Bullet Proof Balance Sheets

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While a focus on growth has always been in fashion, the advent of COVID-19 has enhanced the currency of balance sheets.  

I know this because an article I wrote with client Ken Berman of Gorilla Trades quickly generated more than 400,000 page views after we published it on Kiplinger.

The list of 25 companies includes predictable entries like Google, Amazon, Apple, which sport truly amazing balance sheets, but also fly-below-the-radar mid caps like data security firm Fortinet (FTNT), Cognex (CGNX), which develops machine visions systems, biotech’s Incyte (INCY) and Old Dominion Freight Lines (ODFL).  read more

And Now, Fake Earnings

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413 x 239.pages copyWith earnings season here once again, and the term fake news ricocheting across social and traditional media, it’s not too great a leap to get to the concept of fake earnings.

Lots of companies present earnings that aren’t really earnings.  For example, in January Intel reported earnings of $10.3 billion, and then adjusted earnings of $13.2 billion, about 30% higher . . . At Google, net income was $4.9 billion but adjusted net income was $6.0 billion or 23% higher . . . Drug maker Celgene reported net income of $2 billion, but also presented investors with adjusted net income of $4.8 billion, 140% higher.

It’s not fraudulent to do this.  Rather, companies are simply reporting in Non-GAAP financial measures.  GAAP stands for Generally Accepted Accounting Principles.  As such, using Non GAAP financial measures is akin to drawing outside the lines, but with the noble purpose of making things clearer to investors in a way that’s not possible by staying within the lines of accepted accounting principals.

If this all sounds fishy, it is.  Without question, there are many legitimate instances where removing certain expenses — say large, one time non cash expenses — can give investors a better view of economic reality.  But the volume and aggressiveness of Non GAAP financial reporting is increasingly making regulators nervous.  During this earnings season keep your eyes peeled for non-GAAP earnings figures and their magnitude relative to GAAP earnings, and you’ll see why.

And if you’re in an everything-you-always-wanted-to-know-about-non-GAAP-earnings mood, check out Investor Uses, Expectations, and Concerns on Non-GAAP Financial Measures by my friends at the CFA institute.  It’s a large work, but an important one if you want to get a handle on the differences between real and fake earnings.

What Might Happen in 2016

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=&0=& Wall Street loves a good story, but it hates losses.  With half a billion in losses in 2014, and the company on track to lose more this year than last, somebody is going to pull the plug.   =&1=&  Twitter CEO Jack Dorsey will not survive the year and focus on Square, also losing money.

=&2=&.  Facebook, Amazon, Netflix, Google will continue to eat other industries with the possible exception of Netflix, where competition is coming out of the woodwork.

=&7=&  Every day the Pentagon alone

faces 10 million attacks read more

APPL In, T Out & The Remains of the Day

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=&0=&In March of this year, Apple Inc. was added to the elite, 30-member Dow Jones Industrial Index, and AT&T was unceremoniously removed.

In their press release, S&P Dow Jones Indices, said “The timing of Apple’s addition to the DJIA hinged on two stock splits: Apple’s 7:1 last June and Visa’s 4:1 on March 19th this year.”

Because the Dow is a price weighted index, the March 2015 Visa split underweighted the information technology sector, while Apple’s earlier split will enabled it to join the Dow index without a disproportionate effect.

But what did this rearrangement of the Dow components indicate about our economy?

I suppose it said about as much as when Sears, Roebuck & Co. was removed from the Dow in 1999 and The Home Depot was added.  Clearly, the era of the general merchandiser was over and the era of the big box store had arrived.

In telecom, the dethroning of AT&T signaled to me the race in the carrier business to build the networks is largely over, though I suppose there is some upside in the global wireless business.  It also demonstrated the companies utilizing the networks to deliver benefits to consumers, governments and institutions, such as Facebook, Comcast and Amazon to name a few, are now driving the economy.

What I wonder though is the palace intrigue behind AT^T being removed from the Dow.

After all Verizon remains among the Dow elite and Verizon was once a unit of AT&T. I can’t but help think it’s not that cut and dried; that AT&T would not get dethroned without some back channel communication.

This is after all the company that, in 1999 may have played a role in getting the CEO of largest US financial behemoth at the time, Citigroup, to tell the telecomm analyst in his Salomon Smith Barney unit to take a ‘fresh look’ at Ma Bell. Subsequently the analyst, Jack Grubman, raised his rating to BUY, and then a lot other saddening revelations came to light about influence peddling at the highest levels.

Were such influences afoot between S&P Indices and the back channels of AT&T concerning the sudden removal, it would seem to be a scene from a Greek tragedy. “God Dow, take my son Verizon, not me. He was sprung from my loins, and cannot match my power.”

Truth be told, telecom is a crappy business, in my view.  The only thing left for the land line and wireless carriers to do is duke it out over market share until one of them puts a bullet into the head of the other.  Really, it could all be state owned and managed by the Interstate Highway Commission, as long as the geeks there can manage to keep the Internet up and running.

How and Where to Invest to Outmaneuver the Risks of Falling Inflation

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David Evanson and Oliver Pursche

TheStreet.com, Spring, 2015

The risks of disinflation or falling inflation, and perhaps even deflation, to the U.S. economy are real, and we will likely contend with it for years to come.

As a result, investors will have to invest in a low interest rate environment for years, perhaps for the next decade.

This will require a significant change in how investors view the landscape, as negative returns from bonds along with flat commodity prices will limit investorszz choices in terms of how to lower portfolio volatility.

Disinflation and Deflation

Disinflation occurs when the rate of inflation slows. But it is also a harbinger of deflation, if only mathematically, and deflation is a hairy, hairy beast that is, no doubt, on the minds of central bankers all over the world.

In a deflationary environment, declining prices encourage businesses, government and consumers to wait for lower prices. But the delay in purchasing diminishes economic activity, and the economy can seize up in a death spiral.

The last time deflation occurred on a worldwide basis, 1870 to 1890, it re-arranged the world order, with the U.S. economy coming to prominence while the fortunes of Great Britain waned, and it has been that way ever since.

Although there are promising signals in our economy, there are risks — some might say systemic — that expose us to the ravages of deflation. One such risk is well illustrated in the recent fall in oil prices, down more than half from their summer 2014 highs.

Many were quick to point to the benefits of lower oil prices to consumers, as cheaper gasoline was expected to increase consumer spending, more than offsetting any negative impact to the energy sector.

Unfortunately, the recent decline in oil prices doesnzzt appear to have had the positive impact on consumer spending that most expected, while still having the expected negative impact on energy companies in the form of layoffs at Chevron (CVX – Get Report), Exxon Mobil (XOM) and a host of smaller public and private companies.

Further, we are just beginning to see cuts in capital expenditures from these companies. ConocoPhillips (COP) announced a 2015 capital budget of $13.5 billion, compared with 2014 capital expenditures of about $17 billion.

Itzzs Different This Time

Given that the U.S. Federal Reserve has used almost all the tools in its kit, the environment probably looks risk-laden to many central bankers. Raising rates to head off deflationary pressure may stall the economy.

“U.S. inflation is too low, and Fed officials should wait for more evidence that it will return to the central bankzzs official 2% target before raising interest rates,” Fed governor Jerome Powell said Monday.

The best-case scenario and most bullish expectation is that oil prices will stabilize and slowly climb to the mid-$60 level by the end of the year, consumer spending will increase further, and economic growth will climb to near 3%. Mind you, this is a “Goldilocks” scenario, and to play out properly, everything has to go right.

Should oil prices not rebound or only rebound slightly and energy companies cut spending further, the impact to our economy could be broader than expected. Although unlikely to provoke a recession, this weakness will keep the Fed from raising rates, and our view is, if it does raise rates, it may only be a token gesture of a quarter point.

Here To Stay, Where To Invest

Of course, stocks have made an impressive run the past six years under just these circumstances. However, the change in the United States and really almost worldwide is significant.

The expectation that the Fed would end its zero interest rate policy is coming into question, low rates will persist, and as a result, some investors, will need to consider new ways to put their money to work to avoid outliving their nest egg.

We are advising investors to focus on companies that are building their top and bottom line and have a history of raising their dividends. Large-cap pharmaceutical and technology companies fit this bill and are a good place to start.

Of these variables, we are placing significant emphasis on dividend growth. Remember about a third of all the returns earned in the S&P 500 since 1926 have come in the form of dividends.

In the pharmaceuticals sector, we like Eli Lilly (LLY), Pfizer (PFE) and Sanofi (SNY), all impressive dividend growers. For instance, since 2009, Sanofi has increased its dividend north of 6%, on average each year.

In technology, we like Cisco (CSCO), Intel (INTC) and Microsoft (MSFT).

Although a tech bellwether, Intel might be a dividend aristocrat candidate, too. Since 2009, Intel has increased its dividend about 10.5% a year.

And Cisco, which started paying a dividend in 2011, has increased its dividend by 60% per year on average, through the end of last year.

This article is commentary by an independent contributor. At the time of publication, the author held positions through client accounts in Cisco, Conoco Phillips, Eli Lilly, Intel, Microsoft, Pfizer and Sanofi.


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