Market Recap - March 27, 2009

Stocks traded lower on Friday, as investors sold some shares and took in profits from the big gains over the past couple of weeks.  The Dow Jones Industrial Average fell 148.38 points (-1.87%), and the S&P 500 also dropped 16.92 points (-2.03%). It was a bad way to end such a great week, as the Dow rose 6.8% this week, and the S&P also climbed 6.2%. 

 

The Dow has surged 21% over the past 13 days, and to think that this unbelievable rally could continue without any profit taking or slight reality checks would be unrealistic.  Although investors are definitely more optimistic about the markets and the economy than they were a month ago, it seems like 21% in 13 days was just too much.  There is still some worry that Wall Street will be disappointed when companies release first quarter earnings.  Another argument that many investors have is that the markets need to retest the lows from a couple of weeks ago and bounce up again in order to truly indicate a market bottom.  As great as this rally has been, I still don’t think that it has convinced anyone that things have officially turned around.  Until that happens, volatility will remain high and investors will continue to debate what to do next.

 

Niki Pezeshki

College Trillionaire

Stock of the Day - March 22, 2009 - DEO

Diageo (DEO)

Guinness, Smirnoff, Jose Cuervo, and Captain Morgan are just a few of the alcoholic beverages that Diageo (DEO) produces. Many people believe that sin stocks, or stocks of companies that produce goods considered by some to be immoral or unethical, are recession-resistant. As an alcoholic beverage producer, Diageo finds itself in that category. Is there money to be made from this beer-brewing, wine-bottling, liquor-distilling corporation?

Diageo’s net profit increased 16% to $1.63 billion in the six months ending December 31^st, 2008. At first glance, these numbers make it seem like the company actually is recession-resistant. But, the increase in income can mostly be attributed to a strong U.S. dollar. Although Diageo is based in Europe, the United States is one of the company’s largest markets. Because the company trades its beverages for strong U.S. dollars, it has benefited from exchange rates.

Analysts actually expected much higher results from DEO. The company itself stated that profit from operations was weaker than desired at the end of 2008. CEO Paul Walsh stated that, “the global economic slowdown has affected business in the period, and in November and December this impact was more pronounced.” Diageo cut its growth forecast for full-year operating profit, citing a lack of visibility for the rest of 2009. The report that missed expectations, when combined with an admission of vulnerability to a weakened economy, caused investors to stray away from DEO.

Diageo’s stock has a 52-week range of $40.93-86.19. It most recently traded at $44.18, very close to its 52-week low. While I believe that some drop in share price was necessary to accommodate for weakened macroeconomic conditions, the current price leaves DEO undervalued.

It’s important to note that Diageo maintains a great deal of strength from its top brands. The names are incredibly popular: Smirnoff is the world’s number one vodka, Jose Cuervo is the leading tequila, and Guinness is the top stout. The majority of DEO’s other alcoholic beverages also maintain large market shares. These brands will not suddenly disappear because of slow economic times.

The company’s statistics are also enviable. Diageo bears a large market capitalization of 27.52 billion, pushes out a reliable dividend yielding 3.6%, and most recently generated a free cash flow of $1.24 billion. Add in the fact that the company currently has $3.45 billion in cash, and it’s easy to realize that DEO is a real powerhouse.

My main fear for Diageo is the weakening of the U.S. dollar. Just as DEO benefits from a strong dollar, a weak dollar hurts it. Its sales and large market share in the U.S. would become less valuable if the dollar becomes less valuable. We’re beginning to see a decrease in value of the dollar resulting from a large amount of government spending, a dramatic increase in the printing of money, and shrinking demand for treasuries and debt from foreign countries.

Nevertheless, the U.S. is only one of Diageo’s many markets. The company acts in about 180 countries in North America, Africa, Europe, and Asia. Considering the company’s powerful brands, international diversification, and financial backing makes DEO a great buy at current levels. Diageo is sitting at a relatively cheap price in an industry that does well in harsh economic times, and now is the time to scoop it up.

 

-Matt Schwartz

College Trillionaire

Trillionaire Term of the Day - March 24, 2009 - Stock Buybacks

Stock Buybacks

Stock buybacks, which are also called share repurchases, occur when a company buys back its own shares from the marketplace.  This action by the company reduces the number of outstanding shares that the public is able to buy and sell. 

So, how do stock buybacks benefit investors? Because stock prices are determined by multiplying the P/E ratio by the Earnings per share (EPS), then it would make sense that a higher EPS would lead to a higher stock price.  EPS is calculated by dividing a company’s net income by the number of outstanding shares. So, when a company repurchases its shares, it is decreasing the number of outstanding shares.  This action decreases the denominator in the EPS formula, thus increasing the company’s EPS.   Because the EPS increases, the overall stock price for the company also increases. 

Let’s do an example.  If Company A has a P/E ratio of 10 and an EPS of 2, the company’s stock price will be $20.  Let’s also assume the company has a net income of $200 and has 100 shares outstanding, thus explaining the EPS of 2 ($200 NI / 100 shares).  If Company A decides to repurchase 50 shares, it will only have 50 shares outstanding.  So, the new EPS will be 4 ($200 NI / 50 shares).  So, if the P/E ratio remains at 10 and the EPS has increased to 4, then the new stock price will be $40 (P/E ratio 10 * EPS 4).  When Company A repurchases half of the outstanding shares, the company’s share price doubles!

It should be clear by now that share repurchases are great for investors.  But, why do companies repurchase shares, and what kind of companies repurchase shares?  Companies with a lot of excess cash are more likely to repurchase shares, mainly because they have the money to buy back their shares.  For cash-rich companies, the best way to directly reward investors is through dividend payouts or through stock buybacks. 

Most of the time, companies that repurchase shares do it because they believe their stock price is undervalued.  By buying their own shares at the perceived discounted prices, companies believe that they will be able to greatly profit in the long run when the stocks that they have purchased appreciate in price. 

Make sure to stay on the lookout for companies that have already repurchased shares or are potential candidates to do it.  When a company buys back shares, it shows that it has a lot of excess cash, but it also shows that the company thinks its stock price is undervalued and that it will go up in the future.  Stock buybacks are a very solid indication of what the company thinks about its own future, as a company would not repurchase shares if it thought that its share prices were on the way down.

Niki Pezeshki

College Trillionaire

Market Recap - March 24, 2009

The same financial stocks that pumped the Dow up 500 points yesterday were responsible for dragging the markets down today. The Dow Jones industrial average lost 115 points (-1.5%) to end the day at 7659.97, while the S&P 500 fell 16.57 points (-2%) to 806.35.

The chairman of the Federal Reserve, Ben Bernanke, and Treasury Secretary Timothy Geithner spoke to the House Financial Services Committee today. The top officials will be asking the committee and, in turn, Congress to provide them with stronger regulatory powers over non-bank financial institutions. AIG is a perfect example of a non-bank financial institution. The ‘insurance’ company engaged in many financial acts, but was exempt from the regulations that affect banks. Bernanke claimed that stronger regulatory powers would have prevented much of the crisis that we are now facing.

While a report yesterday stated that February sales of existing homes increased by 5.1%, a report released today showed that home prices fell 6.3% January compared to the January of 2008.

Oil prices rallied today to $53.98 per barrel while the U.S. dollar continued a three-week decrease in value. Currency traders are fleeing to commodities like oil as a method to avoid potential inflation.  These investors believe that the government’s multiple plans to inject trillions of dollars into the financial system will cause inflation. Oil, gold, silver, and other commodities tend to act as safe havens when inflation is rampant.

The drop in the markets today can be mostly attributed to profit taking. The gigantic rally yesterday provided investors with an opportunity to sell off and receive some juicy profits. Nevertheless, the Dow gained three times as many points yesterday as it lost today. I’ll take that ratio any day.

 

-Matt Schwartz

College Trillionaire

Market Recap - March 23, 2009

The stock market skyrocketed on Monday, as Treasury Secretary Timothy Geithner announced the details of the government’s plan to help the troubled financial system.  The Dow Jones Industrial Average gained 497 points (6.84%) and the S&P 500 surged 54.38 points (7.08%)!

The government’s plan is called the Public-Private Investment Program (PPIP), and it will provide banks with up to $1 trillion in financing in order to get them to start lending again.  The great thing about this plan is that it involves the private sector.  It is a very confusing plan, but if you want to read a good summary of it, check out this link: http://www.thestreet.com/story/10476062/1/geithner-plan-may-aim-1-trillion-at-bad-assets.html.

Another catalyst for today’s jump came from the housing sector.  The National Association of Realtors’ reported that home sales greatly increased in the month of February.  From the month of January to February,  home sales grew 5.1%.  While home prices are still at 10-year lows, many people took the jump in home sales as a sign that people are taking advantage of the low prices.  While this might dilute the impressive numbers, it is still good to know that people are starting to spend more on bigger purchases. 

Today’s jump was unbelievable, as the S&P 500 doesn’t always increase by 7% in one year, let alone in one day!  The good news continues to flow out of Washington and the economy seems to be turning around for the better.  A lot of people are saying that this is a temporary rally, and that we need to retest the lows one more time in order to ensure a bottom.  Right now might be a great time to take some profits and sell some shares.

Until tomorrow,

 

Niki Pezeshki

College Trillionaire

Stock of the Day - March 22, 2009 - HSY

Hershey Co. (HSY)

Hershey (HSY) produces and distributes a variety of chocolate and confectionary products, including Hershey’s Kisses and Reese’s.  The company is the largest American chocolate producer, with around 45% of the domestic market share.  It is no longer the largest candy producer though, as Mars Inc. recently surpassed Hershey with its $23 billion acquisition of Wrigley. 

Hershey’s stock price only fell 12% in 2008, and it is currently trading at $34.93.  Its share price has actually only dropped 9.04% since exactly one year ago.  Comparing that to the S&P 500, which has lost 43.07% of its value from the same time one year ago, it is clear to see that Hershey has been doing some things right. 

One of the reasons that Hershey’s stock price has not been hurt too badly in this recession is because chocolate is a largely recession-resistant good.  The company actually increased its sales in 2008 by 4% compared to 2007, and chocolate sales continue to do well, as chocolate is considered to be a very affordable luxury.  Eating chocolate is a cheap way to make yourself feel good, and people have turned to it throughout this recession in order to give themselves a treat. 

While I do think that Hershey’s stock price is currently overvalued, I believe that the chocolate company is setting itself up very well for long-term sales growth and profit growth through many different strategic avenues.

The first way in which Hershey is increasing sales growth is by expanding into international markets, something relatively new to the company, as it has historically operated mainly in America.  The company is currently focusing on expanding its operations into Mexico, Brazil, Canada, and Asia.  With its recent purchase of “Van Houton”, a consumer chocolate business in Asia, the candy maker has started its aggressive attempt to increase its presence abroad.  Hershey is also planning on increasing sales through more advertising.  The company has announced that it will take advantage of lower advertising costs by increasing its ad spending by 20% this year. 

In addition to increasing sales growth, Hershey is focusing heavily on increasing its profit growth.  Understanding that its products are more inelastic and recession-resistant than most other products, Hershey has been raising the prices for its most popular products.  This has worked very well for the company, and it has not hurt sales.  Hershey’s raw costs (Cocoa, plastic, oil, etc.) for producing its chocolate and other candy products have also dropped as a result of the recession.  When combining higher selling costs with lower production costs, it is clear to see that the company’s profit margins are increasing.  This means that for everything that Hershey sells, it is making more profit than it used to.  The company’s increase in profit margin, combined with its increase in sales will lead to solid income growth for the company.   

While the fundamentals look great, I have some issues with the company’s stock price.  First of all, Hershey’s shares have increased by 13.6% since March 10^th, far too drastic of a move for a company that usually has a very stable and slow-moving stock price.  This sudden increase has to do with the recent overall market rally, but it also has a lot to do with the fact that Jim Cramer has been promoting the stock heavily on his show.  The company also has a P/E ratio of 25.65 and a PEG ratio of 3.42.  These numbers are ridiculously high when comparing them to other food processing companies, as the average P/E ratio for the industry is 12.12 and the average PEG ratio is 1.47.  Hershey’s valuation numbers are so high, especially compared to its industry, that its stock price seems to be unbelievably overvalued.  People are starting to notice that Hershey’s stock is too pricey, and 7.4 million shares (4.84% of total shares outstanding) are currently being shorted as a result, compared to only 6.1 million shares last month.  Right now might actually be a great time to short Hershey’s stock, before more people catch on to the fact that it is grossly overvalued and pull the stock price down. 

Hershey’s share price would have to drastically decrease for me to even consider buying it.  But even then, I would hesitate for one simple reason.  With a Beta of .25 (Beta was the term of the day on February 6^th), Hershey’s stock price is usually very stable and moves much slower than the overall market.  If the market has bottomed already, or if it is close to bottoming with the expectations of a huge rally coming up, I would not want to be invested in a company with a Beta of .25.  Instead, I want to be invested in companies with Betas of over 1 that I can really profit off of when the markets do start to rally. 

Although Hershey is doing some things right and is slowly growing both sales and profits, I still think that it is overvalued.  If you are looking for another company in the food processing industry, maybe you should check out Heinz (HNZ).  Heinz is giving out a 5.1% dividend yield and is trading with a P/E ratio of 11.17, making it a much better value than Hershey.

Niki Pezeshki

College Trillionaire