Market Recap - February 27, 2009

February was absolutely terrible for Wall Street. The Dow Jones industrial average dropped 11.7% this month. It was the worst February since 1933, when the Dow fell 15.6%. Today was no exception. The Dow dropped 119 points, or 1.7%, to 7,063 and the S&P 500 lost 17.74 points, or 2.4%, to settle at 735.09. Investors dumped shares of financials as the U.S. government announced that it would be taking a larger stake in Citigroup (C), while General Electric (GE) announced a dividend cut.

The U.S. government announced today that it would be converting $25 billion of Citigroup’s preferred stock into common stock. While the U.S. already owned the preferred shares, the conversion will raise the government’s ownership from 8% to 36%. Investors were terrified by potential dilution of value in Citigroup’s shares, and the company’s stock price plummeted by 39%, losing 96 cents to fall to $1.50.

Citigroup wasn’t the only financial company to suffer. Wells Fargo (WFC) lost $2.30, or 16% and Bank of America (BAC) dropped $1.37, or 25.75%. Similar plans to the Citigroup deal may be enacted for Wells and BAC, and the fear of that happening led to the big sell-off for both of those companies.

The Government’s GDP report that was released today showed that the production of the U.S. economy fell at a 6.2% annual pace at the end of 2008. This means that the value of all the goods and services in the United States is falling at a faster pace than expected. Major companies are taking hits as a result. GE reported that the company would be cutting its quarterly dividend by 68% in an effort save $9 billion per year.  This is the first time that GE has cut its dividend since 1950!

Wall Street handled the surge of bad news fairly well today, especially considering the severity and volume of bad news that was thrown at investors today. February was horrible, but let’s hope that March will be better.

Until next week,

 

-Matt Schwartz

College Trillionaire

Stock of the Day - February 27, 2009 - TM

Toyota Motor Corporation (TM)

The Toyota Motor Corporation (TM) surpassed General Motors (GM) in total worldwide auto sales in for the first time ever in 2008, and the Japanese automaker is currently the top dog in the car industry. But is now a good opportunity to buy shares of Toyota? Declining macroeconomic conditions, higher manufacturing costs, and lowered consumer demand will probably drive the company’s share price lower in upcoming months.

The auto industry is hurting. Badly. The “worst recession since the Great Depression” has beaten up many sectors, but it has put car sales on life support. Toyota said sales fell 32% in January, while Chrysler and GM reported drops in sales of 55% and 49% respectively. Layoff scares, the credit crisis, and a general lack of confidence in the economy have caused consumers to tighten their wallets and avoid purchasing cars.

Toyota realizes that demand will decrease significantly in 2009, and the automakers worldwide production fell 39.1% this January compared to January of 2008 in response to this steady drop in demand. Toyota posted a loss for the first time since 1950 in the quarter that ended in December. The company is forecasting a $5 billion loss for its fiscal year ending on March 31, 2009. The automaker is also being hurt by the higher price of the Japanese Yen, as a higher Yen equates to higher manufacturing and material costs.

Toyota may change its attitude towards expansion and growth during recessionary times. Three major executives are leaving the company, including current president Katsuaki Watanbi. Akio Toyoda, grandson of the company’s founder, will be the new president. Toyoda plans on eliminating the ‘revolutionary change’ that his predecessor was noted for creating. It appears that Toyota worked in excess and spent money inefficiently, but that was permissible when time were good and there were large amounts of income. Lower margins in this economy will force the company to act more frugally.

The demand for Toyota’s vehicles tends to increase when gas prices are high. The Prius hybrid and other vehicles are more economically feasible when oil is expensive. The recession has caused oil and gas prices to drop to low levels. Interestingly, the drop in Toyota’s sales may not be a result of the fall of the general car market. Lower gas prices may be partly responsible for Toyota’s car sales to decrease.

Although there are many short-term problems for Toyota, there is no doubt that the company knows how to make cars that consumers value. Toyota came out on top in the Consumer Reports’ annual review last week of the best cars and trucks. Toyota won best midsized SUV for the Highlander, best small SUV for the RAV4, best minivan for the Sienna, best Green car for the Prius, and the best value for the dollar with its Prius Touring edition.

Toyota is currently trading around $63. And while this number is 43% lower than its 52-week high of $111.47, I can’t rule out a further decline in price. The short-term staying power of the company is what concerns me. I expect stock prices to fall in the short term and rise dramatically when macroeconomic conditions improve. It’s very difficult to tell when the fall will start and the rise begins, but Toyota will definitely be a great deal when signs begin to turn up. I believe Toyota is currently the best carmaker around, it still has a great brand name, and it will definitely succeed in the long term. Having said this, I would wait a few months to watch Toyota’s new leadership, changing oil prices, and general economic conditions and then reevaluate the company. We could be missing a bargain by holding off now, but I don’t believe buying is currently worth the risk.

-Matt Schwartz

College Trillionaire

Trillionaire Term of the Day - February 26, 2009 - Economic Moat

Economic Moat

An economic moat refers to the long-term competitive advantage that one company has over other companies in the same industry. Just as a water moat would keep enemy soldiers from a castle, an economic moat keeps competitors from stealing profits from the industry-leading company. 

Clearly, the bigger economic moat a company has, the larger its competitive advantages are.  Economic moats could come in the form of a strong brand name, lower production costs, and many other factors that give a business the ability to maintain competitive advantages over competitors in order to protect long-term profits. 

Some of the biggest and most stable companies, such as Coca-Cola and Wal-Mart, are famous for their giant economic moats.  Because Wal-Mart has so many competitive advantages over its competitors, it is very hard for other retailers to compete directly with Wal-Mart. 

Warren Buffet actually made the concept of economic moats famous, and much of his long-term investing success is due to his ability to find companies with large economic moats and by taking advantage of the fact that these companies would stay safe from intense competition.  So, as a young investor, make it a point to find companies that you think have large economic moats, and try to find companies that perform a certain aspect of their businesses much better than the competitors in the same industry.  By doing this, you can ensure that the company you have invested in will continue to bring in large profits, and your investment will surely bring you profits as well.  

Niki Pezeshki

College Trillionaire

Market Recap - February 26, 2009

Healthcare stocks pulled down the overall market today, as the White House proposed cutting payments to private insurance plans as part of the new government budget.  The Dow Jones Industrial Average ended the day down 88.81 points (-1.22%) and the S&P 500 also fell 12.07 points (-1.58%). 

Obama’s proposed $3.55 trillion budget will cut government funding of health insurance programs like Medicare and Medicaid.  This decrease in funding will directly hurt healthcare companies, as many of their customers and much of their revenues come from government healthcare plans.  Pharmaceutical company Merck (MCK) was the worst performer in the Dow Jones today as a result of this news, and the company’s stock price fell 6.7%. 

Bank stocks traded mostly higher today on news that the government could provide up to $750 billion more in support of struggling banking companies.  While the money will be held just for emergencies and will not be immediately injected into the banking sector, investors were glad that the government is taking more steps to save the banking sector. 

A lot of poor economic news was also announced today, as jobless claims continue to rise more than expected, home sales are falling to record lows, and U.S. factory activity is also declining every month.  This continued bad economic news quells any chance for optimism, as the news gives investors a dose of reality and shows that an economic turnaround might not come for a while. 

Until tomorrow,

 

Niki Pezeshki

College Trillionaire

 

Trillionaire Term of the Day - February 25, 2009 - Earnings

Earnings Estimates

Earnings estimates are analysts’ predictions of a company’s future quarterly or annual earnings. Investors, companies, and analysts alike have recognized the enormous effects that earnings estimates have on stock prices. It is absolutely critical to have a good understanding of what estimates are, how they are made and influenced, and how they are compared to actual earnings.

Earnings are after-tax net income. Earnings are incredibly important because they directly indicate a company’s profitability. Financial professionals, called analysts, create estimates in the process of determining stock recommendations. These recommendations include “buy”, “sell”, and “hold.” By recommending hold on a security, an analyst means you shouldn’t buy, and if you already own it, don’t sell. Other ratings include “outperform”, which means a security is expected to do slightly better than the overall market. Similar to outperform is “overweight”, which means that the security should fare better than its particular industry, sector, or possibly the entire market.

When analysts create these recommendations, they also estimate earnings to an exact dollar amount. Right now, analysts estimate that The Coca-Cola Company (KO) will report earnings of $1.5 billion (an earnings per share of $.65) for the current quarter. They come to this dollar amount by estimating revenues and costs. They take the estimated revenue and subtract estimated costs to come to estimated earnings.

Accurately estimating earnings for a company of any size is a complicated and imperfect process. Analysts attempt to predict revenue by implementing forecasting models that implement growth rates, macroeconomic factors, and fundamental information. They predict costs by looking for any possible expected changes of cost including wages, raw materials, sales expenses, interest expenses… the list goes on. Some analysts will even talk to a company’s customers, competitors, and suppliers. The main question that runs through an analyst’s head is, “What might cause revenue and costs to be greater or less than last quarter?” They are looking for change.

Estimating earnings is not a perfect science. Ten different analysts can easily come to ten different dollar amounts for earnings. Even if they come to the same number, they probably considered different factors to get there. To illustrate this point, the lowest analyst estimate for Coke is $1.43 billion and the highest is $1.6 billion. Wall Street factors in the differences of opinion by considering the ‘consensus estimate.’ The consensus estimate is simply the average of all analysts’ estimates. Wall Street adds the estimates together, and then divides them by the total number of estimates. The current consensus estimate for KO is $1.5 billion. The consensus is the number being considered when you read articles or hear the word “estimate”.

When you hear people say, “a company beat earnings” they mean that the company’s actual earnings were higher than earnings estimates. The comparison of actual earnings to earnings estimates is the single greatest short-term driver of stock prices. In most circumstances, if a company beats earnings, stock price will shoot up. Likewise, if a company falls short of expected earnings, the stock price normally falls. This direct impact is why estimates are considered to be so important.

Successful companies usually have a lot of smart people working for them. Smart people know that the estimates are important, and they’ve done a lot to try to alter or influence them. Companies often attempt to drive estimates lower! While at first this strategy may seem counterintuitive, it’s much easier to beat estimates when they are lower than they should be. Companies can influence earnings estimates by delivering ‘guidance’ or reporting bad news early. If a company gives negative feedback on itself or reports bad news, analysts will factor the information into their estimates.

The necessity to beat estimates has become such an essential element of a company’s success on Wall Street that some businesses are driven to acts of desperation. The use of accounting manipulation to boost earnings is widespread. While ethically questionable, companies can use a wide variety of techniques that are legal under GAAP (the set of financial rules all publicly traded companies must comply with) in order to alter their earnings and financial statements in order to make them more suitable for their various agendas.

There is a vast wealth of information regarding earnings and earnings estimates. I hope that this article has helped you gain a basic understanding of estimates and why they are so important in the world of investing. I encourage you to read more articles about estimates by searching for them on our favorite financial websites.

 

-Matt Schwartz

College Trillionaire

Market Recap - February 25, 2009

Wall Street was extremely volatile today, as stocks drastically climbed and fell throughout the trading session, but eventually ended with a loss.  The Dow Jones Industrial Average fell 80.05 points (-1.09%) and the S&P also ended down 8.24 points (-1.07%). 

One of the main factors that pulled stocks down came from an unexpectedly bad home sales report.  Home sales in January fell to their lowest levels since 1997, as potential buyers worried about their job security and many potential buyers held off until they could hear more from Obama’s housing market plans.  In order to try to boost demand in the housing market, government officials announced a new $8,000 tax credit for first-time buyers today.   

Factors that pushed came mostly from government help to the banking and financial sector.  The government confirmed that it would buy preferred shares from banks using TARP money, thus giving the banks more capital to work with.  In addition, Federal Reserve Chairman Ben Bernanke reassured investors by claiming that banks will not be nationalized. 

The volatility today came from a sense of uncertainty, as investors just don’t know where to look for clues anymore.  With horrible housing numbers but reassurance from the government for banks, there are many factors pulling some stocks down and other factors simultaneously pushing other stocks up.

Until tomorrow,

 

Niki Pezeshki

College Trillionaire

Trillionaire Term of the Day - February 24, 2009 - Order Methods

Market Orders vs. Limit Orders

When placing an order to your broker to either buy or sell a stock, there are two main methods that you can use in order to complete the transaction.  A market order is a buy or sell order in which the broker will execute the order at the best possible market price currently available.  A limit order is an order to a broker to buy or sell a specified number of shares at a specified price.

For a market order, your stock order will automatically be matched up with the current market price.  Let’s say you want to buy 100 shares of McDonald’s (MCD).  If you place a market order to buy 100 shares, your order will be executed at the current market price at the time of the transaction.  While market orders are simple due to the fact that you allow the market prices to determine the price you will buy or sell the stock at, the problem with market orders is that you might not get the price you originally wanted when the transaction finally goes through.  Because stock prices rise and fall almost continuously, especially for very volatile and highly traded stocks, it often happens that you place an order to buy shares at a certain price, but in the few seconds after you placed your order, the stock price has either increased or decreased.  For example, if you placed your order to buy MCD when it was trading at $55 per share, and your order gets executed after MCD has jumped 50 cents to $55.50 per share, you will be forced to pay $55.50 per share instead of the desired $55.00.  While this might not sound like a big deal, if you are buying large amounts of shares, the 50 cent fluctuation can translate into a lot of money.   

A limit order is different than a market order, as it is an order to a broker to buy shares at or below a specified price or to sell shares at or above a specified price.  Let’s say you want to buy 100 shares of McDonald’s (MCD) at $53.00, but shares of MCD are currently trading at $54.95.  So, instead of patiently waiting and staring at your computer until the price falls to $53, you can simply put a limit order to buy 100 shares of MCD at $53.  Once MCD reaches $53, the transaction will automatically be executed and you will have 100 shares of MCD at $53.  Limit orders are great because they insure the price that you will buy and sell shares for, and you do not have to worry about a stock’s volatility when making a transaction.  The big downside for limit orders is the possibility that an order will never be executed.  For example, you if you really wanted MCD at $53 and it never fell to that level, you would never get your shares of MCD. 

Overall, limit orders are much better for investors than market orders.  Limit orders provide investors with a sense of certainty, and they allow investors to dictate the prices at which they want to buy and sell instead of having the market determine the prices for them.

 

Niki Pezeshki

College Trillionaire

Market Recap - February 24, 2009

Stocks traded higher on Tuesday, as Federal Reserve Chairman Ben Bernanke gave investors some hope.  The Dow Jones Inudstrial Average shot up 236.16 points (3.32%) and the S&P 500 also climbed 29.81 points (4.01%). 

Bernanke made a bold prediction that the recession will at the end of this year.  Although he said the economy will continue to contract for the first six months of 2009, investors were very excited about his optimistic prediction for the end of 2009.  Investors are also highly anticipating Obama’s speech on how he plans on stabilizing the financial system and his plans on further stimulating the economy.  Wall Street will be looking for specific details in Obama’s speech, and if investors are happy with the details, the markets could continue to push upward from their multi-year lows. 

The economy is still very shaky, and today’s upward movement in the markets were mostly due to a prediction by the Fed Chairman, anticipation over Obama’s speech scheduled for tonight, and some investors taking advantage of stocks that have possibly been oversold.  Until the markets go higher based on concrete positive economic news, the stock market fluctuations will continue to be very unstable and volatile.

Obama’s speech tonight should be very interesting, and the markets tomorrow will definitely reflect what investors thought of his speech in terms of how specific it was and whether his detailed plans will actually be positive and help stimulate the economy and the financial system.  So, definitely try to watch the speech tonight and decide whether or not you think he does a good job of instilling hope through specific plans.

Until tomorrow,

 

Niki Pezeshki

College Trillionaire

Trillionaire Term of the Day - February 23, 2009 - Free Cash Flow

Free Cash Flow

One of the single greatest tools you can use to determine the profitability of a company is Free Cash Flow. Free cash flow is a measure of a company’s cash after it has taken care of all expenses. It represents the money that a company can use to expand, improve, and advance.

You can easily calculate free cash flow by using statements of cash flows. These statements can be found on many investing websites, as well as the investor relations portion of any company’s website you’re researching. The equation used is simple:

Cash Flow from Operations – Capital Expenditures = Free Cash Flow

A good way of analyzing a company’s performance over time is to calculate the free cash flows over several years. By discovering trends, you can gather insight as to how a company has generated profits for specific periods of time.

Before a company can invest and make capital expenditures, it has to pay the bills. Free cash flow represents the cash that a company has after paying off all expenses. The “cash flow from operations” portion of the equation above is generated in statements by slightly altering net income. This means that when you look at a free cash flow number, you’re looking at a company’s cash after all expenses are paid and investments are considered.

You should also know that a negative, or low, free cash flow may not always spell trouble. Free cash flow can become negative if a company makes many capital expenditures. Capital expenditures are funds used by a company to obtain or improve assets. In other words, a low free cash flow can be attributed to a company’s investments.

So what does a company do with its extra cash? It can be used to increase shareholder in a number of ways. If deemed profitable, a company can use the extra profits to expand or diversify. It can increase the value of its stock by buying back stock at prices considered to be low. Companies can also use the cash to increase dividends. All of these options are incredibly beneficial to you as a current shareholder or potential buyer of stock.

Analysis of free cash flow should be a staple in your process of purchasing stock. Although it is a simple number to calculate, the knowledge you can gain from it is invaluable. You will instantly benefit by adding free cash flow to your arsenal of investing tools.

-Matt Schwartz

College Trillionaire

Market Recap - February 23, 2009

The markets closed today at the lowest levels since May of 1997. The Dow Jones industrial average dropped 250 points, or 3.41%, to settle at 7114. The Standard & Poor's 500 index fell 26.72 points, or 3.47%, to end the day at 743.33. A major lack of clarity has led investors to fear the future, and the actions of major indexes today reflect their concern.

The government attempted to pacify worries about the struggling financial system today by announcing new plans to help banks. Under the most recent plan, the government would buy convertible preferred shares (preferred shares that can be converted into common shares) to inject capital into needy banks. If executed, the plan could leave the government with up to 40% ownership of Citigroup (C).

While the announcement shows a solid initiative to make improvements, the increased government involvement is also scaring investors. Alarming rumors of complete government takeovers and nationalization of banks have been widespread. The White House and President Obama have maintained their backing of a privately held banking system to ease the worries.

Amidst the announcements of financial stimulus, Obama also publicized his plan to cut the government's annual budget deficit in half by the end of his four-year term. President Obama inherited an estimated yearly deficit of $1.3 trillion from Past President Bush. The total current government debt is estimated to be $10.8 trillion. As a country, we're paying over $250 billion in interest on the national debt every year. Obama plans on lowering the debt and slashing the deficit by phasing out the Iraq war, raising taxes on the wealthy, and making government programs more efficient.

Still, announcements of government aid and proposals were unable to quell the overwhelming amount of pessimism on Wall Street. The gloomy mood will be here to stay until the economy and Main Street show signs of improvement.

Until tomorrow,

-Matt Schwartz

College Trillionaires

Stock of the Day - February 23, 2009 - BRK-A

Berkshire Hathaway, Inc. (BRK-A)

Berkshire Hathaway (BRK-A) is one of the most interesting companies and stocks on Wall Street.  The company is run by CEO Warren Buffet, one of the richest men in the world.  Berkshire is considered to be a holding company, which means that it does not produce goods or services itself, but it owns shares and has ownership stakes in other companies.  Berkshire owns a mix of more than 60 companies, including insurance companies, furniture companies, restaurants, jewelry companies, and many other types of businesses.  The company also owns huge common-share stakes in many publicly traded companies, but its biggest three investments include Wells Fargo (WFC), Coca-Cola (KO), and American Express (AXP). 

Berkshire Hathaway’s stock is the most expensive stock in the United States, even at its currently extreme low levels.  In December 2007, each share of Berkshire was trading at $151,650!  Today, the stock is trading at 5-year lows at around $76,000 per share.  Warren Buffet’s personal fortune is highly correlated to Berkshire’s stock price, as much of his wealth comes from owning shares of Berkshire.  Buffet’s wealth from Berkshire stock is currently worth about $32 billion, down drastically from $62 billion in March 2008!

The 4^th quarter of 2008 was extremely tough for Berkshire’s stock portfolio, as its overall investment portfolio lost 25% of its value.  The company’s three biggest stock holdings fell 70% in the 4^th quarter, and this huge drop in stock price for the three companies cost Berkshire an estimated $11 billion.  Concern about Berkshire’s stock portfolio has been one of the biggest reasons for the company’s own drastic fall in stock price. 

Berkshire Hathaway is a very tough company to analyze, as there are so many different pieces to its business.  Because the company owns so many businesses and makes much of its money through investing in the ever-changing stock market, it is hard to evaluate the company as a whole.  Berkshire also has a massive insurance business, and this business is one of the biggest ways that the company brings in cash.  Through the insurance premiums that Berkshire charges its clients, it uses the extra cash to invest in the stock market and buy ownership stakes in other companies. 

Economic times like these are usually the exact times that Warren Buffet takes advantage of bargain stock prices and distressed companies in need of cash.  Buffet is famous for being able to find undervalued and stable companies that bring in very nice returns over the long term.  Now that stock prices have been so beaten down, Warren Buffet is using all of his company’s extra cash in order to make wise investments in companies that have been unfairly crushed.  But, Buffet invests in companies differently than the average investor.  Because he has so much money, and because companies believe that receiving money from Warren Buffet will bring them positive publicity, Buffet gets extremely favorable deals when he invests money in companies.

In the past few months, Berkshire Hathaway has invested over $10.9 billion with a guaranteed return of 10.6% through preferred stock dividends and fixed income deals.  Some of the companies that Buffet has invested in recently include Goldman Sachs (GS), General Electric (GE), Harley Davidson (HOG), Tiffany’s (TIF), and Swiss Re Bank.  Just to give a couple examples of the kinds of deals that Buffet has been getting for Berkshire Hathaway as a result of his investments, one must only look to his investments in Harley Davidson and Swiss Re.  He lent $300 million to Harley for 5 years at an interest rate of 15% per year, and he lent $2.6 billion to Swiss Re at a guaranteed return of 12%.  So, as you can see, Warren Buffet is really setting up Berkshire Hathaway’s cash situation nicely for the future.  He is taking advantage of companies that are desperate for some cash by lending large sums of money to them in return for great interest rates.  While Berkshire might be losing cash today, the great deals that Buffet has been making will help Berkshire continue to rake in huge returns for many years to come. 

Berkshire Hathaway still has a lot of free cash flow left to take advantage of great deals in the market and to lend out money to cash-strapped companies in return for unusually high interest rates.  Although it is hard to argue against Warren Buffet, as he is considered one of the greatest investors to ever live, his short-term performance on his stock purchases have been extremely shaky.  His bad investments have led to Berkshire’s enormous fall in stock price, but many investors will argue that the short-term is irrelevant, and Buffet’s investments will thrive in the long term. 

As ridiculous it is to say that the most expensive stock in the U.S. is cheap at $76,000, I really think it is.  Times like these, when stock prices have been depressed and greatly deflated, are when Warren Buffet is famous for setting himself up extremely nicely for the future by taking advantage of undervalued stocks.  Berkshire Hathaway will be making very nice returns from its loans to companies such as Goldman Sachs and General Electric for many years to come.  And, while the short term has been rough for Berkshire’s stock portfolio, it would be foolish for me to doubt Buffet for the long term.  The man is an investing genius, and it would be ridiculous to say that he has lost his investing touch after one rough quarter, especially considering how unbelievably successfully he has been for so many decades.  Buffet will continue to use Berkshire’s ample free cash flow to make wise long-term investments, and Berkshire’s stock will eventually thrive once again.  

Niki Pezeshki

College Trillionaire