Monthly Archives: June 2011

Dow Theory: Waiting for Confirmation

Recent activity in the Dow Jones Industrial Average (DJIA) has given favorable indications that we may reach a confirmation of the bullish trend that has been established since July 2009. Below is a chart of the DJIA for the last six months.
On the DJIA chart are several characteristics worth noting. First, and what we believe to be the most important, is the ability for the DJIA to break above the fair value level (yellow line). The fair value level, also referred as the 50% principal, indicates where a majority of investors in the index of stocks are at a break-even point with their investment.

Next is the unconfirmed bull market indication at point A (red line). Occurring at the same time that the DJIA is above the fair value level is the fact that the index broke above point A (red line) which indicates whether or not there is any conviction in the market to go higher. For the time being, there is plenty of conviction in the market as represented in the consecutive triple digit gains that have been posted despite the worrisome foreign and domestic economic news.

There are a couple of important points to highlight about the two positives that have been mentioned. First is the often misinterpreted view by some Dow Theorists to accept that if the price of the DJIA goes above point A (red line), then we’re in a confirmed bull market. In fact, this indication, going above point A, is only telling us that the next target for the index is to the previous high (point B; green line) and the trend is bullish. The market still has the opportunity to get a non-confirmation by either the Dow Jones Transportation Average or the Dow Jones Industrial Average not advancing to a new high (point B; green line). Lack of a confirmation from either index could weigh heavily on the prospects of a market advance.

The next issue dovetails with the first. By going above the fair value plane, it could be interpreted that the market, on a short-term basis, is overvalued. Not only could the market be considered to be overvalued, we could also consider that there is a built-in upper limit for the market. Many investors could interpret the prior high (point B; green line) for the DJIA to be as much risk, in a 2-year doubling of the market, as they’re willing to accept.

Each of these concerns are at play when new information comes in that implies risk is being added to the market. The problems with Greece, US deficit and debt, municipal default, inflation in China, and nuclear threat to Japan are already factored in for the next 3-9 months. There has to be a new twist on the current themes or a black swan event, something that no one has considered, to change the current message of the market.

As a follow up to prior commentary on Dow Theory, the DJTA continues to lead the way higher. In this case, the Transports fell the most (-8.45% v. –7.11%) from the peak in May and the DJTA recovered the most (+7.18% v. +4.35%). We continue to keep a watchful eye on the Dow Jones Transportation Average for any early indications of market direction (chart below).

Our best guess is that the upside prospects are for the DJIA and DJTA to go back to their respective highs set on April 29th and May 10th. Between now and then, investors should remain focused on our Dividend and Nasdaq 100 watch lists for new opportunities with companies that are undervalued and good long-term investments.
  • This is a follow-up to our last Dow Theory market call on April 4, 2011

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In the News: June 26, 2011

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NLO Dividend Watch List: June 24, 2011

The market continues to correct.  The S&P 500 is now down 7.5% from its recent peak while the Dow dipped below the 12,000 mark, a -7.3% pull back from the recent peak.  Our investment filter showed 50 companies within 11% of the low so we decided to reduce our list to those that are within 5% of the low. The list produced 24 quality companies. The following are stocks on our list that are within 6% of their 52-week low.
June 24, 2011 Watch List
Symbol Name Price % Yr Low P/E EPS (ttm) Dividend Yield Payout Ratio
NTRS Northern Trust Corp.  44.98 -0.49% 16.60 2.71 1.12 2.49% 41%
SYBT S.Y. BanCorp., Inc.  22.5 0.04% 13.16 1.71 0.72 3.20% 42%
TGT Target Corp. 46.33 0.39% 11.33 4.09 1.20 2.59% 29%
WEYS Weyco Group, Inc.  22.37 0.54% 19.45 1.15 0.64 2.86% 56%
GBCI Glacier BanCorp., Inc.  12.97 1.01% 21.98 0.59 0.52 4.01% 88%
SFNC Simmons First National Corp.  24.4 1.08% 11.35 2.15 0.76 3.11% 35%
GS Goldman Sachs Group, Inc.   130.91 1.09% 14.34 9.13 1.40 1.07% 15%
HGIC Harleysville Group Inc.  29.89 1.32% 10.71 2.79 1.44 4.82% 52%
ANAT American National Insurance 75.4 1.70% 12.76 5.91 3.08 4.08% 52%
CMA Comerica, Inc. 33.74 2.00% 18.54 1.82 0.40 1.19% 22%
CHFC Chemical Financial Corp.  18.27 2.35% 16.61 1.10 0.80 4.38% 73%
WABC Westamerica BanCorp.  48.12 2.58% 15.13 3.18 1.44 2.99% 45%
BRK-A Berkshire Hathaway Inc. CL 'A' 113,100 2.89% 17.19 6580.82 N/A N/A N/A
SUSQ Susquehanna Bancshares, Inc.  7.65 3.66% 45.00 0.17 0.08 1.05% 47%
MCY Mercury General Corp. 38.85 4.18% 14.28 2.72 2.40 6.18% 88%
HHS Harte-Hanks, Inc. 7.91 4.22% 10.01 0.79 0.32 4.05% 41%
NWN Northwest Natural Gas Co. 44.6 4.62% 17.02 2.62 1.74 3.90% 66%
TCB TCF Financial Corp. 13.56 5.12% 13.70 0.99 0.20 1.47% 20%
MDP Meredith Corp. 30.4 5.12% 10.67 2.85 1.02 3.36% 36%
AVP Avon Products, Inc. 27.53 5.40% 16.99 1.62 0.92 3.34% 57%
BXS BanCorp.South Inc. 12.21 5.53% 76.31 0.16 0.04 0.33% 25%
BOH Bank of Hawaii Corp. 45.34 5.59% 12.63 3.59 1.80 3.97% 50%
UVV Universal Corp. 37.37 5.68% 6.89 5.42 1.92 5.14% 35%
SJW SJW Corp. 23.18 5.94% 18.11 1.28 0.69 2.98% 54%
24 Companies
Watch List Summary
Northern Trust (NTRS) top our list this week. The shares of NTRS traded down and hit a fresh 52-week low at the close of Friday on big volume.  Readers may recalled that we recommended buying Norther Trust back on 9/1/10 and selling it on 12/3/10.  While the current price is about 5% lower, we believe Northern Trust may prove to be a good investment.  Investors should note that the company has not raise its dividend since 2007 but hasn't cut the dividend during the recent banking crisis either.  We view such action as a good indication by NTRS management.  The current payout ratio of 41% gives room for earning to fall by half and still meet the current dividend.  Credit Suisse cut its estimates on NTRS in this article.  Also, the company purchased a fund-administration unit from Citadel last month.


Target (TGT) landed in the third spot after Fitch cut its debt rating.  They've taken the rating down from A to A- on claims that Target is aggressively buying back its own shares and remodeling stores in Canada.  We've said it before that shares of Target look attractive at a 2% yield but it's even more attractive at a 2.59% yield.  This yield boost was because the company raised its dividend by 20%, from $0.25 to $0.30 per share.  Once again, IQTrend has estimated that Target is a good buy when it reaches a 1% yield.


Another company on our radar is American National Insurance (ANAT). Shares are trading 0.54x book value and we can't help but think that this company is about to go on the acquisition block after seeing Transatlantic (TRH) get a buyout offer at almost 0.8x book value.  In any case, investors will receive a 4% dividend as a token to wait for the price to skyrocket or get acquired.  The payout ratio for ANAT is manageable at 52%.  With $570 million in cash and only $60 million in debt, we'll be taking a closer look at this name in the coming weeks (probably will get snatched up before we can pull the trigger.)


Top Five Performance Review


In our ongoing review of the NLO Dividend Watch List, we have taken the top five stocks on our list from June 25, 2010 and have checked their performance one year later. The top five companies on that list can be seen in the table below.


Symbol Name 2010 Price 2011 Price % change
WAG Walgreen Co. 26.93 41.39 53.69%
MON Monsanto Co. 48.27 65.96 36.65%
SVU SUPERVALU Inc. 12.00 8.57 -28.58%
XOM Exxon Mobil Corp.   59.10 76.78 29.92%
HSC Harsco Corp. 25.05 30.88 23.27%

Average 22.99%

DJI Dow Jones Industrial 10,143.81 11,934.58 17.65%
SPX S&P 500 1,076.76 1,268.45 17.80%


It's interesting to note that a "boring" company like Walgreen (WAG) would outshine all those companies on the list.  It even outperformed the high flying Apple (AAPL) since that list was published.  Walgreen returned over 50% while Apple did 21.3%.  In our on-going comparison of WAG and AAPL, what we're trying to emphasis is the consistency of one stock over the other.  As AAPL's popularity waxes and wanes, WAG continues to methodically provided above average returns along with an outstanding dividend.
On our current list, we excluded companies that have no earnings. Stocks that appear on our watch lists are not recommendations to buy. Instead, they are the starting point for doing your research and determining the best company to buy. Ideally, a stock that is purchased from this list is done after a considerable decline in the price and extensive due diligence. We suggest that readers use the March 2009 low (or the companies' most distressed level in the last 2 years) as the downside projection for investing. Our view is to embrace the worse case scenario prior to investing. A minimum of 50% decline or the November 2008 to March 2009 low, whichever is lower, would fit that description. It is important to place these companies on your own watch list so that when the opportunity arises, you can purchase them with a greater margin of safety. It is our expectation that, at the most, only 1/3 of the companies that are part of our list will outperform the market over a one-year period.
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Dow Theory: Price and Values

Dow Theory is as much about values as it is about squiggly lines on a chart. Charles H. Dow, co-founder and former editor of the Wall Street Journal, often expressed the idea of values in many different ways. However, there is one passage from his editorials in the Wall Street Journal that we feel is critical to the general idea of what Dow meant whenever he talked on the subject of values. On July 20, 1901, Dow said the following:
The best way of reading the market is to read from the standpoint of values. The market is not like a balloon plunging hither and thither in the wind. As a whole, it represents a serious, well-considered effort on the part of farsighted and well-informed men to adjust prices to such values as exist or which are expected to exist in the not too remote future. The thought with great operators is not whether a price can be advanced, but whether the value of property which they propose to buy will lead investors and speculators six months hence to take stock at figures from ten to twenty points above present prices.

"In reading the market, therefore, the main point is to discover what a stock can be expected to be worth three months hence and then to see whether manipulators or investors are advancing the price of that stock toward those figures. It is often possible to read movements in the market very clearly in this way. To know values is to comprehend the meaning of movements in the market."
Source: Hamilton, William Peter. Stock Market Barometer. Page 38.
Dow Theorists like Richard Russell often quote the last sentence of the above excerpt, “…to know values is to comprehend the meaning…,” without giving the proper context of what is meant. The progression of thought that precedes the last sentence is critical to understanding why knowing values and their relationship to price is so important. Let’s deconstruct the ideas laid out before us.
First, Charles Dow tells us that the stock prices of today are adjusted for what is expected in the future. The distinction between great operators [Buffett, Einhorn, Paulson, Berkowitz etc.] and average traders/investors is the ability to know values enough to project at least six (6) months down the road that, even at higher prices, the investing public will still be willing to buy more of the stock in question.
Next, these great operators are supposed to be willing to accept half the gains that they expect for 6 months and in half the time. At which point, the great operators move on to other undervalued opportunities. Dow believed that not only should the great operators be able to predict the direction of the price of an undervalued asset, they must also accept less than the full amount possible despite their confidence and accuracy of prior investments using the same approach. This idea is based on a concept called “seeking fair profits,” which we mention in every sell recommendation that is posted on our site.
We readily admit that we don’t know all there is about fundamental analysis which is critical to the understanding of values. However, the creation of this site is specifically for the purpose of pointing you in the right direction. It is not accidental that we’ve selected the two lists, dividend increasing and Nasdaq 100 stocks, for your consideration. What we understand and hope to convey is that specific stocks at or near a new low are the benchmark for testing any and all forms of fundamental analysis, in the pursuit of determining values, with reduced probability of exceptional loss.
As an example, we found a stock recommendation made by Richard Moroney of the Dow Theory Forecasts (DTF) newsletter. On June 24, 2011, DTF recommended that investors consider all of the redeeming attributes of Dish Networks (DISH). DTF had the following to say about (DISH):
Like its service, DISH’s also shares seem attractively valued. At 10 times trailing earnings, the stock trades at a 33% discount to its five-year average and 47% below the average cable or satellite stock.

"Should DISH meet the 2011 consensus profit estimate of $3.16 per share and its P/E simply holds steady, the shares stand to gain 30% by early next year. DISH also boasts widening profit margins, and steady sales growth.”
Additional commentary about the pros and cons of DISH are provided with closing remarks indicating that the stock “…is a Long-Term Buy.”
However, the recommendation of (DISH) at the current price of $28.39 is very much in contradiction to what Charles Dow viewed as an attribute of a “great” operator in the market. Evidence of this is demonstrated in the chart below.
Notice that when DISH appeared on our Nasdaq 100 Watch (September 18th & December 12th), the stock rose $5 in the first six months. After rising $5, DISH rose an additional $7 and settled at the current price of $28.39 or $10 above the price when it first appeared on our watch list. An observer of the chart should take note of the fact that even though February 2010 was lower than the Sept and Dec 2010 prices, the 1-year period prior to February 2010 had price points that were much lower. Therefore, DISH did not fall within 10%-20% of the 1-year low at that time.
The recommendation of (DISH) by DTF, at the current price, seems a bit of a stretch and makes us wonder if such a recommendation can withstand a cursory market reaction, let alone a full-on bear market (a -30% decline or more.) This also makes us question the thought process of DTF when basic principles of momentum investing (buying high, hoping that the long-term is favorable) are applied under the name of a newsletter presumably based on concepts of Charles H. Dow.
We believe that adherence to Charles Dow’s explanation of values is a key contributing factor for why we have constructed our watch lists for you. We are confident that, although not experts in values, you could apply any fundamental methodology you like and feel fairly comfortable about the investment decisions that you’ve made (especially if you’re willing to wait for the long-term to arrive.)
The lack of attention paid to the price as it relates to values, in the case of the recommendation of DISH, may cost an investor a decline of 30% before a material gain is achieved unless the company is bought by a larger institution.


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Cree (CREE): One Year After

It's been one year since we wrote about high-flying and high-multiple stock, Cree (CREE). At the time of our first article, Cree was untouchable at 60x trailing earnings. Our take on the stock was not well received based on the commentaries in the article on SeekingAlpha - "Cree Inc. Is Overpriced." While it was too short to take any credit for our view in June, our follow up work in August seemed even more controversial to many. One comment by a reader of our article on Cree even went so far as to offer us an alternative strategy. The reader said:

"My recommendation to your readers would be to buy Cree as if you were buying Google in 2002-03. Short Veeco (VECO) and Aixtron (AIXG) against them if you want to be net neutral the sector."

As reflected in the chart below, anyone who followed the reader's strategy would have gotten crushed as Cree fell -51%, Veeco rost +31% and Aixtron jumped +25%.

In our previous articles, we expressed the view that multiples were going to contract as competition heated up. One year later, a recent report from Bloomberg on LEDs suggested that price will "plummet" by 2015 reconfirming our thesis. But let's back up and dig into the fundamental numbers and see what we can learn.

Back in June 2010, the consensus of analysts had predicted that Cree would earn somewhere between $0.66 to $1.68. However, Cree ended up earning $1.71, beating the highest estimate. The 2011 estimates in June 2010 were even more bullish. The earnings estimates ranged from $1.68 to $2.30. Since then, that range has tighten considerably. Analysts now expect Cree to earn anywhere from $1.66 to $1.78. Even more outrageous was a commenter's prediction of Cree earning $4.50.

The chart below depicts a graphic picture of the stock's fundamental and price collapse. How can we explain this phenomenon? We're not quite sure. But based on many news feeds about the price of LEDs falling, companies entering the space, and bullish comments on Cree, it was apparent to us that it should be something investors needed to avoid. The risk/reward profile wasn't going to be good from our assessment.

Cree Price Stock Chart

Now that the price of this stock has fallen by 50%, what's the next move? At this point, any investor interested in buying Cree should start running the numbers. The stock's risk/reward profile has reversed course and it may be worth considering. The P/E is now at 20x, which is very close to its historical low of 18. Many analysts have turned bearish on the shares (46% have either hold, sell, or underperformed). Some analysts even expect Cree earnings to fall to $1.61 in 2012.

Despite many of the negative concerns, Cree carries no debt and typically has very strong free-cash flow. The book value continued to rise during the price collapse. As a result, Cree is now trading at 1.67x book, almost as low as the 2009 low (around 1.19x book). A technology company with great IP such as Cree could easily get taken out at 2x book value. Its competitor Toyoda Gosei (TGOSY.PK) currently trades at 2x book.

It appears that our view on Cree has come full circle. This company makes great products but in our view was a bad investment one year ago. Now that everyone appears to be against the company, we can no longer ignore the value attributes of Cree. Although we believe that there is still some downside risk, we recommend considering this stock's compelling fundamental attributes for your next technology stock investment.

It's a Matter of Economics, Cree is Overpriced (6/3/10) - New Low
LED's Bright Prospects Could Dim (6/3/2010) - MarketWatch
From Macro to Micro, Cree Follow Up (8/11/10) - New Low
LED Lighting Prices to ‘Plummet’ By 2015, VantagePoint Says (6/16/11) - Bloomberg

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