The Enterprising Investor’s Guide 3-23-2009

The price-to-peak earnings multiple edged up slightly last week to 8.6x. The market’s recent rally does not mean that we are completely out of the woods. Since last November, when the price-to-peak earnings multiple fell below 10x, we began to aver that–on a historical basis–stocks were beginning to look cheap for long-term investment. That condition remains to this day; however, the recent rally is a bit worrisome because it appears largely fueled by speculation. Citi (C), Bank of America (BAC) and JP Morgan (JPM) all recently announced that they have been profitable in the first two months of the year, which allayed some of the apprehension surrounding the struggling financials. However, caution is warranted, as an increase in operating profit does not necessarily signal an end to bank troubles. Currently, banks are able to borrow at very low interest rates and can turn around and lend that money at substantially higher rates. Wall Street analyst Meredith Whitney believes that banks face many more months of bad news regarding souring consumer and commercial real estate loans and that most banks have further major write-downs ahead, which will negatively impact equity owners.

S&P 500

The percentage of NYSE stocks selling above their 30-week MA rose to 14% this week. This metric has risen for two consecutive weeks since the market reached its recent bottom.


It is possible that the market has grown tired of the steady drumbeat of bad news and has latched on to the assumption that financials have bottomed. There are bullish signals outside of financials, not the least of which is the flurry of M&A activity such as we have seen recently in biotech and now possibly technology with Sun Microsystems (JAVA) and IBM (IBM). Mergers and acquisitions can be a sign that corporations believe that a turnaround is underway; otherwise, why not wait out the bear market and look for a better opportunity to buy a competitor’s stock when its further distressed?

While much of the media’s attention was focused on the AIG (AIG) bonus scandal, the biggest news of the week was the announcement that the government will monetize the national debt. This is a momentous and potentially dangerous solution to our current financial problems as this move will likely be seen as inflationary, thus devaluing the dollar. This week’s Weely Market Comment by Dr. John Hussman has the best description of these problems that we have seen and we highly recommend reading the entire column but have provided a portion of his commentary here:

“Apparently, the Fed believes that absorbing part of the massively expanding government debt and maybe lowering long-term rates by a fraction of a percentage point will increase the capacity and incentive of the markets to purchase risky and toxic debt. Bernanke evidently believes that the choice between a default-free investment and one that is entirely open to principal loss comes down to a few basis points in interest. Even now, the expansion of federal spending as a fraction of GDP has clear inflationary implications looking a few years out, so any expectation that long-term Treasury yields will fall in response to the Fed’s buying must be coupled with the belief that investors will ignore those inflation risks.

There is no doubt that the Fed also intends for the extra trillion in base money to end up as bank reserves. But think about what this move implies in equilibrium. The largest purchasers of U.S. Treasury bonds at present are foreign central banks. So what the Fed is really doing is printing enough money to crater the exchange value of the U.S. dollar, while leaving foreigners with a trillion dollars of savings that they would otherwise have invested in Treasury bonds, which they will now use, not to buy our lousy, toxic assets, but to acquire our productive assets, and at a steep discount thanks to the currency depreciation. So yes, the extra trillion in dollar bills will ultimately end up as bank reserves (and currency in circulation), but only by encouraging Beijing to go on a shopping spree to acquire a claim on our future production. Ultimately, funding the bailout of lousy assets comes at the cost of debasing our currency and selling our good assets to foreigners.”

The Enterprising Investor’s Guide 3-23-2009

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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