Tag: Tony Sagami

 

Stock buybacks are always a good thing… right? That’s what the mass media has trained investors to believe, but there are times when stock buybacks are a horrible strategy.

Let’s take a look at Herbalife, which has had very visible news items as billionaires like Carl Icahn, George Soros, Daniel Loeb, and Bill Ackman publicly debate the future of the company.

Herbalife shares have lost more than half their value in 2014 because of a Federal Trade Commission investigation and a big drop in profits. 50% is a huge haircut, but I believe Herbalife is poised for even more pain.

Rapidly Disappearing Profits

Herbalife recently reported its third-quarter results and they were just awful. Herbalife earned $0.13 per share in Q3, but that was a whopping 92% decline from the $1.32 it earned last year.

That’s awful, but Herbalife says business will be even worse going forward. The Wall Street crowd expected Herbalife to grow revenues by 7% in 2015, but the company said that its revenues will fall by -1% to -2% instead.

Part of that lower guidance is from the impact of the strong US dollar. Guidance for Q4 includes an unfavorable impact of $0.31 from currency conversions. If you remember, I previously wrote that the strong dollar was going to kill the 2015 profits of companies that do lots of business overseas.

I have to admit, I am skeptical of all the multilevel marketing businesses, but Herbalife is reinforcing that preconceived notion.

FTC and FBI Investigation

The Federal Trade Commission is investigating Herbalife for what could ultimately result in charges that Herbalife is operating an illegal pyramid scheme.

In March, the FTC sent Herbalife a civil investigative demand (CID), which is a subpoena on steroids because all the evidence produced by a CID can be used by other agencies in other investigations, such as the FBI, which is also investigating Herbalife.

The FTC outcome is unknown. Heck, Herbalife could eventually be declared innocent and pure… but I wouldn’t bet on it.

Board Members Gone Bad!

When your company is in the middle of FTC and FBI investigations, the last thing you want is for your company officers to get in trouble with the law. A current Herbalife board member, Pedro Cardoso, has been charged with illegal money laundering by Brazilian prosecutors. Time will tell if the charges are true… but it looks very bad.

That’s not the only problem with the Herbalife board of directors. Longtime Herbalife Board Member Leroy Barnes announced that he is leaving. Board members leave for legitimate reasons all the time, but Barnes is the fourth Herbalife board member to leave in 2014. Talk about rats jumping the ship!

The Smoke and Mirrors of Stock Buybacks

The above issues are all serious and enough to stay away from Herbalife, but the biggest red flag I see is the abusive financial engineering that Herbalife is using to prop up its stock.

Example: In Q2, Herbalife spent over $500 million to buy back its own stock for the purpose of propping up its earnings-per-share ratio. Fewer shares translates into higher earnings per share.

The root of the problem is that Herbalife is using up all its cash AND borrowing money like mad to finance the stock buyback.

In the last year, Herbalife’s debt has exploded by over $1 billion. Herbalife is using every penny of operating cash flow and taking on new debt just to buy back its stock.

Moreover, since Herbalife’s stock has plunged by 50% this year, Herbalife wasted hundreds of millions of dollar of shareholder money by buying stock at much higher prices.

And now that revenue, profits, and free cash flow generated by operations are shrinking, Herbalife is on a collision course with insolvency.

Carl Icahn, who is certainly a much better investor than I will ever be, is a big Herbalife fan and even went as far as to call the shares undervalued. “I would tell you I do believe Herbalife is quite undervalued and it is still a good business model.”

Ahhhh… Carl… sorry, but I think you couldn’t be more wrong.

George Soros, by the way, appears to agree with me because he reduced his Herbalife holdings by 60% after the company reported those disastrous third-quarter results a few weeks ago.

I’m not suggesting that you rush out and buy put options on Herbalife tomorrow morning. As always, timing is everything, but I have very little doubt that Herbalife’s stock will be significantly lower a year from now.

Moreover, the real point isn’t whether Herbalife is headed higher or lower, but that good, old-fashioned fundamental research can help you make money in any type of market environment.

Even during bear markets.

30-year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here. To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here.

 

The textbook definition of a correction is a drop of 10% or more. The stock market came close to hitting that correction benchmark and has mounted a furious rally since mid-October. The S&P 500 has staged a remarkable rally, jumping by 12% from its October lows in just four weeks.

There’s something in our DNA that pushes humans to follow the herd, and investors have been herding into the stock market in almost unprecedented enthusiasm. I mean really herd.

Get this: the S&P 500 has closed above its five-day moving average for 20 consecutive days. A five-day moving average is an extremely short-term indicator that can rapidly change, so the feat of staying above this hypersensitive indicator for almost a month is rare.

How rare? It has happened just three times before in the last two decades.

And each time when the market rallied so vigorously, the winning streak ended within four weeks. That tells me that despite the stock market’s hot hand, the risk/reward profile of the stock market is in favor of the downside.

The rally has also pushed valuations back into nosebleed territory. The S&P 500 is now trading at a P/E ratio of 19, which is well above the historical average of 15.

The stock market looks even more overvalued if you dig a little deeper. The Shiller P/E ratio, developed by Nobel Prize-winning economist Robert Shiller, adjusts earnings for inflation and average corporate earnings over the last 10 years. The current Shiller P/E ratio is 26.5, dangerously high compared to the historical average of 16.

Could the stock market get even more overvalued? Sure! During the dot-com heydays, the Shiller P/E got as high as 44.

Perhaps you’re not impressed with Shiller’s work. How do you feel about Warren Buffett? Buffett’s favorite valuation indicator is the total stock market cap divided by GDP.

Buffett called this indicator “the best single measure of where valuations stand at any given moment” because it really compares the relationship between the stock market and the economy. In short, when the overall market capitalization is greater than GDP, the stock market is expensive.

Like the Shiller P/E ratio, this market cap/GDP ratio is dangerously high at 127% of GDP, which is its highest reading since the dot-com days.

Last, the current rally is starting to show cracks in confidence. In strong, healthy, long-lasting rallies, the stock swings tend to narrow. When investors are confident, volatility tends to narrow, which is exactly what we saw over the last two years.

Volatility has increased, and the S&P 500 is now showing what’s called a “broadening top,” a trading pattern that shows a wider trading range.

Think of it as like political election polls. A candidate with a solid lead tends to see his pre-election poll numbers remain steady, if not increasing. If the pre-election polls started to show a narrowing margin of victory in the last weeks before the election, an upset may be in the cards.

Investors are becoming more uncertain, and the bears have narrowed the advantage to the point that a stock market upset seems more likely.

Many, if not most, investors have been conditioned to “buy the dips,” and that has been the right move since the 2008 financial crisis. However, I like to pay more attention to what’s ahead of me instead of what’s behind me; and we’re moving into a new era of post-QE where “selling the rallies” will be the new, right move.

30-year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here. To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here.

 

Get used to the headlines like the one below. You’re going to hear hundreds of US multinational companies blame their profit shortfalls on the strong dollar.

Revenue Miss #1: Lockheed Martin rose sharply after reporting better-than-expected quarterly profits. However, their $11.11 billion of sales for the quarter missed the $11.28 billion forecast and was a 2% year-over-year decline from Q3 2013.

Revenue Miss #2: eBay earned one penny more than expected, but its revenues of $4.35 billion missed expectations for $4.37 billion.

Revenue Miss #3: SanDisk reported better-than-expected profits, but its revenue of $1.75 billion was a little short of the $1.76 billion forecast. More importantly, SanDisk told Wall Street to lower its Q4 revenue expectation to between $1.8 billion to $1.85 billion, below estimates of $1.88 billion.

Revenue Miss #4: IBM, which I lambasted a couple weeks ago, delivered $22.4 billion of sales, a pathetic 3% year-over-year decline and below the $23.37 billion consensus forecast.

Revenue Miss #5: Wall Street liked a better-than-expected profit report from General Motors. GM beat profit expectation by two cents, but revenues did not fare as well; GM had $39.3 billion of quarterly revenues, but Wall Street analysts had forecasted sales of $39.5 billion.

Revenue Miss #6: Coca-Cola, the world’s largest beverage maker, said that net income for its Q3 ended September 26 was $2.1 billion, or 48 cents a share—down from $2.4 billion, or 54 cents a share, a year earlier.

Coca-Cola reported quarterly revenue of $12 billion, a flat performance from the previous quarter. Year to date, the company’s reported revenue is down 1.9% from 2013.

COKE also expects fluctuations in foreign currency exchange rates to have an unfavorable impact on its 2015 results.

Those currency losses are tucked away in the “Other Income (loss)” line of the income statement. The currency effect on operating income will equal 7% in the fourth quarter, and 6% for the full year.

COKE estimates that the strong dollar will reduce its profits by 6% over the next year!

And to make sure that COKE paints itself in the best possible light going forward, it will start using “profit before tax” rather than “operating income” as a primary metric to track profitability.

I could go on, but I think the above examples show there’s a lot of financial engineering going on behind the scenes to meet profit expectations. A serious underlying revenue slowdown is running through corporate America.

The common theme for all these revenue-challenged companies is a heavy dose of foreign sales. Those foreign sales are being negatively affected by a strong US dollar.

The US dollar has been on fire, but instead of helping corporate America, it hurts US multinational companies in two painful ways:

Top Line Pain: A strong dollar raises prices for foreign customers and those higher prices can negatively affect demand.

Bottom Line Pain: The value of overseas sales declines when translated back into US dollars.

The result is a double-whammy of profit pressure. How much of a whammy? Experts say a 1% move in the dollar can have a 2% impact on the earnings of the S&P 500 companies.

When I connect the dots, I see an explosion in the number of companies that will soon report worse-than-expected results, which they will blame on the strong dollar.

You’d be wise to take a close look at the stocks in your portfolio and jettison any that look vulnerable.

Better yet, if you have some speculative capital, there are big profits to be made by betting against—through short sales, inverse ETFs, and/or put options—those ticking time bombs.

30-year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here. To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here.

Investing is about piecing together different bits of information into an illustrative picture—sort of a Wall Street version of the connect-the-dots game we played in kindergarten.

That’s why the headline below from Bloomberg made my investment antennae stand up and motivated me to look for either confirmation that the real estate market was indeed slowing down or contrary evidence to explain if the weak summer sales numbers were just a temporary aberration.

What that Bloomberg article showed was that home prices in 20 US cities increased at the slowest pace in almost two years ending in July, rising at an uninspiring annualized pace of 0.5%. Those are, by the way, the worst numbers since November 2011.

That’s a change from the healthy real estate gains that we’ve seen for two years, and there are lots of other reasons to think that real estate is headed for a rough patch, if not downright trouble.

Warning Sign #1: Worrywart Homebuilders

You know who knows more about real estate than the Gucci-wearing loafers on Wall Street? The people swinging the hammers and putting their own capital on the line with every real estate project they start.

The National Association of Home Builders index of builder confidence dropped by five points from 59 in September to 54 in October.

Each of the index’s three components were sharply lower in October: the current sales conditions index fell 6 points to 57, expectations for future sales fell 3 points to 64, and traffic of prospective buyers dropped 6 points to 41.

Warning Sign #2: Widespread Use of Sales Carrots

Surveys are useful but far from perfect. A better gauge of builder sentiment is how many incentives—such as upgraded cabinets, wood floors, and high-end appliances—they’ll include to close a deal.

Make no mistake: builders don’t give away incentives unless they have to and builders are giving away tens of thousands of dollars in incentives to goose slumping sales.

“Incentives have increased because builders aren’t selling as well as they would like. … Rather than reducing prices (outright), they use incentives,” said John Burns of real estate research firm John Burns Real Estate Consulting Inc.

A Wells Fargo survey of 150 homebuilders reported that that percentage of builders using incentives rose to 26% from 17% in August of 2013 and 21% in July of 2014.

Homebuilder Lennar admitted that it gave away incentives worth $20,400 per house last quarter. Moreover, that $20,400 amounted to 5.8% of the sales price. That’s a heavy hit on profits!

Warning Sign #3: Sales Slowdown

In a recent report, Toll Brothers warned Wall Street that its sales are slowing. Its sales contracts dropped by 4% in the last quarter and it now expects to sell 5,300 to 5,500 homes this year, down from its previous high-end forecast of 5,850 homes.

Moreover, as the above chart shows, home appreciation is now nonexistent and is threatening to turn negative.

Warning Sign #4: Profit Plunge Next?

Slumping sales and stagnant real estate prices are the precursor to profit disappointment. “Construction of single-family homes has been weak,” said CBRE Global Chief Economist Richard Barkham.

The first homebuilder profit warning was just delivered by KB Home, who is selling fewer and fewer homes. KB Home delivered 1,793 homes last quarter, down from 1,825 delivered in the same period a year ago.

That translated into weaker profits. KB Home reported earnings per share (EPS) of $0.28 on $589.2 million of revenue; however, Wall Street was expecting $0.40 EPS and $646.76 million of sales.

Warning Sign #5: Watch the Real Estate Food Chain

There is a lot more to the real estate industry than just homebuilders—the furniture industry, for example.

Stanley Furniture just reported its quarterly results and delivered a loss of $2.3 million and 5.0% drop in sales.

“The demand for upscale wood residential furniture in the industry’s traditional channels of distribution remains relatively weak,” warned CEO Glenn Prillaman.

My vegetable farmer father was one of those people that thought real estate prices would never go down. The 2008 financial crisis and accompanying real estate crash proved that wasn’t the case and the growing number of worrisome data points are warning me that stocks in all the parts of the real estate food chain could be headed for trouble.

Tony Sagami

30-year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here. To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here.