Archive for December, 2006

2006-12-27 :: Apple Falls Off Tree

Wednesday, December 27th, 2006

Apple share have soared higher on better and better earnings. We purchased a small position when they dipped below 90 based upon increased earnings expectations. Then, it was announced that Apple was being investigated for options backdating. The price dipped a bit more and we added some to accounts that hadn’t participated in the initial purchase. Today, its off 5% and we bought some more for the accounts that participated in the initial purchase, around 78. Today’s dip is based upon speculation that CEO Steve Jobs, so closely associated with Apple’s success, might be in serious trouble.

This is one of those situations where a good company with strong earnings is being sold off on rumors, and we are able to buy shares at an artificially low price. Situations like this happen from time to time, and the price can languish at an artificially low level or even fall further before returning to Wall Street’s target price. In Apple’s case, based upon estimated earnings for 2007, the target price is 120. It won’t get there anytime soon, but given that you are buying it at such an undervalued level, the big gain potential justifies holding it as the rumors and speculation batter the share price.

This will be the last post of the year as I am headed for St. Petersburg (see photo above) and New Years in St. Catherine’s Square with a million vodka-loving Russians.

Happy New Year, and cheers to a great 2007!

Mark

2006-12-21 :: Joy Global Gets Some Respect!

Thursday, December 21st, 2006

Summary: Joy Global Reports a Stellar Quarter
12/18/2006 1:06 PM EST

Wrap-up
Here is the key takeaway from the Joy Global (JOYG) call: The coal market in the U.S. is soft, but that is overshadowed by strength in other markets and other geographies. Future guidance for the year ahead reflects continued softness in the domestic coal market. Either you take the bear case and say that all other markets will go the way of U.S. coal or you take the bullish side of the argument and believe that U.S. coal is a standalone issue that is easily absorbed by the diversity of product and geographic mix that JOYG enjoys. Either way, it appears that JOYG was priced for the worst and the stock is set to rebound.

Earnings Results
JOYG reported stellar results as the company earned 71 cents on a GAAP basis and 79 cents, excluding the impact on “discreet” tax items, on revenue of $689 million. These results were far in excess of expectations and sent the stock soaring by over 10% in early activity.

Bookings and Sales
Bookings and sales for the quarter and full year reflected solid double-digit growth year over year, and $836 million of new orders in the fourth quarter increased almost 30% year over year.

U.S. Softness Offset by Growth in Other Markets
The temporary softness in the U.S. underground coal market was more than offset by new order growth in other markets such as copper, iron ore, the oil sands and surface coal markets outside of the U.S. Growth in new orders increased 20% in the quarter and for fiscal 2006. China is still a tremendous growth opportunity. After-market revenue increased by more than 10% in the quarter. The stream of after-market revenue now accounts for 60% of total revenue and is approaching $1.5 billion on an annualized basis.

Margins
Gross profit margins increased from 29% to 31% year over year. Gross profit margins are beginning to flatten due to product mix and cost pressures. Order flow continues to reflect the lumps inherent in the business, with the most recent quarter reflecting the positive aspect of this lumpy nature.

Tax Rate
Excluding the impact of the discreet tax adjustments, the effective tax rate was 27% in fourth quarter 2006 and just under 32% in fiscal 2006. Expect the book tax rate to be in the range of 33% to 34% in 2007.

Accounts Receivable and Inventory Figures
Days sales outstanding fell by six days in the quarter, and inventory turns increased 0.3 turns.

Buybacks
Through last Friday, JOYG has repurchased $500 million of stock under the $1 billion stock repurchase authorization.

Fiscal 2007 Guidance
Overall guidance is conservative, reflecting weakness in the U.S. coal market — with revenue in the range of $2.7 billion to $3.0 billion; operating profits in the range of $500 million to $510 million; slight strengthening in gross profit margins; EPS in the range of $2.85 to $3.25, including a 10-cent benefit from further stock repurchases. Note: Current consensus calls for EPS of $2.95 on revenue of $2.84 billion.

Smooth Transitions in Personnel
Mike Sutherlin’s transition into the role of President and CEO is progressing well, and Mike’s replacement at the Joy Mining subsidiary is well-established in his role.

Joy Global Will Remain Competitive
The acquisition of DBT, a Germany-based business, by competitor Bucyrus (BUCY) will not erode JOYG’s competitive position.

2006-12-19 :: Return of Asian Flu and Thai Bhatulism?

Tuesday, December 19th, 2006

1997 was the year that saw emerging markets plunge with currency crises across Asia, beginning with the devaluation of the Thai Bhat. Overnight, the Thai central bank instituted new currency rules to stem the rise of their currency. Those rules sent the shares of the Thai stock market down 15% over night. Ugly. It bring back memories of one of my newsletters from those days that noted that the true definition of an emerging market is that its a market you can’t emerge from in a crisis.

Below, I’ve cut/paste the AP story on the Thai currency and stock market action. Other Asian markets were also down overnight, so we’ll see if this is a return of 1997 or just a normal hiccup for emerging market investors.

More later!

Mark

AP
Thai Stocks Plunge Nearly 15 Percent
Tuesday December 19, 6:18 am ET
By Michael Casey, Associated Press Writer

Thai Stocks Plunge Nearly 15 Percent As Central Bank Curbs Foreign Inflows BANGKOK, Thailand (AP) — Thai stocks plummeted almost 20 percent at one point Tuesday in the most dramatic turmoil to hit financial markets here since the 1997 Asian financial crisis, rattling markets in the region.

Investors dumped stocks in Hong Kong, India, Indonesia and Malaysia amid contagion concerns that the plunge might to spread through the region and trigger the kind of slump that wracked Asia nearly ten years ago.

The Stock Exchange of Thailand’s benchmark SET Index plunged as much 19.5 percent before recovering some to close at 622.14, down 14.8 percent.

It was the market’s biggest drop ever, the stock exchange said. The hardest hit sectors were banking, energy and telecommunications.

The plunge came after the Bank of Thailand late Monday announced its toughest measures yet to clamp down on speculative inflows that have lifted the Thai currency, the baht, to a nine-year high of 35.09 to the U.S. dollar Monday. On Tuesday, the baht weakened to 35.93 per dollar.

Starting Tuesday, all banks are required to hold in reserve for one year 30 percent of capital inflows that aren’t trade- or services-related, or repatriation of Thai residents’ investments abroad, the bank said. Also, foreign investors must pay a 10 percent penalty unless they keep funds in the country for a year.

“Foreign investors are nervous about the measure introduced by the central bank,” said Sukhbir Kanijoh, an analyst with Kasikorn Securities in Bangkok.

“Many are also worried that more measures will be introduced to curb the strengthening baht that will make the Thai market even less attractive,” he said. “Selling is heavy and selling orders will likely continue throughout tomorrow, unless there is a revision to the measure.”

But David Cohen, chief of Asian economic forecasting for Action Economics in Singapore, said the events in Thailand are fundamentally different from the events surrounding the 1997-98 Asian financial crisis.

The big problem ten years ago was currency weakness; now, it’s currency strength.

“I would emphasize the contrast to the situation in ’97 and ’98. The measures the Bank of Thailand felt obliged to impose were to resist the appreciation of their currency,” Cohen said.

Ben Kwong, chief operating officer at KGI Asia in Hong Kong, also said regional economies are now “relatively healthy” compared to the situation in 1997.

“The situation is different now. Many regional economies have achieved more balanced accounts and currencies are likely to go up, not down,” he said.

Thailand’s measures “aim to change the rules of the game and were a blow to foreign investors’ confidence. The big market reaction is understandable,” he said. “But there shouldn’t be any long-term effects on Hong Kong.”

The Stock Exchange of Thailand on Tuesday called for the central bank to review its decision to impose new rules aimed at weakening the baht, saying the move did prompted foreign investors to dump Thai shares.

Effectively, the central bank’s new rules mean that if a foreign investor allocated the equivalent of 100 million baht to the Thai bond market, the investor could only buy 70 million baht of bonds, while the remainder would be withheld by the central bank, earning no interest. If the investor wanted to withdraw the money in less than a year, only two-thirds of the amount withheld would be returned.

2006-12-17 :: 2007, a Stock Pickers Market

Sunday, December 17th, 2006

The chart above prepared by Harry Shiller compares the return of the S&P 500 to the Volatility Index. The index is a classic technical indicator showing the implied risk in the market derived from the trading of put and call options. The lower the reading on the VIX the more implied risk in the market.

As you look at this chart you can see the notation that the VIX is at a 10 year low and the S&P is at a multi-year high. This is a good indicator that we’ve had a liquidity driven push up of the mega-cap stocks in the S&P 500. The institutional investors that were sitting on the sidelines have put there cash to work in the index, driving it higher, without regard to valuation or fundamentals.

For those folks that are anticipating that 2007 will a repeat of 2006, and that index-style investing will once again beat fundamental analysis and stock picking, I believe they are in for a sad time. The last time the VIX was at this level, in 1993 (according to Harry Shiller’s analysis) we had the S&P returning 2% in the subsequent year as valuations caught up with earnings. The VIX being at this level does not necessarily mean that we are in for a bear market. All it really means is that the liquidity driving the market higher is likely already in the market and won’t be available as a catalyst any longer.

So, look for 2007 to be a return to earnings and valuation based performance in equity investments. Picking the right stocks in the right industries will once again provide the returns we all expect from equity investments.

More later!

Mark

2006-12-13 :: Dollar's Slide

Wednesday, December 13th, 2006

I saw this chart from an article written by Helene Meisler and thought it was pretty telling.  You can see that the Dollar Index has strong support at the 80 level.  We are current 2 points and change above that support line, and we are seeing some strengthening in the index.

What does this mean?  In my view, it will take a pertty strong economic event to push the dollar much lower in the near-term.  Will that be the much anticipated Fed Rate cuts?  Its hard to tell, but in the near-term we will not likely see the dollar index drop below 80.  This means that the outperformance of foreign stocks to domestic based solely upon the dollar falling is over until that event pushed us below 80.  That event will come – most likely in my mind will be a China-induced drop – and when it does it will cause a big drop as the debt fueld excesses of the consumer and the government have to be paid for at some point.

I’ll have more discussion on this in the upcoming 2007 Outlook newsletter.

More later!

Mark

2006-12-12 :: Philosophy and Practice (Entry #2)

Tuesday, December 12th, 2006

Below you will find our internal operating document that outlines for the staff our Philosophy and Practice in the investment management business.  In today’s first post, I discussed our Earnings Growth Model.  This document will give you a better understanding of how it works and how we use it in our wider work of investment management.  Normally, this is something that I use to educate our staff on the BankChampaign way of managing money, but as I was reviewing it I thought you might also like to see it.

Please ignore some of the formatting issues in this post as I tried to cut/paste from the original Word document, and the formatting did not translate to the blog and I can’t seem to correct it.

Soon, you will be receiving a newsletter that details our view on 2007 and where we feel you will make the most money.

I hope all is well with you and yours this holiday season.

Happy Holidays!

Mark

BANKCHAMPAIGN INVESTMENT MANAGEMENT

PHILOSOPHY AND PRACTICE


PHILOSOPHY

At BankChampaign, we are committed to building and managing client investment portfolios that consistently and handily outperform their benchmarks.  We utilize a proprietary system that is grounded in proven investment fundamentals and incorporates our core investment management principals of Sector Allocation, Earnings Growth, Diversification, and Valuation in equity selection.  We will never manage a portfolio as if it is a proxy for an index fund.  We believe our clients pay us to utilize independent thought in order to provide superior returns at managed levels of risk.  We will make our investment management process as visible and understandable as possible for our clients so that they will always know what we are doing and how we are doing it.

 

 

PRACTICE

As we put our philosophy into practice, we apply it to portfolios of individually managed securities as well as managed portfolios of mutual funds. We establish a written and published Investment Strategy and provide periodic updates to it.  We manage client portfolios around mathematical targets and compare performance to widely followed benchmarks. 

 

Asset Allocation

Asset Allocation is the primary determinant of risk, return, and cash flow in an investment portfolio, and it is the first consideration in structuring a client’s portfolio.  Choosing the correct asset mix between equity, fixed income, and cash equivalent investments is always the firs decision, but it must be reviewed over time to ensure that it is relevant for a client’s then-current position in life and risk tolerance.  Our baseline asset allocation is 65% Equities and 35% Fixed Income securities as that allocation has been statistically proven to provide the highest potential return at the lowest standard deviation of returns (also known as risk).  Clients can be more or less aggressive than that depending upon their choice (a fully diversified portfolio, a best ideas portfolio, dividend income portfolio, or a single sector portfolio), their level of willingness to assume risk (increasing or decreasing the percentage allocation to equities and fixed income securities), or their cash flow requirements (dividend income, taxable or tax-exempt interest).

 

Equity Investments

  • Sector Allocation in equity portfolios accounts for a significant portion of a portfolio’s total return.  Based upon our financial analysis of long-term trends – financial, demographic, societal – we will overweight or underweight sectors in order to enhance portfolio returns and reduce overall risk.
  • There are three drivers of stock prices:  earnings growth, valuation, and investor sentiment.  The core of our equity holdings are selected from the individual companies as rated by our proprietary Earnings Growth model, which incorporates a number of factors
    • High Earnings Growth:  earnings growth is a primary driver of stock prices – emphasis is placed on upward earnings revisions and surprises and an earnings growth rate well above average
    • Consistent Profitability:  consistent profitability is a sign of well managed company – emphasis is placed on five years of pre-tax earnings growth consistency
    • Reasonable Valuation:  we ensure that a company is not overvalued compared to its earnings growth and liquidation value – emphasis placed on the PEG Ratio and the Cash Takeover Value of the company
    • Industry Leadership:  companies that are financial leaders in their industry provide a level of safety – emphasis is placed on ROE, Operating Margins, Yield, and Price to Sales
    • Investor Sentiment:  companies tend to go in and out of favor, and their stock prices reflect these swings – emphasis is placed on superior past price performance with increased emphasis on the most recent three months
  • The emotional swings of the stock market that drive stock prices to new highs and new lows not supported by fundamentals, over time, cancel each other out.  By focusing on earnings growth, we are able to provide better-than-peer and better than benchmark returns for clients.
  • We also select companies to include in client portfolios from certain special situations:  cash flow generators, turn around situations, and commodity stocks.  When purchasing companies in these situations, we try to incorporate as much analysis from our Earnings Growth model as possible.

 


Fixed Income Investments

  • Determining the need for tax-exempt income is the first step in our fixed income management process.
  • We then build the fixed income portfolio, selecting securities from among:
    • AAA Rated Insured Municipal Bonds, if tax-exempt income is appropriate
    • AAA Treasury and Government Agency Securities
    • Investment Grade Corporate Bonds
    • Fixed Income Equivalents, where appropriate – REIT’s, MLP’s, Royalty Trusts, and equities with high dividend payout ratios


 


Mutual Funds

Our managed mutual fund portfolios are designed to reflect our views of the financial markets as detailed in our published Investment Strategy.  They utilize no-load mutual funds, and our fee schedules are discounted from those of individually managed security portfolios to reflect that the funds themselves charge management fees.  We compare performance to blended indices to ensure that our mix of funds is performing as desired. 

 

The portfolios are designed to span the risk/reward continuum, and utilize a properly diversified mix of equity and fixed income funds. 

  • Equity funds incorporate both growth and value styles; large-, mid-, and small-cap; and domestic and foreign.
  • Fixed Income funds incorporate short-, intermediate-, and long-duration, domestic and foreign.

 


Portfolio Management


We manage portfolios around the following mathematical targets:

  • Asset Allocation:  we monitor a portfolios current asset allocation, making changes as needed to realign the portfolios to target asset allocation
  • Equity Investment Style: one consequence of our Earnings Growth model is that we tend to favor Growth companies over Value companies in client portfolios.  Our target for fully diversified portfolios is 75% Growth and 25% Value, with the value companies being selected from the special situations above.  For clients that choose a portfolio that is not fully diversified, this measure will not apply.
  • Equity Capitalization:  historically, small- and mid-cap stocks have outperformed large-cap stocks and provided much needed diversification.  Another consequence of our Earnings Growth model is that it tends to favor small- and mid-cap companies that have higher levels of earnings growth.  Our target for a fully diversified investment management portfolio is 50% Large-, 30% Mid-, and 20% Small-cap stocks.  For clients that choose a portfolio that is not fully diversified, this measure will not apply.  For traditional trusts, our target is 70% Large-, 20% Mid-, and 10% Small-cap stocks.
  • Equity Domestic/Foreign Allocation:  historically, foreign stocks have outperformed domestic stocks and provided much needed diversification.  Our target for a fully diversified portfolio is 75% Domestic and 25% Foreign.  For clients that choose a portfolio that is not fully diversified, this measure will not apply. 
  • Equity Earnings Growth:  Our target for the equity portion of a fully diversified portfolio is to have earnings growth average in excess of 15% for portfolio overall.  For clients that choose a portfolio that is not fully diversified, this measure will not apply. 
  • Relative Equity Earnings Growth:  Our target for the equity portion of a fully diversified portfolio is to have relative earnings growth average in excess of 125% of the S&P 500’s earnings growth for the portfolio overall.  For clients that choose a portfolio that is not fully diversified, this measure will not apply. 
  • Portfolio Valuation:  We utilize the PEG Ratio for the portfolio overall and compare it to the S&P 500’s average PEG Ratio.  Our target for the equity portion of a fully diversified portfolio is to have its PEG Ratio be no more than 90% of the S&P 500 PEG Ratio.
  • Equity Sector Targets:  Based upon our published Investment Strategy, we overweight or underweight equity sectors to enhance returns and manage risk.
  • Diversification:  In order to minimize the risk of loss from company-specific events, we maintain positions of no more than 4% of portfolio value in any one company

 


Purchase Strategies

We purchase investments with the expectation that they will be long-term holdings in client portfolios.  When we make a purchase, we determine if we want to purchase it at the current market price because it is a good buy at current levels, or alternatively we enter a Good-Till-Canceled purchase order at a price below current levels. 

 

We set a target price for the stock based upon estimated earnings and valuations, determine what our potential appreciation is, and in many cases set a stop loss to protect the portfolio from the impact of some unforeseen negative information on a new holding. 

 

During a volatile market or a highly appreciated market, we may look to build a position in a stock in client portfolios.  We may purchase a few small lots over time to protect against sudden downturns in the broader market or a correction in a market sector.

 


Sales Strategies

There are a number of reasons that we might sell a holding when we deem it to be appropriate:

  • The stock has achieved its price target and we do not see adequate additional appreciation potential to justify holding it
  • The company’s earnings growth has slowed
  • The company reports earnings below estimates
  • The company has balance sheet problems
  • The industry sector has fundamental problems
  • The stock has dropped below some major technical level
  • We were unable to build our position in a stock due to market movements
  • A stop loss triggers a sale

 


Risk Management

When we determine it to be useful, we utilize stop loss orders in order to protect portfolio positions, based upon the most appropriate of the following:


·        New Purchases:  a stop loss set at 8% below purchase price or set at 1/3 the potential appreciation below the purchase price, providing a 3-to-1 reward-to-risk ratio

  • Existing Holdings:  a stop loss set below an appropriate technical price level, a price that represents a 3-to-1 reward-to-risk level on a revised target price for a holding, or at an original target price can protect a gain in a holding from being erased when sentiment turns negative but fundamentals remain positive:
    • 13-, 22-, 50-, or 200-day Moving Average prices
    • Bollinger Band mid-point or lower-band
    • Fibonoci Retracement Levels of 23.6%, 38.2%, 50%, 61.8% and 78.6%
    • When revising a target price for a holding, we may set a stop loss at 1/3 the potential appreciation from the revised price below the current price, providing a 3-to-1 reward-to-risk ratio
    • Original Target Price stops may be used for stocks that have exceeded their original target prices but either
      • a new target price has not yet been established or
      • the stock has been designated as a candidate for sale but we believe there may continue to be some near-term upside potential price appreciation

 


Benchmarks

In evaluating our performance, we compare our returns to those of established indices, which are consistently applied each reporting period.

  • Wilshire 5000 – the most encompassing of equity benchmarks as it includes large and small cap stocks as well as foreign ADR’s
  • Merrill Lynch Corporate & Government Bond Index – for comparison of fixed income management performance
  • Bond Buyer Muni Index – for comparison of tax exempt income management
  • 90 Day T-Bill Index – for comparison of cash equivalent management

2006-12-12 :: Catching Up

Tuesday, December 12th, 2006

Hi there!  Its been about a month since I last posted on the blog, so if you’ve been getting frustrated by the lack of communication, you have my sincerest apologies.

Its been a busy Fall at BankChampaign.  We have gone through a reorganization to better realign the bank for the coming years, plus Andy and I have been studying after work and on weekends for a new certification.  So, my normal blogging hours have been supplanted by hours keeping my nose in a study manual.

Anyway, I thought you might like to hear that as part of the reorganization, we are hiring a new VP of Trust Administration to assist me.  His name is John Clausen, and many of you will recognize that he is Dean’s son (Dean being our President).  John is an attorney in Champaign, and his focus will be on handling the account and department administrative issues related to my business, as well as starting a formal Financial Planning division.  This should offer us the opportunity to provide additional and expanded services to our clients, as well as allow me to focus on the strategic issues of our business.  In particular, I am going to focus on providing more consistent communication of investment strategy to clients.  This means both in this blog, in a more frequent newsletter, and in personalized written investment reviews for client portfolios.  Andy will relinquish most of his administrative responsibilities and focus on investment communications.  We’ve also shuffled our operations area and added an Operations Officer, Shirley Thornton, who has worked in and out of my Trust and Investment area for the last 10 years.  All in all, 2007 will be the year of improved customer service and a return to our outperformance, from an investment standpoint.

2006 has been a tough year for my investment methodology; it has been the year of the index as index and index-like investing has outperformed everyone like me that buys companies based upon growing earnings.

I’ve posted the graph above which shows the performance of my proprietary Earnings Growth Model compared to the S&P 500 over the last several years.  Those of you that have been clients for several years know that 2006 is not a typical year for us.  My system ranks stocks based upon Earnings Growth and Valuation.  It is a fairly technical mathematical model and includes a number of factors, weighting the 7500 stocks traded on Wall Street from 100 (best) to 1 (worst).  

Fortunately, in the long run, earnings and valuation are the two things that create investment  performance.  Unfortuantely, there are limited periods of time where index-style investing, where the large institutional investors simply buy the megacaps that drive the capitalization-weighted indices and ignore the fundamentals of the companies themselves.  This has been one of those time periods, at least since May 12th when everything changed as the large institutions began to become afraid of the impact that the Fed’s interest rate increases.  At that time, they began to move into the index as a flight to safety.   That type of wholesale liquidation of a portfolio and reinvesting into index members isn’t practical or prudent for individually managed portfolios.  So, you just have to hang on for the rollercoaster ride.

You can see on the graph that up until May 12th, we had spiked ahead strongly this year, but then took a tumble through the end of September.  Since the end of September, we’ve been moving back to catching up with the index for the year.    We have started to see that earnings and valuation are starting to take over from index-style investing, although  this can  have short-term reversals, in the long-term earnings and valuation will always be the winning strategy.

In a separate posting, you will find  our Philosopy and Practice.  I thought it might be interesting for those of you that have never seen this to understand how and why we do what we do.

If I don’t talk to you prior, have a very Happy Holiday season.

Mark