I'm a broken record: Buy BWLD, Short CMG

I"ve posted these thoughts again and again, but as I wrote about it for TradeKing's new community, I decided I'd repost some thoughts here:

The differences in trading between BWLD and CMG over the past four months baffle me.

At the beginning of that period, BWLD traded with a forward P/E in the 20s, while CMG's was 55.

BWLD reported mildly disappointing earnings (though not disasterous - just a slight downward adjustment to forward guidence) and lost half of its value (it's up 20% off the bottom now). Chipotle was up immediately after its earnings (which weren't anything excellent), set a new record high, but is also down now, about 10% lower than its pre-earnings level (in October 2007).

Going into CMG's earnings (which are released next Thursday), I'd be short, or at least sit on the sidelines. They still have a forward P/E of 40, which is clearly pricing in exceptional growth. Though they really haven't failed to disappoint yet, I think a rising cost of raw materials and pressure on the consumer may cause them to guide downward, or at least be cautious. In a high-flying stock, that can mean share price implosion - look at VMWare just a few weeks ago.

I'm long BWLD (shares and March $25 calls [purchased when the stock was at $22]), as I think that they should make a great recovery. Their forward P/E is 18, which is very cheap for a company growing at 20% annually. YUM and MCD have forward P/Es of 16 and 15 (respectively), so for a small, growing company like BWLD, 18 is dirt-cheap.

In two weeks, CMG may be at $100. In a year, BWLD may be back at $35.

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Google Longs got Lucky

The mighty Google has now fallen about 30% from its November high; the last time shares trade below $500 was a full six months ago. The most recent 10% of that decline has occurred in the past week, as the bombs keep dropping on Google. These losses certainly are nothing to sneeze at (and I sympathize for investors who bought in at $730 on the heels of a Cramer recommendation), but the losses really should be even more significant.

Let's look at the news that's dropped in the past week. First, when Google reported its earnings, they missed both top-line and bottom-line estimates (though, admittedly, I think big movements after a 1% disappointment [which is how much Google missed buy on the EPS] are illogical). However, when a stock is priced for near-perfection (as Google certainly was a $750, and to some degree, still was/is), the most minor disappointment can be devastating. (Usually, Google beats and raises estimates.) So after the earnings miss, the stock did drop about 8% after-hours, but even that was relatively minor compared to recent collapses like Apple and VMWare after their disappointments.

Then, the bad news kept coming. After the earnings disappointment, Jefferies & Company downgraded the stock (from buy to hold) and reduced their price target from $725 to $600 (All of this information taken from here, a AP press release found on Yahoo! Finance). "Meanwhile, Citi Investment Research analyst Mark S. Mahaney cut his Google price target to $650 from $775, while RBC Capital Markets analyst Jordan Rohan lowered his target to $675 from $725" (AP press release). One downgrade and two additional price-target drops should have kept Google falling.

Lastly, the news about the Yahoo/Microsoft merger should have been the proverbial straw that broke the search engine's back. If the deal goes through, Google will finally have a serious competitor. With Yahoo having the largest pool of email users and Microsoft providing most of the world with operating system and office software, the companies' strengths should compliment each other well. Google has been trying to break into these areas with Google Apps, Docs, and Spreadsheets, but has failed to displace any significant amount of Microsoft users.

Maybe Yahoo's board or shareholders will reject the offer, or some suitor (many analysts have speculated Newscorp could be one) may come along and bid higher. However, if Microsoft's offer is approved, I don't see antitrust courts blocking the merger. Google controls over 65% of the domestic search market, and leads throughout most of the rest of the world too. Though the vertical integration (operating system -> office suite software -> browser -> search engine) may be scrutinized, I don't think Google's lobbyists (yes, they have lobbyists) will successfully prevent a merger.

So back to my original point - Google has lost $50 in share value since the earnings news dropped. Many Google longs now flaunt Google as a "deep-value" now that it's at $500. But considering the deluge of bad news that's been released in the past week, I wouldn't be surprised if GOOG was currently $100 cheaper.

Don't get me wrong; Google is one of the most incredible, breakthrough-creating companies of the past decade (and will lead the way in the future). But as it becomes mature, it's valuation is looking too rich. Intel and Cisco trade at 13 times forward earnings, while Google is still at over 20 (and one could easily argue that those estimates may not be met). As Google enjoys its domain as a large company, it may have to start trading like one too.



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Abercrombie: Range Bound

If you've watched CNBC for any lengthy period of time, you've probably seen a commercial for "Channeling Stocks" (or something similar-sounding) that promotes the trading of predictable, range-bound stocks.

I do not subscribe to or endorse such a service, but I've been successfully trading a "channel" stock myself - Abercrombie and Fitch (ANF).

Below is a chart of the last year and a half of trading; it's blatantly clear that Abercrombie is now range-bound.For a year and a half, ANF has bounced between about $72 and $82. Starting with the dip in December 2006, there have been five rise-and-falls.

I love ANF's long-term prospects (and do plan to own them for the long run), but with a stock like this, buying and holding through the rise and falls is poor management of one's portfolio. If you bought in at $67 in Dec '06 and held until now, you would have made 20% - congratulations. However, if you would have bought each time it came close to the 30 line on the RSI (top indicator) and sold every time it got close to the top, you would have executed 5 trades that each would have generated more than 10% of gain. Lets run some math quickly:

Say you're investing $1000. In 2006 you could have purchased 15 shares, which you could have sold Friday for $1200. However, if you traded more often....

• Buy 15 shares in 12-06, sell in 02-07 when it crossed the 70line on the RSI. 15 shares sold at 80 then = $1200.
• Buy in around $72 in March when it touches the oversold barrier, and get 16 shares (with $50 left over). Sell in late April when it touches the overbought barrier around $80 (conservative price) and net $1280, plus the $50 on the sidelines.
• Buy back in late June around $72, buying 18 shares (and having about $30 left over). Here, you could have stocked up more later (now seeing how this strategy works) at an even lower price later. Once again, even if you conservatively sold at $80 (not at $82 or $85, which the stock did hit), you'd net $1440, with $1470 total in the fictional account now.
• Buy again at $72 in November, getting 20 shares and having $30 left over. Sell again at $80, a month later, and bring in $1600.
• The latest buying opportunity was the start of this year, when it was below 70 as it touched the oversold line. With the $1630, 23 shares could have been bought. Though it's still not oversold, if you sold at $80 on Friday, you would have cashed out with $1840.

If you had bought and sold, you would have ended up with an 80+% return. Buying and holding produced a laughable 20% gain. (Sarcasm - but the point is, look how much better you could have done.)


All of my entry and exit points in the example above were a few dollars too conservative, because it is unrealistic to expect one to buy and sell at the absolute lows and peaks. (If you're using a discount broker like TradeKing, commissions are only $5 each way and pretty much neglitable, as long as you're trading at least $500 of stock each time [and I took that into account when I rounded with each example trade]). But I have successfully executed this trade three times now, because it has been so predictable. One can confidently use the $72/$82 range, or simply trade with the RSI. Each time I've done this trade, I've sold the position with a stop-limit that I place at $78 when the stock goes above $80, $80 when the stock goes to $82, and $82 when the stock is above $83. It hasn't failed yet.


But I do only close the positions through stop-limit because I expect ANF to break out of the upward limit of the range one day. Abercrombie is a sold company, and the stock was especially resilient when most retailers (and most stocks) were crumbling over the past six months. Abercrombie is expected to continue to grow at 15% over the next 5 years, and it's only trading at 14 times next year's earnings (both stats according to Yahoo! Finance).

I'm not sure that now is the time that ANF will make it to $90 or $100 (because of recessionary fears, consumer constraints, and generally-bad sentiment), but who knows. Maybe consumers will decide to go buy a $50 polo shirt with their rebate checks. Also, lots of market cheerleaders (most notably, recently, Jim Cramer) have been going gaga for retailers as they have rallied recently. The stock is now at $82 and barely above 50 on the RSI, so based on momentum, it doesn't look like it will pull back yet. I'd like to see the price moderate a little in the next week, so it can make a push past $85 without bursting through the overbought barrier.

The moral of the story? With a good company like Abercrombie, buying and holding will create good returns, but buying and selling at predictable points can generate exceptional gains.


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Ebay and Amazon.com - From a Merchant's Perspective

As none of you (probably) know, along with writing this blog, managing my portfolio, and attending college, I also founded, own, and operate a small ski wax company, Whacks Wax.

(I founded Whacks Wax in 2004 as a sort of science project. But the wax worked well, so since then, I've been selling the stuff commercially, having now sold to customers in over 20 countries.)

I owe the existence of my little company to the internet, and for most of the company's existence, exclusively eBay. I set up a website to provide background information, but until this winter, virtually all of WW's sales (90+%) came through eBay. I loved and appreciated eBay; a magical marketplace existed where an unheard-of company could peddle their products for a tiny fee. I didn't have to borrow money to advertise - my item could be seen by many interested customers for virtually no cost to the company.

I'm still very content with eBay (though not a fan of the new fees - but more on that later). This winter marked a big divergence from WW's exclusively-eBay model of the past. By some stroke of SEO (Search Engine Optimization) genius or dumb luck, I managed to push my website into the top-ten results for ski and snowboard wax queries on Yahoo!. The influx of organic traffic created many more off-eBay purchases than in the past.

Also, this winter, I enrolled in a little-known program offered by Amazon.com called "Fulfillment." Fulfillment is a wonderful thing for tiny e-entrepreneurs like myself. Here's how it works:

With Fulfillment, the merchant prints out scannable labels and affixes them to his products. He then ships products to an Amazon.com warehouse (my warehouse is in Lexington, Kentucky, which is excellent because the area also has huge shipping hubs). Amazon scans the items as they enter the warehouse, and then store them right next to Amazon's own merchandise. Then, when someone purchases a piece of wax through my website, I simply provide Amazon.com with that customer's information, and they'll ship it out of their warehouse, usually the same day. (Also, a participating merchant can choose to sell their product through Amazon.com's website; my listing can be seen here.)

I actually decided to sign up in October because it was free through the end of the year, but now, all of that supply-chain streamlining will come at a price; Amazon charges:

• A flat fee per month for participation in the program
• A processing fee for each transaction
• A storage fee based on average square footage per month

(The above information is accurate to my best knowledge; maybe I'll be blindsided with some fee I don't know about this month.)


I have had almost 20% of my purchases come through Amazon.com, so it's certainly a powerful marketplace, even ignoring the Fulfillment service. Coupled with the organic traffic, eBay has become less important to me. That's a bad thing for them, especially as they hiked fees (in a way that hurts consistent sellers like myself most).

Here's a realistic example (based on my company) of how the higher fees will crush big sellers:



Current listing fees for a fixed-price listing of $199.99 of product: $2.40
20 $6 pieces of wax sell - $6 x 5.25%= .30c/each, = $6 total

Total fees for listing = about $8.40

New fee structure:

New listing fee = $2.00 (oh boy, huge savings!)
current final value fee = .50c/each, $10 total

Total under new structure = $12



That's about 30% more for sellers of small items like myself. Ok, so a snowboard wax company isn't crucial to eBay's business, but the sellers of CDs, DVDs, iPod cases, video games, and all other knickknacks under $25 are. (Above $25, the fees don't change significantly.)

Considering Fulfillment, Amazon's excellent, easy-to-use supply chain, coupled with fees at eBay that will squeeze profit margins, eBay is dangerously close to completely alienating high-volume small-item sellers that are crucial to its success.

eBay, as a corporation, has one great thing going for it: PayPal. There's still no serious competitor, and more traditional merchants (airlines, hotels, etc.) are accepting it. Also, I read an article about six months ago that more immigrants are sending remittances through PayPal - its instant and easy.

Revenue from items sold through Amazon's site is accumulated in an account and then transfered into a linked bank account. Since Amazon is a household name, they have no need for the trust, security, and ease of PayPal that has made it successful with other merchants.

So, logically, I think Amazon is making advances while eBay may be making a huge mistake. But when it comes to investing, eBay sports a 15 forward P/E while Amazon's ratio is still bloated at 35. But as Amazon expands overseas and steals domestic business, eBay may be forced to reevaluate its structure if it wants to remain a premier internet marketplace.


P.S. If you ski or snowboard, give Whacks Wax a try.



"I trade with TradeKing: $4.95 stock and options trades, plus lots of tools. It's simply the best way to invest. Click here to find out more."

Brace for some Rapids: Amazon's Earnings Thoughts

This earning season, we have already seen the humbling of technology prodigies Apple (AAPL) and VMWare (VMW). Even Intel, the blue-chip giant, plummeted 15% after good earnings.

I think that history will repeat itself when Amazon.com (AMZN) releases results after the bell today.

Yes, Amazon reported the best Christmas quarter ever. Yes, with eBay changing fee structure, some big (million-dollar) salespeople may be moving accounts to Amazon. Yes, they are expanding internationally.

So what's wrong with being long Amazon now?

Valuation.

One benefit (at least to value-oriented investors like myself) of the recent market retraction has been a restoration of rationality. We have seen Apple's forward P/E drop from 40 to a reasonable 25. VMWare, which went into its earnings with a forward P/E of 70, was quickly humbled and delivered a 30% decline from sobered investors.

Amazon is going into its call with a forward P/E of 45. Amazon is becoming a blue-chip, mature company; no longer can it be driven by speculation. I don't believe that it'll drop 50% after earnings to join Google and Apple at a 25 forward P/E, but when a company is looking to make $1.50 next year, the shares shouldn't be sold for $75.

Analysts and investors will look at this quarter's profits and margins, and price movement may indeed be determined by that. But if Amazon fails to pump up next year's numbers, look for a healthy revaluation a la Apple, VMW, and other former high-flyers.


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Fed or Foe?

Tomorrow, the Federal Reserve Open Market Committee (the FOMC, or simply, the Fed) will emerge from deliberation and direct monetary policy in this country.

Futures have priced in a 50 basis point (.50%) cut.

Therefore, the Fed will cut at least 50 basis points. Many market analysts have pointed out that the tail (Futures markets) may be wagging the dog (the Fed), which is probably partially true. However, at this point, both fiscal policy (taxes, etc. - determined by Congress) and monetary policy (interest rates, etc. - determined by the Fed) seem aimed to prevent recession (or a slowdown) at all costs.

Fiscal "hawks" had been concerned about inflation in the past, but it now seems that cuts in favor of economic stimulation have taken priority. Little resistance has been seen when the Fed has cut in the past; as more write-downs and bad news continue to trickle out, I don't know why opposition would materialize now.

So 50 basis points is a virtual guarantee for tomorrow's announcement, while 75 is a realistic possibility. Here's how I see the market reacting:

• A cut of 50 basis points will be immediately disliked. Financial stocks and homebuilders may sell off. (This will be bad for me, since I currently hold Countrywide shares and Hovnanian LEAP calls.) However, I think the market will eventually right its overreaction (whether it be by the end of the day, week, or in a few weeks).
• A cut of 75 points will please the cheerleader analysts. The market will probably finish up a few percent. The downside? Much of the gains due to the announcement of interest rate cuts may be superficial and short-lived, considering monetary policy doesn't even affect the economy for six months.
• A cut of 25 points will be disastrous for the markets tomorrow. Even if the Fed rationalizes it with improving economic data, the same cheerleaders will boo the decision as irresponsible and unreasonable.
  

Since I have already mentioned them, I'll reiterate an investment idea I've made before:

Buy Countrywide (CFC).

Countrywide is set to be bought by Bank of America sometime this year. When the deal closes, investors holding CFC shares will get .1822 BAC shares for each one of CFC. As of the market close today, a share of Countrywide costs $6.31 and BAC sells for $41.94.

If the deal closed tomorrow, Countrywide would essentially be bought for $7.64 per share. Or, to look at it another way, you can buy a Bank of America share for $34.63 by buying the corresponding amount of CFC.

Of course, there is some possibility the deal won't close. However, BAC's deal terms cited only unknown, unexpected, and misleading information as a reason for breaking the deal. Countrywide reported earnings today, losing a ton of money, but nothing was surprising or misleading, and BAC said nothing about any problem going forward from this point.

Yes, there is inherent risk of owning a financial stock right now. But the arbitrage spread is still over 20%, so there's lots of money to be made in a very questionable market. If you're looking to own Bank of America over the next 5, 10, or 20 years, this may be your best opportunity.

If the Fed doesn't please tomorrow, both BAC and CFC may get hammered. It's certainly going to be a volatile few months for financials, but the reward may be worth the risk.

For my sake, and for the portfolios of millions of investors like me, I hope that the tail keeps wagging the dog tomorrow.



I trade with TradeKing: $4.95 stock and options trades, plus lots of tools. It's simply the best way to invest. Click here to find out more.

Earnings Predictions: Jan 28

The markets are teeter-tottering daily as economic and corporate data test the confidence of investors worldwide.

Coupled with Fed cuts, statements, and meetings, as well as a slew of economic data, the earnings season injects even greater unpredictability into the market.

Here's three of my predictions, justifications, and analysis for three major companies releasing earnings after the bell today.

• VM Ware (VMW) will probably be headed lower after releasing earnings today. They currently sport a 70 forward P/E; without a major beat, Wall Street will not be able to continue to justify such a lofty valuation. Odds are, VMW may beat but fail to impress Wall Street. I wouldn't be surprised to see a 10-20% haircut if that's true; just look at Apple's fall after lower-than-expected guidance. However, if they manage to blow out and revise upward, it'll be a major boost of confidence in the economy. I think the first situation is much more likely.
• American Express (AXP) may report a good quarter, but in their call, I bet that they cite some unpredictably in the future because of a weakening economy at home. I think AXP is a solid company that may be unfairly beaten up if the report is somewhat cautious.
  
• Sandisk (SNDK) may be a bright spot in the reports today. This quarter may be good, as many flash-memory-using devises (iPods, phones, other MP3 players, etc) seemed to sell well during Christmas, but more importantly, I think they'll affirm a quickly growing demand for their memory in lots of devises. The first flash-memory-based computers are just coming out now; in three years, flash will be the standard storage medium. I think a bright future forecast will propel SNDK out of it's current undue hole.

With the possibility of cautious or negative reports from major companies, the markets may be in for a wild day tomorrow. If things go better than I expect, the case for a market bottom will strengthen.


"I trade with TradeKing: $4.95 stock and options trades, plus lots of tools. It's simply the best way to invest. Click here to find out more.