Are Equities Are In The Toilet?

[Mark Heide]

There has been alot of discussion on equities here, but I'd like to hear what are the alternatives for preserving wealth with some gains.

Looking forward, here's some news about the current situation and why I do not think the valuations of equities reflect the actual economic situation:

http://money.cnn.com/2003/02/25/news/economy/consumer/index.htm

http://money.cnn.com/2003/02/13/news/economy/retail_sales/index.htm

http://www.conference-board.org/economics/press.cfm?press_id=2084

http://money.cnn.com/2003/03/03/news/economy/ism/index.htm

http://www.federalreserve.gov/releases/G17/Current/default.htm

http://money.cnn.com/2003/03/07/news/economy/unemployment/index.htm

http://www.bls.gov/news.release/empsit.nr0.htm

http://www.conference-board.org/economics/helpwanted.cfm

http://money.cnn.com/2003/02/21/news/economy/cpi/index.htm

All comments welcome. Expecially alternatives to equities.

Mark

[adios]

Always keep in mind that stock prices don't necessarily correlate to economic reality. With that said the stock market i.e. the S&P 500 basically is supposed to be a leading indicator of economic activity. In fact it is used as one of the leading indicators. That is why too much emphasis on trailing PE's is a mistake IMO. Of course predicting the future can't be done all that reliably. The links you posted bring up many issues.

The Economy

As you probably know typically the measure of the economic health of our economy is taken by growth or lack thereof in GDP. GDP is comprised of cosumption (consummer spending), investment spending, government spending and net exports. I believe that consumption accounts for about 70% of GDP so you can probably see why many focus so much on the consummer.

The Consummr

As you probably know consummer spending is typically divided into two categories; spending on consummer staples (non durable items) and spending on durable goods. Spending on durable goods such as new automobiles tends to be very volatile. Spending on consummer staples (non durables) such as soap, BASIC clothing, food, and personal care items tends to be very consistent. My contention is that the US economy supports non durable spending very well i.e. just about anyone who has a job can afford these items and there will always be enough low paying jobs at least to support this level of economic activity. Spending on durable goods is another matter. Consummer confidence numbers are supposed to be indicators of the propensity for the consummer to spend money on durable goods.


Employment

Of course in order to be able to purchase the necessities of life and satiate the desire for luxury items among other things, the consummer must have money. Most people sell their labor in the form of a job in exchange for money. Therefore job growth or lack thereof is an important economic component and in fact it's the key component of GDP growth. The Fed is very concerned about job growth in the economy and rightfully so. If you want a signal when the Fed is likely to start tightening IMO look at job growth in the economy. Job growth is a direct result of the GDP component referred to as investment spending (spending on capital goods). Spending on technology is one aspect of investment spending. Investment spending is cyclical. Investment spending has been in the toilet for a long time, much longer than I would have guessed given the interest rate environment. Investment spending made a positive contribution to GDP for the first time in years in the 4th qtr of 2002 a good sign. About six months ago I fired off an email to an economics prof that I had previously. I told him that I don't understand why investment spending is so lackluster given the interest rate environment. I pointed out to him that one of the principles he taught in his classes was that if business could see a profit in making an investment they would make the investment. Further I stated that it was obvious that since interest rates were low, there just had to be more profitable opportunities for investment. He wrote back and said not so fast. He stated that the uncertainty in the future was inhibiting investment spending and uncertainty translates to risk. Corporations perceive much more risk in the economy in the future and thus are inhibited from making investments. One thing I will point out, an unemployment rate of 5.8% isn't all that high when looking at the history of employment since the 60's let's say.

Types of Jobs

Basically jobs are divided into service jobs and manufacturing jobs. Service jobs outnumber manufacturing jobs by a large margin, something like 7-3 I believe. The manufacturing sector has been in decline for a long time and I think you probably could surmise why that is. Labor tends to be expensive here in the USA. I think it says something about our standard of living going forward in the USA. I'm sure wildbill has a perspective that's worth noting on this.


Inflation-Deflation

I don't view either as a big problem with the possible exception of real estate prices. I think the risks there are way overblown though. Much more liquidity in the mortgage market than there used to be and I'm an old timer that remembers what is like buying real estate 30 years ago.


Stock Valuations

Future earnings, assets, and risk premium. Items one and three make for highly volatile prices. Finally I'll leave you with the following stock and you tell me if it's overvalued or undervalued or fairly valued:

Gateway Computers symbol GTW. Seriously I would like to get your thoughts on it.

[Ray Zee]

gateway--- i dont know about its value---

but its like tv's. they are getting totally generic and are sold like toasters. so a company like gateway which has to rely on brand name cannot survive long term, unless it branches into some other field. same with dell. remember micron computers and ibm ones. you hardly here about them anymore except for laptops which still are produced by just a few brands. even compact went to mass market. and is finding that people dont want to pay a premium for a name on a case made of assembled parts from other manufactures.

[Mark Heide]

Tom,

I don't like the financial picture for GTW and would not recommend buying it. You may see some short term technical trading on it, but it looks extremely risky. One of their biggest mistakes was opening up Gateway stores, which turnout to be terrible. Here's a link to a recent story:

http://www.quicken.com/investments/news/tst/?p=GTW&ntlink=http://www.thestreet.com/_intuit/tech/kcswanson/10074960.html

Mark

[adios]

Gateway has a market cap of 777.7 million. They have cash and short term investments (where excess cash is parked) of over $1 billion dollars. That's right they are selling for less than what their cash is worth! GTW has zero debt i.e. a debt to equity ratio of zero, nada. The book value of GTW is $3.85 a share and the last quote I got on share price was $2.40 a share. I estimate that GTW could pay a dividend of $2.40 a share which is the last quote I got and have plenty of cash to operate with, in excess of $250 million. If they did this there would absolutely be no risk in owning the shares. Alas they won't as their CEO holds 1/3 of the shares. I don't care how crappy the business is, if I get it for free I'll take all the shares you want to give me. We need to repeal takeover laws perhaps. The only reason Gateway isn't higher IMO is that investors feel they are unlikely to see any of the excess cash in their pockets. If that was to change somehow I believe the stock would easily trade at BV. There are many other companies that have crappy businesses, clean balance sheets, and lots of cash. wildbill isn't crazy about dividends but this is exactly the type of situation that I find so frustrating regarding companies that don't pay them. I guess what I'm trying to say is that by all measures GTW is an undervalued stock if dividends don't matter. But they do matter at least eventually they do. Also I'd be remiss if I didn't point out that taxes have to be paid on divis distributed even in a retirement account(except perhaps a Roth IRA I believe) where taxes are deferred. This true even though the divis represent corporate profits that have already been taxed. We need a political leader that has the guts to try and end double taxation /forums/images/icons/smile.gif.

PS: GTW is doing a massive restructuring closing the "Country stores" and laying off a lot of workers to bring costs down.

[Wildbill]

If it were only so easy Tom. Remember that these aren't bank accounts, but companies. This one has a bad model and a sorry looking future. Yeah it seems like you could just shut it down and get more than $2.40, but that isn't about to happen. Remember that decision is in the hands of the execs and the board and their concern is to keep their jobs before worrying too much about now almost worthless stock. Another further concern for that cash is if they indeed closed up, they would have countless liabilities in terms of warranties and also in severances. When all is said and done, there might not quite be enough cash to cover the dividend. What this company does look like is an excellent takeover for a tech company that needs cash and distribution, but has a better idea than Gateway does.

You see things like this all the time, companies will get buyout offers and yet claim another offer is better for shareholders. Later someone puts its as clear as possible, reason why they say that is because management has been offered jobs with the second offer and is told to get lost with the offer that truly gives shareholders best value. They act as if their presence is what makes a company strong, but usually companies in this situation don't exactly have useful managers.

One thing I would warn you against is using book value. Book value is a meaningless statistic if you ask me. Book value is a statistic accountants came up with and does nothing for future valuation. Companies that made a ton of money 10 years ago can have great book value ratios, but if they aren't making money anymore they could be in real trouble and you wouldn't know it! After all companies are in the business of finding good investments and operating them well, not in pumping up the equity section of the balance sheet.

[Mark Heide]

Tom,

GTW is not making enough sales to cover their costs. For how long can that continue? With the present state of the economy, I don't think they will last. If they do, they would have to become a smaller operation. In order to keep their heads above water they are going to have to unload assets and take share away from Dell and HP. Both Dell and HP have become very competative. The situation was much different if you look at Gateway before the dot.com era. Back in 1996, Compaq and HP were overpriced PCs which allowed companies like Dell and Gateway to break into the market. Now, most of the boxes are competatively priced, so Gateway no longer has that price advantage which was their key to success in the past. With their current business model, I don't see how they are going to survive.

Mark

[adios]

For argument's sake let's say that GTW drifts down to $2.00 a share again with it's cash position largely intact. At that point the CEO says the hell with it, I'm giving share holder's a $2.75 a share dividend and we'll just make a go of it with what we've got. Do you still think GTW would not be undervalued? GTW has had a decent run since it's restructuring announcement so I don't think it's far fetched to say that it can trade that low again in the near future. Or let's put it this way, say the GTW CEO comes out and says that if GTW stock gets down to $2.25 a share, I'm paying a $2.75 a share dividend. Do you think it would trade that low ever? Or let's say the Gateway CEO says I'm paying a $2.75 a share dividend do you think that GTW would trade at $2.39 a share where it went out today? I sure don't think it would in fact I'm sure it wouldn't. I mean if somebody is giving away free money, and a remote chance of making more money at NO RISK how could anyone turn that down? Put another way, if a stock trades at 0 I'll buy every share that I can lay my hands on. GTW trades this low for the reasons you guys state plus the fact that investors believe they have little chance to get their hands on a penny of the cash hoard. I submit that even if investors felt there was a legitimate 50-50 chance that they would get this cash hoard returned to them as a dividend the stock would trade much higher.

[Wildbill]

You are right Tom, but we have to live in the world as it is, not as it might exist in our finance books. Your points are all valid from a very theoretical sense, but even your finance and econ professors will tell you to get your ass out of the books and accept reality /forums/images/icons/grin.gif

Just remember what I said, these are rich guys running the company and a guy like Waitt has all the money he will ever need so its become a pride thing. Its like saying Michael Jordan should know exactly when he should have stayed retired, but he didn't. These are their lives, their egos, their power. Without an operating company, they will feel ashamed and have to go cry on their big bank statements. As for paying out a dividend, well that would be ridiculous if your burning cash. Unless you are between contracts or something where you know exactly where your cash flow will return positive you really can't give anything off. These are the things that takeovers and especially LBOs are made of.

If I was in charge, I would just take the company private. If the business was even stabilizing a bit I am sure he would be working on the deal but good luck finding financiers that are going to get excited about a negative cash flow situation with no clear way to change strategy. In the end they might just do what you say and liquidate most of the company. Just remember if it closes on its own accord its likely that they will pay a pretty good severance to all involved and that will eat up close to all of the cash premium you see now.

[scalf]

/forums/images/icons/crazy.gif interesting; that as equites have mother of all(at least recent) rallies; right as conventional wisdom disses them...

with all thy getting; get understanding...gl /forums/images/icons/grin.gif /forums/images/icons/club.gif