Applied Materials (AMAT)

February 20, 2007

Applied Materials manufactures semiconductors and fabrication equipment for the semiconductor industry worldwide. Some predict that these businesses will suffer in 2007 due to a chip glut. That may be true, but Applied Materials is clearly a market leader in this important business. The shares appear to be fairly priced, and the company has some very interesting long-term growth prospects. I own AMAT indirectly through an investment in the Clean Energy ETF (PBW) and I do not plan to buy it in its own right.

Applied Materials is a former highflier of the 1990s which has come down to earth. AMAT’s price to earnings, sales, and book value ratios all compare favorably with the S&P 500, and the P/E ratio of 16 matches the expected earnings growth rate. The dividend yield is rather low at 1.05%, and the beta is high at 1.42, so this is not an investment for the faint-hearted. But an average annual total return of at least 15% appears reasonable based on current fundamentals. The company looks financially strong and it has little debt. Applied Materials’ annual net earnings have been quite volatile, but they have made money every year since 1997, except for 2003; and their net earnings have been strong since then. They started paying a dividend of .09 a share in 2005 and doubled it to .18 in 2006. The payout ratio is only 15%. There have been many 2-for-1 splits over the years. The most recent was in 2002.

According to a recent article in Telegraph.co.uk, AMAT is two years away from a photovoltaic product that will reach the magic level of $1 a watt, at which solar electricity becomes directly competitive with electricity generated from fossil fuels. Cell conversion efficiency and economies of scale are moving ahead so fast that the cost will be down to 70 cents per watt by 2010, with a target of 30 or 40 cents by 2017.

“We think solar power can provide 20% of all the incremental energy needed worldwide by 2040,” said Mike Splinter, chief executive of Applied Materials. “This is a very powerful technology and we’re seeing dramatic improvements all the time. It can be used across the entire range from small houses to big buildings and power plants,” he said. “The beauty of this is that you can use it in rural areas of India without having to lay down power lines or truck in fuel.”

Applied Materials is betting on both of two rival solar technologies: the new thin film panels as well as the traditional crystalline wafer-based cells, which are not as cheap but produce higher yield per surface area. The thin film panels are so light they can be stuck to the side of buildings as well as on their roofs. This material can be mass-produced in long rolls of any color and easily applied by ordinary construction workers.

The major oil companies are ignoring this development, and electric utility companies don’t want to hear about it, but I think that within five years solar power will finally be cheap enough to be practical, even in cold northern regions, and that will mark the beginning of a world-wide solar power boom. Within ten years, I think the cost of photovoltaics will have fallen enough for solar electricity to be much cheaper than electricity from conventional sources. The technology is beginning to proliferate in a parabolic curve, just the way computer chips did in the 1980s and 1990s, and Applied Materials is ideally positioned to profit from this new trend.

Fording Canadian Coal Trust (FDG)

February 16, 2007

According to Yahoo Finance, Fording Canadian Coal Trust operates as an open-ended mutual fund in Canada. The trust owns a 60% interest in Elk Valley Coal Partnership, which produces and sells seaborne metallurgical coal. The partnership’s primary product is hard coking coal, which is a metallurgical coal that is used primarily for making coke in integrated steel mills. Elk Valley Coal owns interests in six open-pit mines that consist of Fording River, Coal Mountain, Line Creek, Elkview, and Greenhills mines that are located in the Elk Valley region of southeast British Columbia; and Cardinal River mine located in west central Alberta. Fording Canadian Coal Trust also owns 100% interest in NYCO, which engages in wollastonite mining operations in New York State and Mexico, and Tripoli mining operations in Missouri. Its product wollastonite is an industrial mineral that is primarily used in the manufacture of automotive composites, adhesives and sealants, metallurgical fluxes, friction material, paints and corrosion-resistant coatings, fire-resistant construction wallboard, cement-based products, and ceramics; and Tripoli is an industrial mineral that is used primarily in buffing and polishing applications. As of December 31, 2005, Elk Valley Coal had proved and probable mineral reserves of bituminous coal of approximately 682 millions tonnes, as well as NYCO had 111 millions tonnes of proved and probable mineral reserves of wollastonite and Tripoli. Fording Canadian Coal Trust was founded in 1991 and is headquartered in Calgary, Canada.

Fording looks more like a gold mine than a coal mining operation. FDG’s has been around about five years. It has outperformed the S&P 500. The current yield is 16.47%. Dividends are paid in Canadian Dollars, so they will fluctuate with the payout and with the exchange rate. Essentially all of the company’s income is paid out as dividends. Net income has increased by a factor of ten since 2001. Annual dividend payments from 2003 – 2006 have been .12, .74, 1.13, and 4.02. The stock has a low beta of .64, a Price/Earnings ratio of 6.1, and a Price/Cash Flow ratio of 5.4. The stock has a low 3-year correlation to all S&P sectors, the highest correlations being for energy, utilities, and industrials at .65, .55, and .42 respectively.

After a sharp nosedive, FDG’s trend appears to have turned up. The stock reached a high of 45.15 in 2005, then declined to a low of 18.90 in November 2006 due to several factors: legislation to impose heavy taxes on dividends from Canadian Royalty Trusts; an ongoing correction in the bull market for energy products; and the recent decline of the Canadian Dollar against the U.S. Dollar. FDG has subsequently rallied from the 18.90 November low to a high of 23.87 last week, where it became overbought, and it is now in a consolidation pattern. The Canadian Dollar has been rallying strongly this week too, after declining from 91.42 last summer to 84.22 last week. I do not own FDG now but I may buy some in the near future. If the proposed taxation of CANROYs does come to pass, I am willing to share some of the generous and rising dividend stream with the Canadian government to help fund their wonderful medical, educational and social services.

The Facts About Inflation and Energy Price Trends

February 15, 2007

The chairman of the Federal Reserve, Ben Bernanke, gave Congress a positive view of the economy yesterday, predicting that declining energy and commodity prices are likely to reduce inflation. “There are some indications that inflation pressures are beginning to diminish,” Bernanke told the Senate Banking Committee.

The popular stock indexes rallied on this news. The Dow closed at an all-time high of 12,741.86. The S&P 500 rose to a six-year high of 1,455.30.

Since a market downdraft will eventually occur and one of these new highs will become the bull market top, it is my job to look at the other side: to review the facts critically, and see if the assumptions being made by the market are correct.

“There are some indications that inflation pressures are beginning to diminish.”

Bernanke probably studies inflation pressures by looking at economic data. I look at the three-year weekly charts for Crude Oil, Gold, and the CRB Index. Inflation pressures can not abate if those three are rising!

My read on these three is that they have finished a normal bull market correction, and are they are about to begin a new upswing which could be sharp and prolonged.

Crude Oil appears likely to challenge $70 this spring and could easily rise to $80 or higher later in the year. Gold has already risen strongly from the correction lows and appears ready to take out the old high of $730.40 in the near future. And the CRB Index, arguably the best measure of raw material costs which could impact consumer inflation, looks quite similar to the Crude Oil chart, only even more bullish. I believe the bull market in commodities is about to resume with vigor.

In view of this information, I believe the stock market’s optimism is not justified. I think inflation will remain problematic for the Fed. I do not believe they will cut interest rates this year and I suspect they actually may be forced to raise rates. I am very comfortable with my heavy commitment to energy stocks and my growing commitment to gold mining stocks. I expect the utilities, financial sector and REITs to come under pressure in the near future, perhaps enough to create a buying opportunity.

Lessons from John Dorfman

February 14, 2007

John Dorfman has been writing a value-oriented stock market column for Bloomberg for nine years. Dorfman is an independent thinker and his columns have been a gold mine of original investment ideas. John is retiring as a Bloomberg columnist to devote full attention to his Boston investment firm, Thunderstorm Capital. I will miss reading his articles but I am sure he will prosper.

In his last column, Dorfman sums up what he has learned from nine years of intensive research of many investment strategies. I have extracted the first four points to preserve for posterity. They are deceptively simple, but I think they are extremely important:

One: Out-of-favor stocks are the best road to capital gains.
Two: Don’t be swayed by what Wall Street analysts say.
Three: High portfolio turnover is not necessary for good results.
Four: The investment value of a stock is independent of whether it has been moving up or down.

The Ultimate Lazy Portfolio

February 13, 2007

One of my favorite blogs is The Kirk Report. There are few days when this Kirk does not provide a variety of thought-provoking and useful material. Yesterday he had a post about Scott Burns’ “Lazy Portfolios” -simple but effective model portfolios meant as a foundation for long-term investing. Here are the portfolios, which are said to have solid long-term track records:

Scott Burns’ Lazy Portfolios (Assetbuilder.com):

Coach Potato Portfolio:
– 50% in Vanguard Total Stock Market Index Fund (VTSMX)
– 50% in Vanguard Inflation Protected Securities Fund (VIPSX)

Margarita Portfolio:
– 33.3% in Vanguard Total Stock Market Index Fund (VTSMX)
– 33.3% in Vanguard Inflation Protected Securities Fund (VIPSX)
– 33.3% in Vanguard Total International Stock Index Fund (VGTSX)

Four Square Portfolio:
– 25% in Vanguard Total Stock Market Index Fund (VTSMX)
– 25% in Vanguard Inflation Protected Securities Fund (VIPSX)
– 25% in Vanguard Total International Stock Index Fund (VGTSX)
– 25% in Vanguard REIT Index (VGSIX)

Five Fold Portfolio:
– 20% in Vanguard Total Stock Market Index Fund (VTSMX)
– 20% in Vanguard Inflation Protected Securities Fund (VIPSX)
– 20% in Vanguard Total International Stock Index Fund (VGTSX)
– 20% in Vanguard REIT Index (VGSIX)
– 20% in American Century International Bond Fund (BEGBX)

Six Ways From Sunday Portfolio:
– 16.65% in Vanguard Total Stock Market Index Fund (VTSMX)
– 16.65% in Vanguard Inflation Protected Securities Fund (VIPSX)
– 16.65% in Vanguard Total International Stock Index Fund (VGTSX)
– 16.65% in Vanguard REIT Index (VGSIX)
– 16.65% in American Century International Bond Fund (BEGBX)
– 16.65% in Vanguard Energy (VGENX)

I agree that simple is good; I especially like the Couch Potato portfolio, but if you really want simple and lazy, how about this?

The Sloth Portfolio: 100% in Vanguard Total Stock Market Index Fund (VTSMX)

VTSMX has outperformed the S&P 500 over the last five years. It has also outperformed VIPSX, although with more volatility; therefore The Sloth Portfolio should have outperformed the Couch Potato Portfolio by a good margin. If someone accumulates shares by dollar-cost averaging they are likely to do quite well with relatively low risk.

I am not recommending that anyone invest in VTSMX – just thinking out loud.

If someone in his 20s, with a good income, but lacking the time and inclination to study the financial markets, were to decide to $1000 a month in VTSMX come hell or high water, and then stick to the plan for 40 years, he should end up with a very nice nest egg indeed!

I think investing in bonds is a losing proposition at this time, due to the low prevailing interest rates, and I don’t think that Treasury Inflation Protected Securities are very much more attractive than conventional bonds. Stocks of profitable companies which regularly raise their dividends offer secure income with better inflation protection, in my opinion. A low rate of return is still a low rate of return, no matter what spin you put on it. But when and if long-term Treasuries are again yielding more than 10%, I will load up on them. In the meantime bonds will continue to occupy a relatively small percentage of my portfolio.

Is it really a sign of a top when closed-end funds trade at a premium?

February 12, 2007

There was an article on Seeking Alpha this morning entitled “Sign of a Market Top? Closed-End Funds Trading at Premium to Net Asset Value“. The article states this is “a phenomenon almost without precedent” and quotes Barron’s columnist Randall Forsyth as saying this is happening for the “first time in my memory”. But as this chart from MarketGauge by DataView LLC indicates, there have been two incidences of this phenomenon since 1998. The closed-end funds traded at a premium for a good part of 2001, halfway through the bear market; and closed-end funds also traded at a premium for most of 2004. The S&P 500 index went on to gain more than 250 points from the end of 2004 to the end of 2006. Based on the data available, I don’t think this is a sign of a top. On the contrary, the limited data available in this chart suggests that the opposite may be true. The closed-end funds were selling at the largest discount to net asset value right at the market top in 2000.

Comments

February 12, 2007

Comments are an important issue that every blogger has to deal with. Since the beginning I have taken care to respond to every comment. You would like to be able to have intelligent discussions with your readers, but it takes a lot of time to keep up. There is a lot of spam, and the vast majority of valid comments are silly. They can even be insulting. I tried to filter the results by requiring that commenters must be registered users of wordpress.com who are logged in, but that did not help. Here are excerpts from a comment left by “poppy8sd” to my recent post on Whole Foods Market:

It is the stuff of a confused unschooled mind . . . You could benefit from self-education . . . you don’t know what you’re talking about . . . what you’re saying is irrelevant.”

This kind of comment can be irritating if you feel you need to respond to it! That one caused me to consider blocking all comments, but in the end I have decided to do the opposite. I am opening up the comments again so anyone can participate. However, I’m changing my policy about responding: Comments can now be posted freely by anyone, but I will not answer unless I find the topic interesting.

Whole Foods Market (WFMI)

February 9, 2007

I keep a list of growth stocks that I might be interested in buying if they ever tank enough to selll at less than 20 times earnings. Whole Foods Market, currently selling at 32 times earnings, is on the list. This stock has enjoyed phenomenal growth, but it has been in a downtrend for the last year. I have been watching for signs that WFMI is bottoming out, but recent developments lead me to believe that the company is headed for more trouble in the months ahead.
WFMI is currently operating 191 stores and it has plans to open 80 more this year. Whole Foods’ stores in large cities have certainly done well, but as the company grows they are of course forced to open their new stores in smaller cities, such as Birmingham, AL, pop 231K; Boise, ID, pop. 193K; Sugarland, TX, pop 76K; and Portland, ME, pop. 64K.

I think you need a much larger city to be able draw enough of the kind of customers who shop regularly at WFMI. You need people who have bought into the Whole Foods philosophy: people who feel better about themselves when they pay premium prices for goods that are readily available at better prices elsewhere. There may be 100K people like this in New York or Los Angeles, but how many are there in Boise?

WFMI also appears to be opening these new stores with a complete lack of insight into the sensitivities, loyalties, and regional traditions of smaller U.S. communities.

A Feb. 7 AP article, “Maine Whole Foods to Sell Live Lobsters“, illustrates the problem. Whole Foods is opening a 46K square foot store in Portland next week. Although they do not sell lobsters in their other stores “in the name of crustacean compassion”, they are planning to sell them in Portland. But, instead of buying lobsters off the Portland wharf several blocks away from the store, they are planning to use a New Hampshire distributor which meets their “demands for how the lobsters should be treated”. This has already caused incalculable PR damage in Portland. “I think it’s unfair to suggest that the 7,000 (Maine) lobstermen and hundreds of lobster dealers and retailers don’t know how to handle a Maine lobster,” said Kristen Millar, executive director of the Maine Lobster Promotion Council. Tom Martin, a Portland lobsterman, noted that “When they say they buy local and support local fishermen and farmers, and then they tell us we’re doing everything wrong, obviously it doesn’t sit very well with us.” If you are going to sell lobsters in Maine, you need to know that Maine people will not buy lobsters imported from New Hampshire, even if the crustaceans were originally caught in Maine waters.

Furthermore, to prevent customers from boiling their lobsters live in the traditional manner, Whole Foods plans to electrocute them in the store with a device called a “CrustaStun”. Tom Martin, the lobsterman, was quoted as saying: “A lobster electric chair? I wonder how that will sound for their public relations, that they’re going to give the lobster the electric chair.” And to finish off this public relations catastrophe, which must have alienated almost all of Whole Foods’ potential customers in Maine, P.E.T.A. weighed in on the issue: “Our expectation is that all Maine stores that sell live lobsters will have to implement animal welfare protocols in order compete with Whole Foods . . . ” Nothing could be farther from the truth.

It could be that Whole Foods is about to learn an expensive lesson. I am not a short seller, but this is tempting.

Update on PowerShares Progressive Energy ETF (PUW)

February 8, 2007

The progressive energy ETF was reviewed in this blog when it started trading last fall. I thought it sounded promising, especially as a complement to its sister ETF, PowerShares WilderHill Clean Energy (PBW), which I own. To recap briefly, PUW is based on the WilderHill Progressive Energy Index. This Index is comprised U.S. listed companies that are significantly involved in “transitional energy bridge technologies”, with an emphasis on improving the use of fossil fuels. Simply put, the ETF invests in companies which are likely to profit from more efficient use of existing energy resources. The portfolio is rebalanced and reconstituted quarterly. PUW’s expense ratio is a reasonable .60. According to a chart on powershares.com’s website, the index would have outperformed the NASDAQ and the S&P 500 by a wide margin in the last five years, but with a little less volatility. The index has a beta of .92. Of course, these results are hypothetical, and do not take into account management and transaction fees.

After studying PUW last November, I concluded that I would be interested in buying if it proved to have sufficient trading volume and satisfactory trending characteristics. Normally it takes a year to assess these things, but here is a preliminary judgment based on the first few months of trading history.

The chart shows that trading volume has been light, but satisfactory, with an average of 14K shares a day, and there has been a trend toward increasing volume, on at least the higher volume days. PUW has exhibited an nice upward price trend which has resulted in almost a 9% share price increase in a little less than four full months. Relative strength to the S&P 500 has been satisfactory, although some drag was evident during the recent selloff of energy stocks; but relative strength to PBW has been excellent,at least until the last few days, when PBW has become stronger.

PUW does look like it would be a good complementary investment for PBW, broadening participation in energy-efficiency technology and dampening overall volatility. I will start monitoring it regularly while waiting for a good entry point.

Cullen/Frost Bankers, Inc. (CFR)

February 7, 2007

Cullen/Frost looks like a good long-term investment which is fairly priced at this time, with an expected average annual return in the 13% range. I am going to pass because of CFR’s high correlation to the energy sector, where my portfolio is overweight, but for anyone without that problem CFR might reward further research. This Texas bank has enjoyed excellent profit and dividend growth but it is relatively inexpensive compared to some its peers. CFR has strongly outperformed the S&P, but it has a higher dividend yield and less volatility. In addition to offering the customary banking services through 100 offices all over Texas, the company does international banking business with customers residing in Mexico or doing business with customers in Mexico, sells a variety of insurance products, and acts as a correspondent for other banks in the area.


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