in this post. For now, let’s dive in into whether or not the stock should worth the $100-plus share price it carries at the moment.



    Fundamental and Value Profile

    Hasbro, Inc. (HAS) is a play and entertainment company. The Company’s operating segments include the U.S. and Canada, International, and Entertainment and Licensing. From toys and games to content development, including television programming, motion pictures, digital gaming and a consumer products licensing program, Hasbro fulfills the fundamental need for play and connection for children and families around the world. The Company’s U.S. and Canada segment is engaged in the marketing and sale of its products in the United States and Canada. The International segment is engaged in the marketing and sale of the Company’s product categories to retailers and wholesalers in most countries in Europe, Latin and South America, and the Asia Pacific region and through distributors in those countries where it has no direct presence. The Entertainment and Licensing segment includes the Company’s consumer products licensing, digital gaming, television and movie entertainment operations. HAS’ current market cap is $13.3 billion.

    • Earnings and Sales Growth: Over the trailing twelve-month period, earnings declined almost 77% while revenue dropped about 16%. Over the same period, HAS has operated with a very narrow margin profile of less than 5% that was actually negative over the last quarter.
    • Free Cash Flow: HAS’s free cash flow prior to the last quarter was healthy, at about $497 million. The company has about $1.1 billion in cash and liquid assets, a number that declined from almost $1.6 billion in the quarter prior.
    • Debt to Equity: HAS has a debt/equity ratio of .98 as of the quarter prior to today. Total long-term debt in the most recent was about the same, at about $1.64 billion.
    • Dividend: HAS pays an annual dividend of $2.52 per share, which translates to a yield of about 2.36% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for HAS is $12.58 and translates to a Price/Book ratio of 8.47 at the stock’s current price. That is quite high, well above the industry average of 3.2 and its own historical average of 5.22. A move to par with its historical average would put the stock at about $66 per share – more than 38% below the stock’s current price. I believe this is a pretty fair evaluation of what the stock’s long-term, fair market value should be. For a value-based investor, the stock would have to drop to at least this level before it would merit serious consideration.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

    • Current Price Action/Trends and Pivots: The dotted green line highlights the stock’s upward trend, dating back to early April. The stock has shown good bullish strength from this period, increasing about $10 per share before this morning’s big break higher. I’m using the dotted blue line for a couple of things. First, before today this was the stock’s most likely strong resistance level, and today’s clear break, with a huge gap between Friday’s close and this morning’s opening price above it is a clear technical indication of the stock’s current bullish momentum. The line is also useful when thinking about investor behavior as it relates to overnight gaps. Since gaps like this translates to large, unexpected but happy gains for people who bought in before the jump happened, it isn’t unusual to see an increasing in selling immediately after the gap, as profits are taken and locked in. An abundance of technical study suggests that gaps tend to fill themselves, which means that a bullish gap like the one we’re looking at now is very likely see the stock drop back down in the near term. One technical theory that I think has good anecdotal evidence behind it suggests the stock should fill approximately half of the distance covered by the initial gap. The blue line, sitting right around $99 per share, is right in that price area, and is further bolstered by repeated pivot highs in that same range, in February of this year and multiple points in 2017. That puts the stock’s minimum immediate downside risk in the $6 to $7 per share range now – far above what any near-term upside forecast is likely to be.
    • Near-term Keys: If the stock stabilizes in the $99 to $100 range, that could be a good indication the stock will push back to test the high it set today around $106 per share, which could offer a good signal for a short-term swing trade using call options or buying the stock outright. A break below the $99 support level should put you on notice to watch to see if the stock will find support along its intermediate trend line around $93. A break below that level would mark a reversal of that upward trend, and could easily see the stock drop all the way to the $83 level to test its 52-week low. A break below $93 could offer a nice signal to start working the bearish side of the market by shorting the stock or using put options.


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