Two months back I wrote that shares of Express Scripts (ESRX), a leading pharmacy benefits manager, were bloated at $93 each. A P/E of 30 for the company was simply unsustainable. Today ESRX is down nearly $10 to $74 per share after issuing an in-line earnings report. Although I would not do a complete 180 and go long quite yet, I do think it is time for ESRX shorts to be covered for a 20% gain. Where should the money go? I’m interested in taking a look at Aetna (AET), which is down more than 20% today to $36 per share.
Shares of Sun Microsystems (SUNW) opened up more than 4% on Tuesday after CEO Scott McNealy announced his resignation last night. There is little doubt that new blood at the helm of the once high flying tech company is a good step for the company, but is SUNW stock a good buy?
Despite a huge cash hoard, the SUNW shares have been stagnant as financial results have left much to be desired. The main thing holding back the stock has been a lack of profits. The company’s cost structure is so bloated that even with billions in revenue, they aren’t making a dime. The strong balance sheet, coupled with an attractive price-to-sales ratio has gotten many value investors to bite in recent years, but they have little in the way of profit to show for it.
Without profits, investors can’t assign a multiple to earnings. Even if the company were able to swing earnings of 10 or 20 cents per share, the stock doesn’t look cheap. A 16 or 18 P/E on even $0.25 of EPS and you get a share price lower than it is today. It is possible that a new CEO can turn the company around, but until consistent profitability is demonstrated, Sun Micro shares will be laggards.
If you look at the fundamental outlook for the healthcare industry over the next couple of decades you can’t help but be impressed. After all, the demographic shifts our country is going to see as the baby boomers retire is quite compelling. From an investment perspective, leading companies serving our aging population stand to profit tremendously.
However, the current market climate for such stocks is quite interesting; healthcare stocks are getting hammered with investor interest lackluster at best. We know big pharma is facing severe headwinds. But insurance firms are down, as are medical device companies, not to mention the brutal sell-off in biotechnology in recent weeks.
It’s true that any government-led reform to the healthcare sector could be negative for these companies to a certain degree. Right now, cost containment within Medicare and Medicaid is pretty much non-existent. If policy makers took firm action to bring costs down, pricing pressures would compress profit margins for essentially all healthcare firms.
However, how likely is such broad reform? And even if it does occur, will it completely cancel out all the incremental business gained from the aging boomer generation? I think these are important questions to ask when analyzing the sector and I suspect there are some excellent values beginning to surface, and prices could certainly continue falling in the short-term as governmental involvement is always more of a concern during election years.
I’ve said here on several occasions that giving earnings guidance does two things, and neither one is beneficial to shareholders. One, it puts management’s focus on short term results, not a long term strategic plan for boosting shareholder value. Two, it does Wall Street analysts’ jobs for them so they can avoid having to do any real legwork on their own.
An interview on CNBC last Friday afternoon was centered around how some companies have begun to stop issuing quarterly guidance in favor of annual projections. Evidently the number of company giving guidance for three-month periods has dropped from over 60% to slightly more than 50%. I don’t expect most firms to take the Sears Holdings/Google approach of not issuing guidance at all, but this is certainly a good start. A company should never be put in a position to feel compelled to ship product on the last day of a quarter just to hit their numbers, appease shareholders, and prevent a one-day stock price blowup.
One ramification of this shift is that quarterly earnings results will be more volatile. Rather than coming in right on target or a penny ahead of consensus every quarter, there will be a lot more instances of big upside surprises and large shortfalls. This will undoubtedly make share prices more volatile during earnings season, but it will also make my job as a money manager much more fun and important as more surprises require more analysis and decision making.
Fortunately, there seem to have been relatively few earnings warnings this quarter (this is a trend I began to see last quarter as compared with prior periods), so I would guess results will be pretty good when companies begin announcing their first quarter results later this month.
“Sears Holdings (SHLD) announced today that its Board of Directors has approved the repurchase of up to an additional $500 million of the company’s common shares. This authorization is in addition to the $30 million worth of shares that remain available for repurchase under the $1 billion share repurchase program previously announced. Since initiating that program in Sept. 2005, Sears Holdings has purchased approximately 8.0 million of the company’s common shares at an average cost per share of $120.86.”
That is the first paragraph of a Sears Holdings press release issued Wednesday morning. One of the most attractive aspects of owning Sears stock is the fact that as of December 31st they had $4.44 billion in cash on the balance sheet, which equates to $28 per share, or more than 20% of the company’s equity value. Share repurchases are one of the main tools Eddie Lampert and Co. will use to convert store cash flow into higher earnings per share, which will subsequently create quite a lot of shareholder value.
Unlike Cisco (CSCO) and Intel (INTC), they aren’t buying back stock when it is overvalued just to cover up options dilution. Rather they are buying it because it is undervalued and they have a pretty good idea that their average cost per share will be below market prices several months later.
With Apple (AAPL) garnering only 3 percent of the U.S. personal computer market in 2005, it’s not hard to see why the company’s shares are surging 7 percent today. With news of a software program allowing users to run Windows XP on Macs released this morning, all of the sudden the company can go after much of that other 97 percent. Apple’s design team certainly has a unique opportunity here. I don’t see why they couldn’t get 10% of the U.S. market within 5 years with the right new products.
Surely you’ve heard of Gradient Analytics by now, as it’s all the Wall Street media outlets have been talking about lately. In case not though, let’s recap. Gradient is a research firm based in Scottsdale, Arizona. They focus on forensic accounting analysis of public companies.
The latest issue that has been getting all the attention has to do with negative reports Gradient issued on Biovail (BVF), a poorly run Canadian drug company. Biovail is suing Gradient claiming their inaccurate and misleading reports caused a 50 percent drop in BVF stock during 2003 and 2004. News broke that Steve Cohen, hedge fund manager at SAC Capital and Gradient customer, actually requested a report from Gradient that focused on negative aspects of Biovail’s business. SAC was interested in shorting Biovail shares, or perhaps they already were short at the time of request. Gradient did produce a report, and subsequently distributed it to the rest of its customers.
On the surface, this kind of thing looks very suspicious. If SAC Capital was short BVF and asked Gradient to write a negative report on it so they could profit from their short position, it certainly appears that so-called “independent” research is far from independent. Even still, a Gradient report is not responsible for a 50 percent drop in BVF stock, as the company contends. The company’s financial results account for the drop.
In response to the lawsuit, Gradient has said that SAC was requesting a follow-up to a previous report it published about Biovail on its own. If that is true, and SAC was not ghost-writing these reports with false information (as some are contending), then it is hard to reach the conclusion that any law was broken. Unless Gradient and/or SAC knowingly disseminated false information in order to profit from existing short positions, this issue seems to be blowing way out of proportion.
Most are screaming for disclosure of these types of relationships. As a result, Gradient should add some fine print at the end of its reports saying that they might have been published based on a client’s request, not because it was the research firm’s original idea. I have no problem with such disclosures, but don’t think for a second that it will change anything.
Sell side research now discloses how many buy, sell, and hold ratings they have on all of their investment banking clients, but we still see mostly buy ratings on stocks of banking clients. I recently read a report from a boutique firm specializing in healthcare stocks. They had a buy rating on the small cap biotech company I was reading about. In fact, at the end of the report they disclosed that their research analysts cover 11 companies with whom their firm has a banking relationship. All 11 stocks are rated “buy”.
How much stock should investors put on Gradient’s research anyway? Last week shares of Rackable Systems (RACK) dropped 6 bucks temporarily after Gradient’s computer model spit out a negative red flag about increasing inventories. They postulated this was a sign of poor earnings quality.
Unfortunately for Gradient’s clients, the computer program wasn’t able to research Rackable’s business model. Had it done that it would have learned that Rackable, much like Dell (DELL), builds product only after it is ordered. So, all of its inventory has already been sold, thereby making increasing inventory levels a signal of stength in the business, not the opposite as Gradient concluded.