Does Size Really Matter?

Over the last week or two, CNBC coverage has focused a lot of its time on the large cap versus small cap debate. Dozens of professionals have been dragged on air to give the arguments for why they think large caps will outperform in 2006, and an equal number to make the opposite case for small caps.

Please ignore these conversations. Investing in equities should not focus on such a debate. The point of investing in public companies (or any company for that matter) is to get a good deal; to buy something that you feel is undervalued now and will ultimately be worth more in the future. Looking at company-specific issues is how you should go about doing this.

Focusing on how big a company is has nothing to do with the potential for it to be a good investment. Now I know many investors are of the “passive” type and only buy indexes. In determining how to allocate their funds, they will try and figure out which of the many asset classes they should overweight and underweight, small cap value, large cap growth, and the list goes on.

Passive investors will spend time looking at the valuation disparity between large cap and small cap stocks, compare their growth outlooks on the whole, and try to figure out which one is the relative bargain. Rather than simply guess how well a set of hundreds of companies are going to fare collectively, I think it’s a much better use of one’s time to get to know a handful of companies really well and determine if they represent good value.

Whether we’re talking about micro caps, small caps, mid caps, or large caps, there are always going to be great investment opportunities in each segment of the market. Buying an entire asset class is really nothing more than speculating, given that you aren’t really analyzing whether or not any of the companies in that large subset are actually good investments or not. I’d be willing to bet you’ll be more accurate predicting relative value of individual companies than you will entire indexes based on company size.

Another Entry Point for URBN

At the beginning of the year I highlighted shares of Urban Outfitters (URBN) as an attractive growth play for investors. Followers of that advice saw the stock rise from the low 20’s to the low 30’s over the course of 2005. However, recent weakness in retail stocks has caused a pullback in URBN and for those who have yet to take a position in the company, there is an opportunity here, I believe.

Not only are the fundamentals strong, but the technicals look good as well. Readers of this blog know I don’t use charts to pick stocks, but when a company I like fundamentally also has a good chart pattern, it’s usually a good entry point.

Here’s a second version of the chart, in response to the reader’s comment:

Despite Real Estate Boom, Stocks Still King

Here’s a pop quiz:

By how much has the domestic residential real estate market outperformed the S&P 500 index over the past three years?

The U. S. real estate market has seen its biggest boom in history in recent years. Investors who have moved away from the stock market and shifted their assets into housing are probably very happy they made such a move. But should they be? It depends, but the numbers themselves tell an interesting story.

Since 2003, residential housing prices in the U.S. have risen by 10 percent per year. In fact, the annual returns have been accelerating, 7% in 2003, 11% in 2004, and 12% in 2005. Despite such a strong market, investors in the stock market have actually done even better, as the S&P 500 has advanced 13% per year during the same period.

If a huge housing boom can’t even match the stock market’s performance, it serves as yet another quantitative example of why equities have outperformed real estate by a factor of three throughout history.

Bringing Back Late Fees!?

It turns out that Blockbuster (BBI) franchises across the country are starting to bring back late fees. That’s right, after a huge advertising campaign boasting about no more late fees, many consumers will find them coming back. Why have store owners decided to bring them back? With the program in place, people just keep movies out for weeks at a time, and as a result there isn’t enough inventory in stock to satisfy new release demand.

In the long term, this will be a non-event. We’ll all have a library of thousands of movies at our fingertips via on-demand services at home. In the shorter term though, it will be interesting to see how Blockbuster’s financials are affected. Will the increase in high-margin fee income more than offset the loss of customers who came to Blockbuster because of the lack of late fees? Probably. However, even though franchise owners can choose whether or not to charge late fees, company-owned stores will continue without them, for now at least.

AOL-Google Deal Appears Close

Despite reports that Microsoft (MSFT) was the front-runner to land a partnership deal with AOL, the Wall Street Journal is now saying that Time Warner is in exclusive talks with long-time partner, Google (GOOG), and a deal could be finalized as early as next week.

This news is not surprising to me. If you were running AOL and wanted to make a deal to maximize the potential for you to regain relevancy in the Internet world, who would you partner with? You’d be crazy not to go with Google at this point in time, especially since Google and AOL have already been working together for years.

The market likely won’t boost Google shares very much, if at all, on this news (especially if the financial terms look generous given many people have valued AOL at zero) but I think this is a big deal for Google and will generate meaningful incremental revenue for years to come.

Red Flagging Six Flags

In case you missed it, shares of Six Flags (PKS) have been on quite the run ever since the company put itself up for sale in August, rising from $5 to the current price tag of $7.22 each. There was no doubt that a sale would have been a welcomed event for investors. After all, the company hasn’t made money in years and has over $1 billion in debt (in fact, their debt load is more than 150% of the current market cap).

There is only one problem though. We learned this week that the company is no longer pursuing a sale. The reason? Nobody wants any part of Six Flags. That’s right, after four months of shopping the company, they didn’t get a single offer.

Don’t worry, though. Washington Redskins owner Dan Snyder is now Chairman of the Board and the company has a new CEO, Mark Shapiro. Recently CEO of Snyder’s investment firm, Shapiro, 35, was also formerly an executive at ESPN. What does he know about running a theme park company? I’d presume not much, which can’t be a good sign for investors in PKS.

H&R Block Financial Advisors’ Top Picks for 2006

Thought maybe readers would find this list helpful. Not that I think H&R Block Financial Advisors are great stock pickers, but maybe some of these fit criteria that you look for in a stock.

Comcast (CMCSA) Consumer Disc.
Int’l Speedway (ISCA) Consumer Disc.
CVS Corp (CVS) Consumer Staples
Pepsi Bottling (PBG) Consumer Staples
United Natural Foods (UNFI) Consumer Staples
Global Santa Fe (GSF) Energy
Schlumberger (SLB) Energy
Capital One (COF) Financials
Wachovia (WB) Financials
Neurocrine (NBIX) Health Care
Stryker (SYK) Health Care
Teva (TEVA) Health Care
3M (MMM) Industrials
URS (URS) Industrials
Dell (DELL) Technology
Intel (INTC) Technology
Micron (MU) Technology
Verizon (VZ) Telecom
FPL Group (FPL) Utilities

Full disclosure: Peridot owns shares of Capital One

Peridot Book Club

For those looking for a good stock market read, I suggest Wharton professor Jeremy Siegel’s “The Future For Investors.” Siegel’s follow-up to “Stocks for the Long Run” (published the 1994) offers a very interesting and compelling outlook for stock markets throughout the world.

Not only are potential challenges addressed (selling pressures due to retiring baby boomers and the rise of China and India as global economic powerhouses), but Siegel also presents characteristics of past market winners and losers, and how they will be affected in coming decades.

While he offers portfolio asset allocation advice toward the end of the book, with which some will agree and others will prefer to deviate from, I think the real value of the text is in the quantitative evidence Siegel offers from his extensive research and his outlook on the rest of the 21st century. This definitely will help investors think about their investment portfolios in a valuable and comprehensive way.
All in all, a must read for those interested in hearing opinions of a brilliant professor who called the top of the Nasdaq market bubble months before the collapse began.

Flat Curve Could Hamper Commerce in Short Term

Shares of New Jersey based Commerce Bancorp (CBH) have been strong lately, along with other bank stocks, as investors hope the Fed will stop hiking interest rates when the Fed Funds rate hits 4.5% early next year. However, after a run from $27-$28 to $33-$34, shares of CBH could see weakness in the short term.

Although the company’s long term growth prospects remain among the brightest in the industry, the flatness of the yield curve will make it difficult for CBH to beat, or even meet, Wall Street’s profit expectations in both the fourth quarter and early 2006.

Any guidance reduction in Commerce’s soon-to-be-released mi- quarter update will likely cause a 5 to 10 percent sell-off in the stock. At that point, long term investors can be more aggressive with their positions.

Is Cable A Value Trap?

Many value investors have loaded up on shares of the nation’s leading cable companies in recent years as share prices have lagged. The Dolan family even considered taking Cablevision (CVC) private, but then pulled the offer off of the table. While the stock of CVC and others such as Comcast (CMCSA) do look attractive by historical measures, the outlook for these operators has changed meaningfully, in my opinion, over the last few months.

The argument for the Comcasts of the world was pretty simple heading into 2005. The stocks were down big, investors were ignoring them, and cash flow was very strong, growing 10% per year. In addition, cable broadband access seemed to be maintaining its lead over the Baby Bells’ DSL offerings.

Since cable modems were faster than digital subscriber lines, and many voice customers were scrapping their landlines, the cable companies stood to benefit greatly by bundling digital cable television, high speed broadband access, and VOIP phone services. Throw in Tivo boxes and video on-demand movies and customers could get everything they needed, on one bill, for $100 to $125 per month.

The stocks have languished this year though, even as financial results have been pretty good. The three-pronged attack of bundling voice, data, and video has hit a snag. Some of these services are simple commodity businesses that anyone can offer. Vonage offers unlimited long distance, just as Comcast does. Since the service is the same, pricing will continue to fall.

Then things got even worse. Companies such as Skype began offering VOIP phone service for free. Rumors began swirling that Google (GOOG) was looking into offering free wireless Internet access in order to drive net traffic to its advertising-based sites.

While pricing for cable television will remain fairly flat, and VoD movie libraries could lead to Blockbuster (BBI) becoming extinct, it is entirely possible that wireless Internet access and VOIP long distance phone service are eventually offered for free. If that happens, the cable companies will be back to only offering one service, not bundling three through a single coaxial cable. If this happens, cable operator stocks will go down in history as a major value trap.