Thursday, November 13, 2008

Cheap is as cheap does

I'm sitting here scratching my head, trying to figure out what it was that caused today's incredible rally toward the end of the day. Maybe there was a hedge fund convention that started at 1pm eastern, mandatory attendance gentlemen, and that let up the selling pressure for a few hours? Or maybe some Mars moved into the orbit of Venus causing an updraft in the positive energy flow amongst the planets and intra-day traders. I've read a couple of articles that attempt to explain it as the reaction to ultra cheap stock valuations, but that explanation makes as much sense to me as the first two ideas I floated.

For stocks to be cheap, there has to be some benchmark to measure them against, whether it is peers, expected earnings, or history. The problem is that I don't think that we really have a clue what earnings are going to be for a majority of companies, the historical basis we're considering is too short (putting them versus the last 5 or 10 years is, dare I say it, just plain stupid - we're in an economic situation that goes back at least 30 years, if not 80 years), and when you put companies up against their peers the only relatively expensive companies are the companies that are actually doing okay in this economic malaise (you know, the only companies that I wouldn't mind owning at this point.)

Case in point: in the retail landscape, it's hard to find a company doing better than Wal-Mart, and they're relatively expensive too. They reported earnings this morning that were a penny better than expected (a huge accomplishment for a company of their size!) Now the headline you might have seen splashed about was that they took guidance down for next quarter, but that was because of a swing in foreign exchange, not because of operational issues. If you take the $0.06 hit that they are expecting from foreign exchange out of the equation, they are actually taking guidance UP for Q4. That is the kind of company I want to own.

Let's contrast that with the reports this afternoon from Kohl's and Nordstrom. They're both good operators: good management, good systems. Crappy sales. To quote my favorite former CIO, you might call the numbers they put up 'dismal and deleterious.'

On the surface they theoretically both beat expectations, but I'd hope at this point that you're looking below the surface. Kohl's actually beat expectations by a penny, but took Q4 earnings guidance down by 1/3. Customers just aren't buying. So is it cheap at 10x earnings? Maybe, if you truly believe that they'll grow earnings at 14% over the next 5 years... but do you REALLY believe that? I didn't think so.

Nordstrom beat recently lowered expectations by $0.02, but that result included a help of $0.03 from non-recurring items that they hadn't included in previous guidance. Or, put another way, they reported real numbers that were a little worse than they guided to a week ago. Oh, and then they put some icing on the cake... they lowered earnings by HALF for Q4. HALF. Hello, Seattle? We have a problem. This is the third time they've taken guidance down this year. And to have earnings looking like something closer to $0.35 for Q4 than $0.70, that's just abysmal. So it's trading at 5.4x times next year's earnings, doesn't that make it a buy? Sure. Go ahead. But use your money, not mine.

1 comment:

missty said...


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