Intelligent Speculator

Out of the news last week was a subject that was barely discussed given everything that has been going on in the markets, the creation of yet another Sovereign Wealth Fund, this time by the French government.  Its main goals are of course to increase its value but also to “stabilise the capital of French businesses”. It will start off with 20 billion Euros, not bad for a new fund.

This tendancy has became very popular in recent years as more and more countries have created funds that do look for returns but are also set to look out for the national companies. The mainstream media has been mainly discussing the funds based in the middle east because they perhaps make better stories to tell and certainly bring a lot more controversy. But still, the creation and growth of these funds brings up a lot of questions about how much power we are giving these governments.

If globalization has so many benefits, why do governments feel like they need such entities to protect their national treasures? It is ironic that the same governments that are always discussing the importance of the free markets are also creating such funds, that are basically built to help the government stage interventions when it does not like what the free market is bringing (“protect strategic French assets from predatory foreign investors”).

And to all of those who say that at least the US government is not setting up such, it might be true on a federal level, but many states such as Alaska are slowly building up such funds. Sure, national pension funds have been around for ages but except for a few exceptions, they were managed in a very similar way to private funds, basically looking for return and trying to manage future outpayments. But these “Sovereign funds” generally have missions that are outside of risk/returns and more lied to restoring or maintaining national pride or seeking national objectives.

And let’s not forget that it is very far from clear that such funds comply with national free trade treaties as when foreign companies try to merge or make hostile bids, counter offers by national funds are often on a grey line legal-wise.  Not surprisingly, the EU has expressed concern over this news. “What is important is that we avoid any kind of protectionism. It would be bad for the country that resorts to it and for Europe as a whole,” Barroso said when asked what he thought about the idea of European sovereign wealth funds. “We are not against nationalising or acquiring a stake in a company but we must bear in mind that competition rules must be respected,” Barroso said. “If each member state were to take protective measures, that could create problems in its neighbours and endanger the single market by fragmenting it,” he added.

Every Saturday, The Intelligent Speculator does a review of good read around the blogosphere. Here’s what caught my attention this week:

How YOUR Saving Advice Caused The Financial Crisis posted at The Shark Investor.

Surprising (and Promising) Aspects of the Financial Crisis posted at The Personal Financier.

Berkshire Hathaway Portfolio Changes for the quarter posted at Dividend Growth Investor.

Financial issues impacting individuals beyond just the stock market. (KCLau’s Money Tips)

Inflation protection strategies for ones portfolio. (FIRE Finance)

Investing School covers a basic tenant of the stock market by explaining the Price to Earnings Ratio (P/E).

Is your 401(k) account safe. (The Digerati Life)

Stock Analysis: Canadian National Railway Company (NYSE:CNI) A Value Buy, But Not a Dividend Buy posted at Dividends 4 Life.

Carnivals:

Festival of Stocks

Carnival of Investing

Carnival of Personal Finance

Carnival of Money Hacks

Just before discussing Valueclick, I want to do a quick comment. Last week, we had suggested going long Baidu (BIDU) against a short on Yahoo (YHOO) and while like all pics on this blog, it is a long term play, the investment returned 27,52% in 1 week* and so I would cut half of my position to take the profit, it’s a major move for a one week investment and so locking in part of it makes sense in my opinion.

*Since this trade involves no cash, we calculate return with the locked up amount on such a trade (70% of the short position).

Now back to the main subject here:

Talk about a stock getting hammered right? And for good reason. Valueclick, one of the dominant companies in the online advertising world from 4-5 years ago looks like it is slowly being swallowed by Google and others and lost a lot of its innovative power. Valueclick had most of its growth thanks to many acquisitions that have been key as they purchased assets such as Commission Junction, Fastclick in the past few years.

That gave the company an opportunity to profit in many ways. Of course, they were now able to offer advertisers access to different technologies, a much more diverse content and to do cross-selling for advertisers that would wish to combine branding, lead generation, etc. But Valueclick Inc. has been very disapointing as they have not been generating much innocation in their products which has reflected in their numbers as revenue has been flat to down in the past 2 years, something that is just not acceptable in a field that has been growing so fast. Sure, the latest quarter has seen slower growth across the industry, but in an industry that is growing at about 20%, it raises a lot of questions to see Valueclick being unable to join the growth story.

One positive in Valueclick is that they have no long term debt (have not had in their history I believe) and they are still buying back their stock believing it is cheap. It might be since it is trading at an 8 PE ratio and if it could present a more detailed idea of its future, that could make it a very attractive price at this valuation.

Another reason to own Valueclick would be based on the possibility of it being acquired. This has been in the rumors for a long time now and frankly I’m surprised it has not happened yet, but the major decline of the stock might make this possibility a lot easier for a cash rich company like Microsoft who is looking to increase its presence in the online advertising world to compete with Google.

So I would own this stock but would hope for either an acquisition rumor or a detailed plan. This would be based a low valuation and very limited downside because of its strong balance sheet.

In Millions of USD (except for per share items)	3 months Ending 2008-09-30	3 months Ending 2008-06-30	3 months Ending 2008-03-31	3 months Ending 2007-12-31	3 months Ending 2007-09-30
Revenue	152.9	163.83	176.03	183.12	156.89
Other Revenue, Total	-	-	-	-	-
*Total Revenue *	*152.90 *	*163.83 *	*176.03 *	*183.12 *	*156.89 *
Cost of Revenue, Total	53.72	51.7	55.11	58.05	50.45
*Gross Profit *	*99.18 *	*112.13 *	*120.92 *	*125.08 *	*106.44 *
Selling/General/Admin. Expenses, Total	90.59	66.32	73.36	78.86	64.67
Research & Development	12.38	10.16	9.96	9.57	8.72
Depreciation/Amortization	7.14	7.78	7.76	7.98	6.73
Interest Expense(Income) – Net Operating	-	-	-	-	-
Unusual Expense (Income)	-	-	-	0	-
Other Operating Expenses, Total	-	-	-	-	-
*Total Operating Expense *	*163.83 *	*135.96 *	*146.19 *	*154.47 *	*130.56 *
*Operating Income *	*-10.93 *	*27.87 *	*29.84 *	*28.66 *	*26.33 *
Interest Income(Expense), Net Non-Operating	-0.37	1.41	3.05	2.8	2.94
Gain (Loss) on Sale of Assets	-	-	-	-	-
Other, Net	-	-	-	-	-
*Income Before Tax *	*-11.29 *	*29.28 *	*32.89 *	*31.45 *	*29.27 *
*Income After Tax *	*2.00 *	*16.49 *	*19.17 *	*17.52 *	*16.83 *
Minority Interest	-	-	-	0	-
Equity In Affiliates	-	-	-	-	-
*Net Income Before Extra. Items *	*2.00 *	*16.49 *	*19.17 *	*17.52 *	*16.83 *
Accounting Change	-	-	-	-	-
Discontinued Operations	-	-	-	-	-
Extraordinary Item	-	-	-	-	-
*Net Income *	*2.00 *	*16.49 *	*19.17 *	*17.52 *	*16.83 *
Preferred Dividends	-	-	-	-	-
*Income Available to Common Excl. Extra Items *	*2.00 *	*16.49 *	*19.17 *	*17.52 *	*16.83 *
*Income Available to Common Incl. Extra Items *	*2.00 *	*16.49 *	*19.17 *	*17.52 *	*16.83 *
Basic Weighted Average Shares	-	-	-	-	-
*Basic EPS Excluding Extraordinary Items *	*- *	*- *	*- *	*- *	*- *
*Basic EPS Including Extraordinary Items *	*- *	*- *	*- *	*- *	*- *
Dilution Adjustment	-	-	-	-	-
Diluted Weighted Average Shares	89.96	96.13	98.56	99.24	100.17
Diluted EPS Excluding Extraordinary Items	0.02	0.17	0.19	0.18	0.17
*Diluted EPS Including Extraordinary Items *	*- *	*- *	*- *	*- *	*- *
Dividends per Share – Common Stock Primary Issue	0	0	0	0	0
Gross Dividends – Common Stock	-	-	-	-	-
Net Income after Stock Based Comp. Expense	-	-	-	-	-
Basic EPS after Stock Based Comp. Expense	-	-	-	-	-
Diluted EPS after Stock Based Comp. Expense	-	-	-	-	-
Depreciation, Supplemental	-	-	-	-	-
Total Special Items	-	-	-	-	-
*Normalized Income Before Taxes *	*- *	*- *	*- *	*- *	*- *
Effect of Special Items on Income Taxes	-	-	-	-	-
Income Taxes Ex. Impact of Special Items	-	-	-	-	-
*Normalized Income After Taxes *	*- *	*- *	*- *	*- *	*- *
*Normalized Income Avail to Common *	*- *	*- *	*- *	*- *	*- *
Basic Normalized EPS	-	-	-	-	-
Diluted Normalized EPS	0.02	0.17	0.19	0.18	0.17

You have surely heard this, maybe not in a speculative trading account, but in a RRSP or 401K, it is generally recomended to have a portion of your portfolio in “safe investments”. The basic concept is generally explained as having a more risky portfolio when you are young so that over time you will achieve a higher return. Then, as you age, you increase the proportion of safe investments because if a stock market decline or cash occurs, you will not have as much time to make back the losses and thus not as much acceptance for risk.

The general rule is that the proportion of “safe investments” should be roughly equal to your age. Why do I write “safe investments” between quotes in this article? Because in this current crisis, we are learning a lot about investment and it’s creating a lot of questions about investment and how it should be done.

Why? Simply look at the below graph, UYG is an ETF that tracks corporate bonds. To be fair, it tracks high yield bonds. If you look at LQD, which tracks investment grade bonds (higher quality), their performance has been a lot better (-16% YTD). But still, to many, corporate bonds in general were “safe investments” and I hope that you are not reading this after seeing your retirement fund get crushed because you were holding corporate bonds that did not hold true to their objective (i.e. maintaining their value in a declining market environment). Of course, maybe that only occurs in normal market circumstances and indeed the past few months have not been “normal” by any means. But still, it is good to know and we should now stand as warned.

The blue line in the graph is HYG ETF while the red is the Dow Jones Indsutrial index.

But like most investments, the most important is to not panic. Spreads between corporate bonds and treasuries are in many ways at record levels and as the economy gets better, should improve. It’s not as clear for high yield bonds as some of those will without any doubt suffer from some defaults.  Junk bonds (the most speculative bonds out there) currently trade at a yield of almost 19%, a high since such statistics exist. As the Fed and other central banks fight to improve the liquidity of the system, we see an improvement in those lending conditions for corporate companies worldwide.

Is it me or did October look like it finance and the markets were always in the headlines? Friends, family, neighbors, it seems as though it was everyone’s favorite subject. And how could you blame them? Every day, when looking at a newspaper or any news broadcast on TV, the first story seemed to be a big day on the markets (usually a big DOWN day).

So let’s set a little perspective on the month, was it really that bad? Or was this an exaggeration by the media? Let’s look at a few stats:

Biggest intra-month losses (high close to low close):

Month	Date of High Close	Date of Low Close	Number of Days	High-Low Loss
October-29	10-Oct-29	29-Oct-29	19	-33.69%
October-87	5-Oct-87	19-Oct-87	14	-31.47%
September-31	1-Sep-31	30-Sep-31	29	-30.24%
October-08	1-Oct-08	27-Oct-08	26	-26.88%
May-32	6-May-32	31-May-32	25	-26.60%
March-38	1-Mar-38	31-Mar-38	30	-25.83%
May-40	3-May-40	21-May-40	18	-24.59%
November-29	4-Nov-29	13-Nov-29	9	-22.81%
October-37	1-Oct-37	18-Oct-37	17	-21.57%
September-32	7-Sep-32	19-Sep-32	12	-21.16%
July-33	18-Jul-33	21-Jul-33	3	-20.90%
April-30	2-Apr-30	24-Apr-30	22	-20.53%
October-32	3-Oct-32	10-Oct-32	7	-20.35%

See that? October 2008 is the 4^th on record and apart from one instance in the famous 1987 market crash, all of the other instances occurred before May 1940..! Amazing isn’t it! So seeing that, you can understand why it made the news, the move was truly remarkable.

And another fact, it did not simply occur over a day or two, in fact, if you look at this graph published by the NY Times, you can see that the occurrence of “extreme day movements” is unlike anything we have ever seen in terms of the number of large movements (4% or more, up or down).

So the next time you see some headline about the markets, the apocalypse or anything of that nature, maybe you will know that it’s not as much of an exaggeration as you might think. Sure, it helps sell newspapers and magazines and to get good tv ratings, but it’s not all bluff.

In fact, it’s been interesting to see a lot of professionals, people who invest for a living, and who do not dare enter the market right now, simply because there is so little that is rational, which makes it very difficult to take a position. You might think that a stock is cheap under fundamental criteria’s only to see it decrease by a further 10-20%. You might make your money back soon, and might even be ready to take the risk, betting on a long term return. But any investor would still be looking for good entry points, and it’s difficult to know how you could determine where that would be….

I guess one of the better points of all of this is that we are all learning a lot of valuable lessons, and since it’s never too late to start learning and improving…

How low can the Dow go?

Make no mistake about it, the market action on Wednesday (November 19th) was extremely negative for all of the indices that we track. The close below 8,000 on the DOW can only be described as negative, indicating further weakness to the downside. I am looking for this index to trade down to around the 6600-6700 level.

Check out INO TV new video (it’s free!!) and see exactly where we got out of the indexes and were we see them headed right now…

Enjoy the video

Every Saturday, The Intelligent Speculator does a review of good read around the blogosphere. Here’s what caught my attention this week:

Zach Stocks is reviewing Petrohawk Energy Corporation (HK)

Fire Finance tells us Which Stock Market Indexes to Choose

Dividends4Life presents Searching the World For The Best Dividend Stocks

ABCs of Investing believes Timing the market is only a viable option if you know the risks!

PennyJobs.com presents Not Even Warren Buffett Can Escape the Economic Crisis.

FMF presents Why I Sold My Mutual Funds

Group presents How to Make Money by Laddering Covered Calls

Carnivals:

Carnival of Money Hacks

Carnival of Personal Finance

Investing Carnival

The credit crunch, we’ve heard about it time and time again right? And the main problem of it all has been generally put on the collapse of the US housing prices. You would think that could have a major impact on the US consumers. For over a decade now, a major part of the growth of the US economy has been coming from the important sums of money that the US consumer has taken off from their house as they took more and more debt. While the values of their houses (and thus assets) increased, it was not a problem. But it’s been a rising problem for some time now.

Yes, it’s all obvious, I know. But then explain to me one thing. How is it possible that Reuters is reporting now, in mid-November, that US banks are tightening credit card lending..? Really? Did it take this long for banks to notice that a major part of their clients would be unable to pay back their credit card debt? How is it that a bank will give a credit card to clients that already have over 10 cards with each of them having nearly 2K on them? Seems incredible to me and yet that is exactly what happened. They are now cutting back but it’s probably a little late to start doing this as they probably have quite a few clients that have been living on their credit cards for months now.

American Express(AXP.N), perhaps the lender with the highest earnings clients, was hit hard in its latest earnings as profits fell 37%. American Express chief executive Kenneth Chenault said last month that defaults in June had worsened beyond his expectations. And as you go from the American Express’ high end clients to clients that are less “wealthy”, the impact becomes even more important. JP Morgan said: “Given the potential stress on the consumer from rising unemployment, the continued downward pressure on housing prices and the elevated national inventory of unsold homes, management remains extremely cautious,” the bank said in the filing.

It seems as though the banks will have some trouble in this area for months to come and if they are currently starting to set more controls or to limit credit lines for some clients, you would tend to think that there will be some bad surprises for at lease a couple of quarters in this field, which gives us one more reason to be wary of investing in the financials.

One way to play this might be to be long regional banks (who are not as involved in consumer credit generally) against the established and general finance sector (XLF).

Any thoughts?

Have you ever heard of Baidu.com? Kidding right? You have never heard about the fourth most used search engine (according to Alexa.com)? Ok, I can see how the website being Chinese might explain part of it…:) Baidu made a big splash a few years ago when it was deemed the next Google and rose over 200% after its IPO.

Since then, it has been experiencing the growth you would expect from China’s top engine and its revenues have increased as well. They increased by over 100% last year. Just look at its latest income statements:

	FQ3 2008	FQ2 2008	FQ1 2008	FQ4 2007
Revenue	134	115	80	77
Revenue Growth	16.49%	43.92%	4.36%	16.94%
Gross Margin	66.34	64.99	60.20	62.17
Research & Development	11	10	7	6
R&D/Sales (%)	8.51%	8.86%	8.95%	8.15%
SG&A	35	35	28	24
SGA&/Sales (%)	26.27%	30.56%	34.55%	31.30%
EBITDA
EBITDA/Sales (%)	0.00%	0.00%	0.00%	0.00%
Operating Margin	40.07%	34.43%	25.66%	30.87%
Pretax Margin	36.10%	34.22%	33.61%	35.32%
Tax Rate	5.38%	2.80%
Net Margin	37.85%	33.02%	25.52%	38.50%
EPS excl Extraordinary Items (not diluted)	1.4839	1.1124	0.60	0.87
EPS Growth (%)	33.40%	85.83%	-31.53%	23.54%

---

Baidu is certainly a major growth story, however it got slammed by a major drop of 22% in the markets earlier this week when some reports out of China reported that it was doing something that even in China is considered to be very serious. When you searched for certain medications on their search engine, you would see results on the first page not of legitimate companies but of sellers of knock-offs, that were illegal. Bad? Yes, very. And this will certainly bring some legal issues to Baidu as well as bring a lot of other questions about its policies and how it is generating its revenues. But I still consider Baidu to be an attractive investment, mainly for these 2 reasons:

-Let’s not forget where this company operates: China. While the reportred practice is serious and would certainly bring massive problems to a US company, in China the playing grounds is very different as rules are not as clear and not as applied. What Baidu did was certainly illegal but we should not judge Baido according to US laws only.

-Its valuation has become very very attractive. Depending on what dates and estimates you are looking at, Baidu is trading at similar P/E ratios as Yahoo, which to me seems incredible when we look at the fiasco that Yahoo is in. Baidu has a terrific market position in perhaps the world’s top growth market, not exactly the declining market share & flat revenue position of Yahoo.

So overall, while it is certainly important to consider the impacts of the legal issues that Baidu is facing, I do consider Baidu(BIDU) to be a BUY. It could even be bough while going short Yahoo(the major risk to that would be a surprise new bid by Microsoft for YHOO).

Nortel Networks is one of those companies that has so many stories associated with it. Based in Canada, it profited greatly from the technology boom in the early 2000’s and among other things, was part of the huge infrastructure boom of fiber optics. And while many of the similar companies went under, a few survived but they seem to be stuck in a restructuring mode and seem to always be in catch-up mode. Now, one of the tough parts to value (as is the case for the auto industry in the US) is how a possible government intervention could be structured and what it would mean for the common stock value. At its height, Nortel (NT) was worth an amazing 10% of the TSX60 index and has a symbolic value that could help the Canadian government help it out.

Last week, Nortel released its latest earnings and it wasn’t very nice. In fact, it was so bad that the stock continued to tumble and got a price target of 0$ by RBC analyst Mark Sue. Sure the company still has a lot of cash, but it is going through it at a worrying rate and RBC anticipated it could be down to some trouble by the end of next year. With a company down 95% from its high, revenues declining and employees being laid off, it’s certainly not looking very bright in Nortel’s future. “Without government intervention or major financial sponsors, Nortel may run of out cash before its $1-billion, 2011 bonds mature,” Mr. Sue said. “Our price target of $0 represents our belief that bankruptcy is a distinct possibility and common shareholders are last in line.”

If you compare the numbers ending September 30th 2008 to the numbers for the 3rd quarter of 2008, you will see lower revenues, a lower gross margin, as well as an important loss of $3,5B

And with the current economic problems, it’s difficult to think that there will be a big turnaround for Nortel. But still, a major part of the value of Nortel is because of the expected bankruptcy, but in the case where it could escape that ending, it could be worth a lot more. “It’s either worth $0 or it’s worth a lot more, and I think it’s worth more,” he said. “They have invested $20-billion in research in the last 10 years. I know people have been disappointed for the better part of 10 years, but there’s better value here than the stock is implying.”

Still, in my opinion, it’s better to stay away from NT for the time being, it’s just too difficult to trade on hopes of government interventions as they can be done in ways that can make the stock worthless, or in ways that could improve the value of equity, you just never know.

Another great week of fluctuation has past and good stock picks are all over the place. The real question is “when the market will get rid of that big fat bear?”

Every Saturday, The Intelligent Speculator does a review of good read around the blogosphere. Here’s what caught my attention this week:

Nurseb911 presents Taking Stock in MFC: posted at Triaging My Way To Financial Success

Dorian Wales presents Review: The Gone Fishin’ Portfolio by Alex Green posted at The Personal Financier.

D4L presents Stock Analysis: Emerson Electric Co (EMR) posted at Dividends4Life.

Nucor Corporation (NUE) Dividend Stock Analysis posted at Dividend Growth Investor.

How Is What We Are Going Through Now Different From The Great Depression in the 1930’s? posted at My Investing Blog.

How an $800 Tax Bill Taught Me Not to Be a Greedy Idiot posted at The Money Hawk.

Carnivals:

Carnival of Investing

Carnival of Personal Finance

Festival of Stocks