05 Aug Market Comments
Irrespective of the daily barrage of negative news out of Europe, China and our American politicians, the U.S. stock market continues to trend higher. This is known on ‘Wall Street’ as climbing ‘the wall of worry’. To attempt to make sense out of it amidst all the negative news is only frustrating. Believe me, the stock market is going to do whatever it wants – end of story.
As a value investor, I only attempt to focus on the things I can control – my emotions, the risk I’m willing to take, the securities I choose to own and the prices I’m willing to pay. It is uncertainty and the fear of losing that allows value investors the opportunity to succeed. It is uncertainty that allows the purchase of high quality securities at attractive prices. Value investors tend to believe the smoke will eventually clear, investors will become rational and patience will be rewarded.
What I’m seeing today is that many corporations are doing exceedingly well. Sales are growing (albeit slowly), balance sheets are strengthening, dividends are rising and shares outstanding are shrinking. Business is moving forward. However, the prices for many securities already appear to reflect this and seem only reasonably attractive at this time.
In the mirror opposite, I find the bond market anything but reasonably attractive for investors. With interest rates at all-time lows, having declined continuously for the past 30 years, I believe that prices have nowhere to go but ‘down’. The only question is ‘When?’ I believe borrowers should be taking advantage of today’s artificially low rates to refinance higher cost debt and finance intelligent new purchases.
Going forward, I will do my best to take advantage of opportunities the markets might present, provide you with outstanding service and hopefully confirm the confidence you’ve placed in me.
Below you will find recent notes on my Top Holdings, I hope you find them of interest – particularly the comments on JP Morgan.
Top Holdings Notes — AAPL, ATT, BRK, DVN, GE, GOOG, JNJ, JPM, NSRGY, OAK, UL, WFC, XOM
Apple — 3rd Quarter Comments
Revenue for the quarter experienced year-over-year growth of 23%. The Company sold 26.0 million iPhones in the quarter, representing 28 percent unit growth, said it will be launching the latest model iOS 6 this fall and estimated that the number of iPhones in the Fortune 500 had more than doubled in the past year. Apple sold 17.0 million iPads during the quarter, an 84 percent unit increase. The company continues to have great success in the U.S. education market, with sales setting a new quarterly record and nearly doubling year-over-year to just under 1 million iPads. They estimate that the number of iPads in the Fortune 500 has more than tripled in the past year. Also, just last Friday Apple launched the new iPad in China after resolving the iPad trademark issue. The Company sold 4.0 million Macs during the quarter, a two percent unit increase and 6.8 million iPods, a 10 percent unit decline. The iPod’s share of the U.S. market for MP3 players remained at over 70% based on the latest monthly data published by NPD. Of note, since its launch in October, more than 150 million people are using Apple’s iCloud services. Apple is still generating a ton of cash, although not as much as in previous quarters. The iPhone and iPad maker now has about $117.22 billion in cash holdings, up from the $110.18 billion it had as of June 30. To put that in perspective, only 19 companies in the S&P 500 — not counting Apple itself — have higher market caps than that. CEO Tim Cook has said Apple has more cash than it needs, and the company will begin paying a quarterly dividend this quarter, the fiscal fourth quarter. It will also start a $10 billion share buyback program the quarter after that.
AT&T — 2nd Quarter Comments
“We executed well across the business and posted another strong quarter with growing revenues, expanding margins and double-digit earnings growth,” said Randall Stephenson, AT&T chairman and chief executive officer. “Our mobile Internet leadership continues, with solid gains in smartphones and tablets, plus our wireless margins have never been better. And most impressive, with this growth, we also achieved our best-ever postpaid wireless churn, which points to the premier experience customers receive on our network. AT&T’s operating income margin expanded to 21.6 percent, compared to 19.6 percent, the best in four years. Postpaid subscriber ARPU increased 1.7 percent versus the year-earlier quarter to $64.93, which is the highest in the industry. Postpaid, prepaid and total churn reached their lowest levels ever. During the second quarter, AT&T continued buying back shares under its outstanding 300 million shares repurchase authorization. The company repurchased 75.8 million of its shares for $2.5 billion in the quarter. Year to date, the company has repurchased 143.5 million shares for $4.6 billion. The company expects to continue to buy back shares consistent with its repurchase authorization.
Berkshire Hathaway — 2nd Quarter Comments
Non-insurance businesses combined with better underwriting profits drove a 38% year over year increase in second-quarter operating earnings. Improvements in the insurance group’s underwriting income were the largest contributor to the rise. Berkshire’s non-insurance businesses also continued to be a source of strength for the firm, reporting a 20% increase in operating earnings. Berkshire’s reported book value at the end of the second quarter was $107,377 per Class A equivalent share, or $71.58 per Class B. With more than $40 billion in cash Berkshire did not repurchase any shares through the first six months. Buffett had previously disclosed the intention to buy back shares at prices below 110% ($78.74) of the firm’s book value.
Devon Energy — 2nd Quarter comments
Production increased 3% compared with the same period a year ago and was impacted by gas processing disruptions. Chief Executive John Richels said ‘Oil production increased by 26% year over year and we have approximately 85% of our oil production locked in with an average protected floor of $97 per barrel and 65% of our natural gas production protected at $3.76 per Mcf for the 2nd half of 2012. We continue to be positioned as a low-cost producer among our peer group and exited the quarter with $7 billion of cash and short-term investments and a net debt-to-cap ratio of about 14%.Our existing acreage base comprises some 5 billion barrels of risked oil resource, representing many years of high quality undrilled inventory. In addition, we are leveraging our portfolio through joint ventures to allow us to accelerate that growth. Our measured approach to the business, strong balance sheet and high-quality property base all position us to deliver on our long-term business plan’.
2010 Letter to Shareholders — ‘In May, we announced a $3.5 billion share repurchase program. Completion of the program will reduce Devon’s outstanding share count by approximately 10 percent. To date, we have repurchased more than $1.6 billion of our common stock at a very compelling value of roughly $10 per barrel of proved reserves. Moreover, this valuation attributes no value to our thousands of unproved locations across all of our shale plays, no value to the continued expansion of our Canadian oil sands projects and no value to the millions of prospective acres we have established across North America. We believe that Devon’s common stock continues to represent a compelling use of our capital. In 2010, we also made the decision to apply $1.8 billion of the sales proceeds to reduce debt, further strengthening our industry-leading balance sheet. We exited the year with net debt to capitalization of only 10 percent, including $3.4 billion of cash on hand’. – CEO John Richels.
2011 Annual Report — In May 2010, our Board of Directors approved a $3.5 billion share repurchase program. We completed this program in the fourth quarter of 2011. In total, we repurchased 49.2 million common shares for $3.5 billion, or $71.18 per share. — CEO John Richels
Exxon — 2nd Quarter Comments
Production was essentially flat, earnings from U.S. Upstream operations for 2012 were $1,688 million, down $1,040 million from 2011. U.S. earnings were particularly weak as a result of the company’s exposure to natural gas (61% of total U.S. production). Earnings outside the U.S. were $14,472 million, essentially flat with the prior year, Downstream earnings of $8,232 million increased $5,777 million from 2011, the gain associated with the Japan restructuring contributed $5.3 billion. “Capital and exploration expenditures were $9.3 billion in the second quarter and a record $18.2 billion for the first six months of 2012 . Gross share purchases through the first half of 2012 were $10.7 billion, reducing shares outstanding by 127 million shares, share purchases to reduce shares outstanding are currently anticipated to equal $5 billion in the third quarter of 2012. Dividends per share of $0.57 increased 21% compared to the second quarter of 2011.
General Electric — 2nd Quarter Comments
“Today’s results demonstrate that we are executing on our growth strategy in the midst of a still volatile global economy,” said GE Chairman and CEO Jeff Immelt. “GE Capital’s strong operating performance and capital position allowed it to return a $3 billion dividend to the parent, and our Industrial segments delivered another quarter of double-digit organic revenue growth. Our strategy to invest in growth markets is paying off, as we achieved orders expansion in growth markets of 14% and revenue growth of 17%. We ended the quarter with a record backlog and $74 billion of consolidated cash and cash equivalents.”
Google — 2nd Quarter Comments
Google Revenues (advertising and other) 90% of consolidated revenues — were $10.96 billion in the second quarter of 2012, representing a 21% increase over second quarter 2011. Paid Clicks — which include clicks related to ads served on Google sites and the sites of our Network members, increased approximately 42% over the second quarter of 2011 and increased approximately 1% over the first quarter of 2012. Cost-Per-Click — which includes clicks related to ads served on Google sites and the sites of our Network members, decreased approximately 16% over the second quarter of 2011 and increased approximately 1% over the first quarter of 2012. Google’s market share rose to 66.8% compared to 65.5% in the same month last year, while Yahoo’s share slipped to 13% from 15.9%. Microsoft, which recently took a massive write-down related to its online business that includes search site Bing, saw its share rise to 15.6% from 14.4%. Google handles about two-thirds of all U.S. Web searches, according to comScore Inc., and more than 80% in many parts of Europe. As of June 30, 2012, cash, cash equivalents, and short-term marketable securities were $43.1 billion.
Johnson & Johnson — 2nd Quarter Comments
New CEO Alex Gorsky said on 2Q conference call his near-term priorities are to restore supply of McNeil over-the-counter medicines, build on recent momentum in the pharmaceutical unit and to successfully integrate the acquisition of Synthes medical-device maker. He also commented “I think we will continue to prioritize our use of cash as first to dividends as a primary return to shareholders, secondly, an investment in value creating acquisitions that enhance our ability to generate free cash flow in the future, and thirdly, any future returns to shareholders in the form of share buybacks”.
JP Morgan — 2nd Quarter Comments
Buffett recently commented in Berkshire Hathaway’s 2011 Annual Report that “One CEO who always stresses the price/value factor in repurchase decisions is Jamie Dimon at J.P. Morgan; I recommend that you read his annual letter”- So I did and here are some of Dimon’s comments:
Why we bought back the stock and how we look at stock value.
“Our tangible book value per share (approx. $34.50) is a good, very conservative measure of shareholder value. If your assets and liabilities are properly valued, if your accounting is appropriately conservative, if you have real earnings without taking excessive risk and if you have strong franchises with defensible margins, tangible book value should be a very conservative measure of value. And we have substantial, valuable intangibles. Our brand, our clients, our people, our systems and our capabilities are not replicable — even if I gave you hundreds of billions of dollars to do it. We have many businesses that earn extraordinary returns on equity because there is very little equity involved; e.g., much of our asset management business, our advisory business, parts of our payments businesses and others. Many of our assets would sell at a substantial premium to what currently is on the books; e.g., credit card loans, consumer branches and others. To be honest, some also would sell at a discount vs. what they’re on the books for — though many of these assets or loans will give us the cash flow return we expect and which normally are attached to a client where we earn a lot of non-loan related, highly profitable revenue (i.e., cash management, etc.). The loan itself might sell at a discount, but the whole relationship would not. And, certainly, most of our businesses, if we sold them whole, would sell at a substantial premium to tangible book value. Our best and highest use of capital (after the dividend) is always to build our business organically — particularly where we have significant competitive advantages and good returns. We already have described many of those opportunities in this letter, and I won’t repeat them here. The second-highest use would be great acquisitions, but, as I also have indicated, it is unlikely that we will do one that requires substantial amounts of capital. We have huge capital generation. When you look out many years into the future, JPMorgan Chase should generate huge amounts of capital, and much of it will be hard to deploy. Unfortunately, the CCAR test restricts our ability to buy back stock because it looks at just two years of capital generation. So while we have less capital than the 9.5% that we currently believe we will need under Basel III, once we get there, we will be generating extreme amounts of excess capital and our organic growth and acquisitions unlikely will be able to use it all. So buying back stock is a great option — If you like our businesses, buying back stock at tangible book value is a very good deal. So you can assume that we are a buyer in size around tangible book value. Unfortunately, we were restricted from buying back more stock when it was cheap – below tangible book value –and we did not get permission to buy back stock until it was selling at $45 a share. Our appetite for buying back stock is not as great (of course) at higher prices. Currently, above $45 a share, we plan to continue to buy back the amount of stock that we issue every year for employee compensation– we think this is just good discipline. As for the excess capital, we will either find good investments to make or simply use it to more quickly achieve our new Basel III targets”. In a call with analysts, CEO Dimon said that the bank would look to resume a previously announced $15 billion share repurchase program after it submits a new capital plan to the Federal Reserve. Dimon said he hopes to have the bank positioned for buybacks by the fourth quarter. Also, according to an SEC filing Friday (July 20th), Dimon bought 500,00 shares of common stock at between $34.01 and $34.46.
Nestle — 1st Half Comments
In the first half of 2012, the Nestlé Group’s organic growth was 6.6%, composed of real internal growth of 2.9% and pricing of 3.7%. Our business grew 12.9% in emerging markets and 2.6% in developed markets. The underlying earnings per share (EPS) rose 12.4% in constant currencies. Andrew Wood, an analyst at Bernstein, said: “All businesses/regions beat expectations but perhaps most impressive was the growth seen in Europe despite the current economic woes.”
Oaktree Capital — 2nd Quarter Comments
Oaktree Capital Group LLC (OAK) announced a 6% rise in second-quarter so-called economic earnings Tuesday, as management fees, incentive income and investment returns all grew. Its distributable earnings, which measures cash flow to investors, rose to $176.4 million in the second quarter, from $170.3 million a year ago. Assets that Oaktree managed rose to $78.7 billion at the end of June 30, up from $77.9 billion as of March 31, but down from $79.5 billion a year ago. Mr. Marks expects Oaktree will continue to sell investments, but said market valuations aren’t particularly attractive right now. “There aren’t many things so cheap you want to buy them, and there aren’t many things so dear you want to sell them,” he said. The latest earnings also highlighted the firm’s contrarian approach to investing. While some other asset managers have been drawn toward residential real estate, Mr. Marks said he is expecting to make fewer residential property investments now that “everybody’s brother is saying it looks like there will be a housing recovery.”
Just two months after a lackluster listing, Oaktree (OAK) said in a filing it had bought back 400,000 Class A units in a private deal on June 15 at $35.30 each.
Unilever — 2nd Quarter Comments
Second quarter underlying sales growth was 5.8%, emerging markets underlying sales growth was up 11.4%. Regarding specific regions, Latin America’s growth in the quarter accelerated to 12.2% and strong performances were also realized in India, Turkey, Indonesia and Vietnam. CEO Paul Polman noted Unilever’s strengthening position as the emerging markets leader in consumer goods, driven by strong innovations and the roll-out of the company’s brands into new markets.
Wells Fargo — 2nd Quarter Comments
“Our performance was strong across the board,” said Chief Financial Officer Tim Sloan. “In the quarter, we had record net income and earnings per share. We had record quarterly mortgage applications, increases in lending to consumers and businesses, and continued growth in deposits and cross-sell.” “Credit quality trends continued to show improvement in the second quarter, with reductions in net losses, nonperforming assets, nonaccrual loans, and loans 90 days or more past due and still accruing,” said Chief Risk Officer Mike Loughlin. “Customer experience ratings exceeded last quarter’s record, as customers rated their experience in our retail banking stores at an all-time high, based on survey results.” In the second quarter, the Company purchased approximately 53 million shares of its common stock and an additional estimated 11 million shares through a forward repurchase transaction expected to settle in third quarter, paid quarterly common stock dividends of $0.22 per share, and redeemed $1.8 billion of trust preferred securities. Book value per common share ended the quarter at $ 26.06. Warren Buffett recently commented, “I like Wells Fargo better than anything by far, we have been buying Wells Fargo month after month for a lot of years. Among the big banks, I think it is the best.” Fitch rating service recently acknowledged Wells Fargo’s residential real estate exposure by highlighting their #1 market share in origination and servicing, as well its large portfolio of first and second lien mortgages and mortgage-backed securities.
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