Bank of America Dividend Yield Sits Far Above 30-Year Bond

Bank of America (BAC) is not a stock that has gotten my attention very often in recent years, but last week after the shares dropped to $47 and the company boosted its dividend yet again, I switching into the bullish camp (from neutral) for the stock.

BAC currently yields 5.4%, which is about 50 basis points above the 30-year treasury bond. That also equates to a trailing P/E of 10 times. I am very much aware that investors are spooked about mortgage lending and financial market exposure with the big banks, but compared with larger rivals JPMorgan Chase (JPM) and Citigroup (C), Bank of America has less exposure and should fare better should credit issues persist or get worse from here. Not only do they tend to avoid the very low end of the credit spectrum in the mortgage area, but a smaller portion of their profits come from financial markets than the others.

Given where the stock trades, and the enormous dividend yield, I doubt the stock has big downside potential from here, and if the current worries prove to be overblown and BAC's earnings growth continues, you could get decent capital appreciation in addition to your more than 5% annual payout.

Full Disclosure: Long shares of BAC at the time of writing

Just Don't Panic

On days like this the best advice I can give is, don't panic. Panic selling just because the market gets a little scary will, more often than not, prove to be a big mistake. Every once in a while the psychology of the market takes over. Regardless of fundamentals, stock prices simply move in irrational ways. The best thing to do is simply sit tight and wait it out.

This is not to say that every stock's move lately is irrational, but a company can post strong earnings, have a good conference call, get a nice stock price bump, and then a few days later the market tanks and the shares are much lower than they were before. In the short term, psychology always trumps fundamentals.

However, if you've done your homework and are confident in your investment thesis for particular names, just wait it out. You can add to positions if you want, but that can be hard in a tape like this. Selling into the panic most likely will cause you to have called the bottom and not profited from it.

Are there any real contrarian buys out there? I would not try to bottom fish in the mortgage area. There will be a point in time where Countrywide (CFC) is a buy, but I think we have a long way to go. It looks like the housing market won't improve much, if at all, in 2008. I think it's too early to jump in.

That said, the reason why CFC will be a buy at some point in the future is because of the valuation. Unlike the brokerage stocks, which could be facing peak earnings, Countrywide is staring at trough earnings and the stock still trades at a 10 P/E. It could certainly get worse before it gets better, so CFC's recently reduced 2007 guidance of $3.00 per share might be too high. Who knows, maybe they'll earn $2.00 when it's all said and done, which means there is plenty of downside left. Until housing stabilizes for a long period of time and inventories diminish, I would stay away.

All in all though, just don't panic. We've gone through periods like this before (earlier this year in fact), and things always wind up being okay longer term. Unless we see serious and sustainable ripple effects in the economy from the housing market, I am not overly concerned. However, patience is required during times like these more than others.

Full Disclosure: No position in CFC at the time of writing

Akamai Crushed, Outlook Still Attractive

This will be a fairly short post since I had no plans to write about Akamai (AKAM) today, but after reporting in-line earnings this streaming video content provider is getting slammed to the tune of 18% this morning to $38 and change. Akamai is one of those high multiple growth stocks that everyone expects to beat numbers every quarter. After meeting expectations and guiding in-line for the third quarter, analysts are downgrading and investors are fleeing.

I think the sell-off is overdone and I am initiating some positions this morning. The company's fundamentals remain strong as online video has years of growth ahead of it. All of the sudden the stock trades at only 23 times 2008 earnings. For a growth stock like AKAM, I think that is a bargain. Many investors will worry about margin pressures and such since it appears they are giving price discounts for long-term contracts, but most likely the company is just being conservative.

Given the market they serve and their leadership position, I think a 23 forward year multiple for the stock is pretty cheap. These are the types of earnings season sell-offs that I often like to play on the long side. AKAM shares weren't worth the price at their highs ($57), but now that they are down 35% to $38, I think that falls into "growth at a reasonable price" territory.

Full Disclosure: Long shares of AKAM at the time of writing

Consider Natural Gas ETF for New Energy Investments

Quite predictably, crude oil has been on a roll in recent weeks as the summer driving season has driven seasonally strong performance. With oil trading around $75 per barrel, fresh money investments into the energy sector might not be ideal at these prices. Don't get me wrong, I am still bullish on oil in general, but investors should not jump on the energy bandwagon with new money when we are in the middle of peak oil season.

For new money right now I would suggest investors take a look at natural gas. In fact, in mid April a new ETF was formed to track natural gas prices. Even while oil has soared from the low 60's to the mid 70's, natural gas has collapsed from more than $8 to below $6. Another non-existent hurricane season has contributed to the drop, but natural gas prices will remain volatile in the future, and given the weakness lately, it appears to be an attractive entry point.

The natural gas ETF trades under the symbol UNG and has plummeted from above $54 to $38 in the last couple of months, as you can see from the chart below. After a 30 percent drop, I think it looks attractive for investors looking to add some energy exposure but are wary of buying crude oil stocks at current prices. You can also play this via unhedged natural gas producers, but since this ETF is new, I figured I would point it out as another potential investment vehicle in the space.


Full Disclosure: No position in UNG at the time of writing

Why Would a CEO Stick with Quarterly Guidance?

I read an interesting take on this question today and I think it has a lot of merit. While many of us would prefer public companies abandon quarterly guidance, there are reasons why a CEO would keep giving it out. One reason might be to make them look good, and therefore enhance their job security.

If you are an active investment manager (whether for personal assets or professionally) you have likely observed in recent years that a pattern has developed during earnings season on Wall Street. Companies tend to beat estimates for the most recent quarter and guide estimates lower for the current and/or future periods. The end result is that most quarters finish with earnings coming in ahead of estimates on the whole.

While stock prices might dip in the short term because investors care more about future guidance than earnings already booked, this practice sets the bar very low. By keeping expectations meager, it maximizes the odds that the company will beat numbers next quarter, and that makes management look good. Under-promise and over-deliver ("UPOD" as Jim Cramer calls it). It works, and it's what public companies should do in general (although maybe less often than every three months).

I think this is a great explanation for why many companies will keep playing the guidance game. It sets the bar low, makes them look like they're doing a good job running their companies, and boosts their job security. If you don't give guidance at all, the analysts could set the bar too high, forcing you to miss numbers and get an earful from investors.

How can investors play this growing trend? Buy stocks after a post-earnings sell off due to a guide down. After the company sets the bar low, investors adjust their valuations accordingly. Over the next couple months, Wall Street will realize the numbers are too low and the stocks will get a boost as strong performance is priced in again. Use that strength to pare off positions before the next earnings report if you think they might be lackluster or conservative.

That seems like the best way to trade the ever-growing trend of beating earnings and guiding lower for future quarters.

Seagate Adopts Baffling Policy on Financial Guidance

I am sitting here listening to the second quarter conference call hosted by Seagate Technology (STX), the world's leading provider of hard disk drives for the consumer electronics industry, and I just had to write a post with the audio going in the background. Seagate CEO Bill Watkins has just announced that his company is changing their policy on company guidance.

I have written on this blog before that financial guidance is very overrated. Many companies have abandoned giving guidance completely (kudos to them) and others have at least stopped giving quarterly projections. So, I was expecting STX to either cease quarterly guidance and give only annual projections, or to halt guidance completely. Wrong on both counts!

Seagate will now give only quarterly guidance. Are they kidding? The whole point of stopping quarterly guidance is to focus management on the long term and not put them in a situation where they might take actions just to hit a number in the short term. Now they are embracing three-month projections?

I understand them not wanting to give out annual projections. The disk drive business is very hard to predict, as it is largely a commoditized market. Supply and demand, and therefore pricing, is tough to gauge over long periods of time. Essentially, STX management is saying they have no idea what they will earn in fiscal 2008 (which began on July 1st).

If you are going to ditch giving guidance, then stop giving guidance! It seems very strange that they say they are focused on the long term, but yet are still going to predict sales and profits every three months. They should have just stopped guidance altogether.

Full Disclosure: Some Peridot clients have positions in STX, but those positions are under review

How Relevant is Dow 14,000?

The move from Dow 12,000 to Dow 14,000 has been pretty stunning. How relevant is that index though? We can argue that it is heavily weighted towards mega cap stocks, and that is true, but so is the S&P 500 since it is market cap weighted. Some of you may not be aware of this, but the Dow Jones Industrial Average is not market cap weighted. Instead, it is share price weighted.

This serves to make its moves pretty much irrelevant in terms of gauging the market's overall health. A one dollar move in Boeing (BA) has the same effect as a one dollar move in Microsoft (MSFT), even though Boeing trades over $100 per share and MSFT shares sell for $30 each.

What is the end result of this pricing method for the Dow? Boeing has more than 3 times as much influence as Microsoft does, and the same pattern holds for any other Dow component. In fact, materials and industrials account for a whopping 35% of the Dow Jones Industrial Average due to their high share prices (which may not be shocking given the name of the index).

Those two groups have been leading the market higher, so it is not surprising that the Dow has been soaring. On the other hand, financial services firms have been lagging this year, but they only account for 14% of the Dow, more than 30% less than their weight in the S&P 500. Dow 14,000 is a nice round number, but it really doesn't tell us a lot about the market as a whole, only certain sectors that dominate its composition.

Should We Invest in Unethical Companies?

I had a telephone conversation last week with a new client and one of the questions he had for me was, "Do you invest in unethical companies?" He was speaking about Wal-Mart (WMT) specifically, it turns out, but there are a lot of investors who avoid buying shares in companies with which they disapprove of their products, their way of doing business, or both. Common examples include stocks with ties to alcohol, tobacco, firearms, casinos, Mideast oil, etc. It was a good question and one that I don't think I've addressed on this blog before, so I figured I would give my perspective.

Before I get into an explanation, the answer to this question is yes, I will buy shares in the likes of Anheuser Busch (BUD), Altria (MO), Halliburton (HAL), Wal-Mart, and MGM Grand (MGM) if I think the stocks are good investments. This assumes of course that the client is okay with this. If a client does not want to own certain stocks, I have no problem following their request.

The issue here, in most cases, is whether or not you want to support companies like this if you disagree (insert a stronger word here if you prefer) with what they stand for. Many people equate buying stock to supporting a company. The reality though, is that Wal-Mart does not benefit in any way if I were to buy 100 shares of their stock. That action simply results in one of their current investors transferring their shares to me, in return for cash. Wal-Mart does not benefit monetarily from that transaction. After an initial sale of common shares, the money changing hands is between individuals, so the company is out of the picture.

I have no problem ceasing support for companies I don't like. However, if I wanted to stop supporting Wal-Mart, for example, I would simply choose to never again set foot in one of their stores. No longer shopping there is adversely affecting their business. Not investing in their stock is not having the same effect. Since my job is to make money for clients, I will generally invest in the stocks that I feel can accomplish that goal, regardless of whether or not I like the underlying firms or not.

This reasoning of course assumes that you are not buying shares in an IPO or a new offering of stock through which the firm is directly receiving the proceeds from the sale. In those cases, not buying the stock does have an impact on them, even though there will always be someone else willing to invest even if you're not. Still, it's the principle that is important.

Full Disclosure: No positions in the companies mentioned at the time of writing, but not for the reasons discussed above :)

I Hope Eddie Lampert Is Mulling a Deal

What could be worse than trying to turn around Kmart and Sears? The only thing I can think of is trying to do that when the low end consumer is being squeezed from all angles and the housing market is weak. Today's earnings warnings from Home Depot (HD) and Sears (SHLD) aren't that surprising when we look at the macro view of the economy domestically, but even still, the Sears number was pretty bad and Home Depot only escaped a wrath of selling because of their enormous buyback. Sears announced a $1 billion buyback, but that is just a drop in the bucket for them (4% of shares outstanding).

Home Depot got lucky. They timed the sale of their supply business well enough that they can just use that money to buyback shares above the market price and keep their stock up even when earnings are declining. Sears has a problem, though, in that it hasn't diversified yet like everyone thought it would. The Kmart/Sears merger was supposed to be about real estate, excess cash flow, making more acquisitions, becoming the next Berkshire, etc. What happened?

Well, Eddie Lampert decided to try and fix the retail business as best he could. That's a perfectly fine idea (just look at what JC Penney has been able to do over the last five years and you'll see retail turnarounds like this do happen) but given we have the low end consumer getting squeezed and a weak housing market (which just happen to be the two core focuses for Kmart and Sears), the fact that Lampert hasn't diversified Sears Holdings yet is a problem right now.

Long term investors (myself included) likely aren't overly concerned because they know the retail weakness won't last forever, and they know Lampert has other ideas for excess cash. But, given the stock price weakness lately, he really needs to do something to get the shares moving again, a la Home Depot. So what should he do?

Quite simply, a deal, any deal. I don't mean just any deal that happens to be available (it has to make sense), but it also does not have to be an outright buyout of another company. Surely Wall Street would applaud the purchase of something at a bargain basement price, preferably outside of retail completely, but even an internal deal could boost shareholder morale.

The most logical would be a large real estate deal like many investors have been hoping for since Lampert bought Kmart out of bankruptcy and leveraged that stake to takeover Sears. Eddie hasn't sold underperforming locations as fast as many people thought he might. It is clear he wants to try things before giving up on certain locations. However, a deal to monetize some real estate would accomplish two things that would help the stock price.

First, it would show to investors that the real estate actually does have meaningful value. It has been debated exactly how much the Sears real estate is worth. Everybody has their own forecasts, but in reality, something is only worth what someone else is willing to pay. Selling stores would give investors a way to value that real estate (which is likely understated in most valuation models focused mostly on retail profits) and also show them that Lampert is willing to cut his losses on more stores.

The second thing it would do would be to help the bottom line. Selling underperforming stores not only gives you money to diversify with, but it also boosts your earnings, which are already under pressure due to the economic environment. Surely there are stores that aren't making any money, even after many have been closed. Closing those underperforming locations will help boost retail margins, which would also boost investors' perception of what the company's retail business is worth.

All in all, Sears is in the unenviable situation of trying to turn around a retailer during tough times. Since this makes it harder than usual, if they want to continue down the retail road, it is imperative for the company to make some moves to diversify away from low-end retail and housing. The only way to do that is to free up some cash, or use cash you already have on hand, and do a deal. Either sell some real estate and reallocate that money, or use the money you have now and buy something unrelated to Kmart and Sears.

If Lampert does something like that sometime this year, Sears stock can get moving again. As long as he waits it out, the odds are good that the stock is dead money for a while. I'm confident he will make the right moves, which is why I've owned the stock for years and will continue to hold it, but after Tuesday's earnings warning, I think it is important for him to do something sooner rather than later. If not, he will eventually lose some of his loyal supporters.

Full Disclosure: Long shares of Sears Holdings

2007 Select List Returns +7.3% YTD, Beating S&P

The second annual Peridot Capital Select List, ten stock selections published at the beginning of year, beat out the S&P 500's 6% gain by 130 basis points during the first six months of the year. Troubles at Amgen limited the gains, which without the biotechnology leader would have outperformed the benchmark by more than 50 percent.

Just like last year, a Mid-Year Update has been released this week containing updated views on the ten selections. The report is available for $14.95 to new readers, or $9.95 if you purchased a copy of the 2007 Select List already and would like the follow-up report. To order the report via PayPal, simply visit the Peridot Capital research web site.

Is It Time to Buy Bear Stearns?

Whenever a good company falls upon hard times that could very well just be temporary, it pays for value investors to take a look and see if Wall Street has overly punished the stock. After the hedge fund blowups at Bear Stearns (BSC) recently (they made some bad bets in the mortgage market), BSC stock has retreated more than 30 points from its highs, as the chart below shows.

Is the stock a bargain? Well, I compared it with the other big investment banking companies and I expected to see more of a discrepancy in the valuations than I found. The Big 5 (Bear along with Goldman, Lehman, Merrill, and Morgan) all trade right around 10 times forecasted earnings for 2007. As P/E multiples go, buyers of BSC aren't getting any discount compared with the likes of Goldman Sachs (GS). That didn't exactly get me excited about bottom fishing with Bear.

I also looked at a ratio called price-to-tangible book value. This measure is the same as price-to-book, but ignores intangible assets that can't be easily and quickly valued. Book value is perhaps the most important valuation metric for banks given that the vast majority of their assets are liquid financial instruments and all banks pretty much do the same things business-wise, for the most part.

On this measure Bear Stearns trades at a discount of 1.6 times net tangible assets. This compares with 3.1 times for Goldman and between 2.2 and 2.4 times for the other three major players in the industry. As you can see, investors are paying up for Goldman's superior track record and management. While Bear is cheaper, the stock would probably have to get down to 1.5 times book or less for me to really get excited about it as a contrarian play. That is not to say the discount won't narrow as the sub-prime issues subside, but 1.6 times book isn't a price that I feel like I absolutely need to jump at. It's cheap, especially relative to the other brokers, but not ridiculously cheap by any means.

Full Disclosure: No positions in any of the companies mentioned at the time of writing

Free Round-Trip Airfare from American Express

You may have seen this offer promoted on television commercials already, but if not, the American Express Business Gold Rewards Credit Card is running a limited time promotional offer for new card holders that is hard to beat. Just sign up for a new Business Gold Rewards card and after your first purchase you will get 25,000 rewards points that may be exchanged for one free round-trip domestic flight or a $250 gift certificate to use at any number of popular retailers such as Barnes & Noble, Home Depot, The Gap, Blockbuster, and Banana Republic.

Whether you have a home-based business or you sell stuff on eBay, you can apply for a business credit card. In addition, the $125 annual fee is waived for the first year. If you don't find the card worth keeping, you can always cancel it without paying any fees. To take advantage of this 25,000 point bonus offer, apply now. For more information, check out Hustlerama for more credit card bonuses.

Note: Web site reviews and special offers appearing on this blog may be sponsored by a third party. As a result, the author may have been compensated for the post.

For a 40% Premium, How Could Hilton Say "No" To Blackstone?

Rumors of a large private equity deal in the lodging industry had been running rampant recently and late Tuesday we learned that Blackstone Group (BX) plans to acquire Hilton Hotels (HLT) for $18.5 billion plus the assumption of debt. Hilton shareholders should be elated, as they are getting a 40% premium for their shares.

The M&A boom we are seeing right now is clearly propelling the market higher. Firms like Blackstone have billions of dollars to put to work and they can't raise more money until what they have now gets spent. As a result, you see prices like this being paid for Hilton. For a 40% premium, they had to say "yes" to Blackstone. If the offer was 20%, maybe they pass, but not 40%.

And this is a big reason why the market has been so good lately. Private equity firms need to spend their cash hoards and aren't afraid to overbid if it means getting a deal done. The companies getting bought out jump, helping the market. The stocks considered next in line for a bid get a pop on the rumors and speculation, and short sellers have to scramble to cover any positions that could possibly get a bid. You can't afford to risk being short a name like Hilton before a Blackstone bid comes along.

Liquidity will dry up at some point, deal flow will lighten up, and market returns might be subdued, but there is really no way to know when exactly that will happen. It is clear the private equity firms themselves think we are in the late innings, or else we would not have seen Blackstone go public and KKR file for an IPO just a few hours ago. Until the game is over though, there is plenty of liquidity to keep stock prices fairly high.

Investors should simply focus on values in the marketplace. Maybe one of your companies gets a bid, maybe not, but it would be wise to make sure you are comfortable with your investments even if they remain independent. Unless you think you are the ultimate market timer, I would avoid the private equity IPO market, including Blackstone, KKR, as well as the others that will surely follow suit as long as the new issue market can support them.

Full Disclosure: No positions in the companies mentioned at the time of writing

How Should Hedge Funds and Private Equity Be Taxed?

It seems like Congress goes into attack mode anytime somebody is making a lot of money. In some cases I agree with our elected officials and in other cases their arguments make little sense if you look at the big picture. Take the oil companies for instance. We all know the industry is swimming in money. If Congress aims to repeal subsidies these firms get from the federal government, I have a hard time opposing the idea. Our country does not need to subsidize our oil companies. However, if you propose some kind of excess profits tax simply because oil prices are high, that is ridiculous. We live in a market economy and markets are cyclical. You can't tax companies during boom times just because you feel like it.

Anyway, the topic du jour is the taxation of hedge funds and private equity funds. Again, we have a group of wealthy people who are making billions and paying the same (if not less) taxes as the average worker. To figure out where I fall on issues like these, I try not to bring politics into it at all. To me, it's logic-driven reasoning that should rule the day and help form an opinion.

I haven't been following the issue that closely, but the sticking point is the fact that hedge fund and private equity fund general partners split investment profits with their limited partners. The investment managers serve as general partners and collect 20% of the profits from the investments they make, which is often taxed as long-term capital gains, at a rate of 15%. The fact that someone can make $100 million and only pay 15% in taxes is evidently upsetting a lot of people in Washington.

At first blush it might seem like the 15% tax rate makes sense. If a hedge fund has $100 million in assets and earns 10%, there is $10 million in profit to be divided up. Assuming an 80/20 split, the manager makes $2 million and the limited partners share $8 million based on their ownership percentages. Since the $10 million in profit was the result of capital gains, then it is easy to see why some feel the 15% tax is fair.

There is one difference though, that seems very important. The whole point of having a low capital gains tax rate (relative to income tax rates) is to incentivize people to invest in businesses and put their capital at risk. Such actions are the life blood of our capitalist system. In return for risking your own money by investing in other ventures that need funding, you are rewarded with a lower tax rate on any profits you earn.

The problem is, hedge fund managers aren't risking their own capital a lot of the time. They are pooling money from their investors and managing it for them. Sure, they don't earn anything unless they produce positive returns, but if they lose money, they don't lose as much, if at all, because they typically have less capital at risk, if they invest in the fund at all. This seems like the most logical reason why one would be against the 15% tax rate for hedge fund managers.

Now, it's true that most fund managers have invested some of their own money in the funds they manage. Perhaps what the tax law needs to say is, when you have your own money at risk, you can claim profits as a capital gain, but when your investors are simply sharing a portion of the profit earned on their capital, in return for your management ability, then that income should be treated as a management fee, and therefore taxed at ordinary income tax rates.

It's a tough issue for sure. I just hope the law going forward reflects reality, meaning that if you get a tax break for capital gains, it better actually be your capital that was put at risk in order to produce the gains in the first place. A fair compromise in my eyes would be to allow managers to pay 15% on the portion that is their own capital at risk, and ordinary income tax rates on fees earned on limited partner's assets that are paid out to the general partner. That way, the whole point of the 15% capital gains tax rate (reward risk taking with lower taxes) is preserved.

What do you think?