How to Screen for Strong Banks

Amidst all the carnage in the financial sector, how can you screen for the stronger banks and financial institutions that are likely go come out of the credit crunch as leaders.

The best starting point is creating a screen that searches for potential candidates. The key question is what criteria should be in this screen. Basically you need to hunt for financial institutions that display the following characteristics.

• The earnings are still positive.
• The yield is above 0.5%.
• The bank stocks trades at reasonable volume above a price of $2
• The bank stock price performance is exhibiting strength against both the S&P 500 and the bank stock index over the past 3 and 6 month periods.
• Technical the bank is exhibiting positive moving average trends in the short term and the rate of change is positive.

A basic bank screen that meets the points above can be created within HingeScreen. A user can go to create mode and add the following criteria. In this case, we are searching for financial institutions priced above $2 with volumes over 10K that have outperformed the S&P 500 and KBW bank index. The trailing dividend yield must be above 0.5% (forward yield can also be considered). Technically the rate of change (ROC) must be positive, while the recent 20 day moving average must be above the 50 day. These technical points will show a recent positive trend in stock pricing.

The screen is saved as BankScanOne.

The next step is to jump to Execute Mode and run the screen. The results align with expectations; it is a mix of stronger regional banks, REITs (primarily with a healthcare focus), and some financial service organizations.

The stronger banks in the results such Valley National Bancorp NJ (VLY), and Wilshire Bancorp (WIBC) are examples of regional institutions that avoided obscene mortgage lending and maintained their balance sheets in good order over the past few years.

The majority of the REITS that show up in the results such as Health Care Property (HCP), Health Care REIT (HCN), and Healthcare Realty Trust (HR) are examples of REITS that are focused on stronger market segments and have easily avoided the worse aspects of the real estate downturn.

A few financial service organizations such as Northern Trust (NTRS) and PNC Financial Serv. (PNC) also show up in the results. A number of players providing financial services have used the downturn to strengthen their offerings and market position.

Using HingeScreen it is easy to save the results to a spreadsheet for further evaluation. Simply press the button on the right that looks like a floppy disk and the results are saved to a spreadsheet format file that can be opened using Excel. By default the saved result files are placed in the C:\Program Files\HingeFire\Results directory.

HingeScreen is a powerful tool to find stocks that meet the performance and diversification needs for your portfolio. It is useful for identifying candidates that are likely to come out of a downturn as leaders in a sector. HingeFire provides an excellent video library outlining how to use the tool at: http://www.hingefire.com/Education/KnowledgeBase/HingeVideos.aspx

Wachovia Earnings Call

Wachovia held its earnings call Tuesday. As expected the news was bleak; headlined by an $8.9 Billion loss, a steep dividend cut, and 10,750 job cuts. However, the stock rallied on the news and earnings call. While the loss and job cuts are painful, it appears that Wachovia has a plan to turn its operations around and deal with the bank’s mortgage exposure.

The stock rally demonstrates the confidence that Wall Street has in new CEO Robert Steel. Some of the points in the turn-around plan were outlined in the conference call transcript. Wachovia will not be raising more capital or selling additional stock that would dilute current shareholders stake. The dividend cut to 5 cents per share will save $700 million per quarter, while the wholesale mortgage operation will be shut down. Analysts expect that the bank will remain an independent operation.

Hitting Top Returns in midst of Market Turmoil

What does it take to hit solid market returns even when market conditions are leaving the most experienced investors fearful? It comes down to proper stock selection and having the appropriate tools to find the best investments on both the long and short side of the market.

The FREE HingeFire stock screener is a powerful product that merges fundamental and technical indicators in a single tool. This helps put the market edge in the corner of investors.

GregB is now ranked 267 out of 18824 players in the Wall Street Survivor Contest (Traders Wanted - Play $50,000 Stock Trading Game). The evening before the contest, I ran the HingeBuy and HingeSell screens in the HingeScreen 1.5 product. These screens normally produce 30 to 50 results. HingeBuy provides a list of stocks that have the potential to out-perform the market; while HingeSell produces a list of stocks that are likely to under-perform.

It comes down to proper stock selection enabled by the HingeScreen product. I only had to pick a set of stocks once, at the very beginning of the contest to be successful. No need to churn the portfolio or trade.

A summary of the results to date are provided below. Note that all of the longs are still above water despite the violent downtrend in the market over the past few weeks. The balanced long and short portfolio is an excellent example of how to squeeze excess alpha out of the market. The overall return of the portfolio was +14.74% over a few weeks (72.68% on a yearly basis).

Longs
Symbol Return
------------------------
MOS +15.92%
XEC +0.86%
AXYS +0.46%
DAR +10.36%
BMI +0.06%

Shorts
Symbol Return
------------------------
FSNM +53.83%
GSAT +31.12%
CIX +22.65%
LYTS +19.54%
MEDX -5.19%


Disclosure: These stocks have been selected in a fantasy stock selection contest. They are not held in my real portfolio. Investing involves risk. Your results using software screening informational tools may vary. Proper portfolio diversification is important and any outlined investments may not be appropriate for your financial objectives or risk tolerance. This is not a solicitation to buy or sell securities.

Cisco dashes 2008 recovery hopes but there is light

Earlier commentary associated Cisco outlined hopes of a tech sector recovery in 2008. Recent comments on Tuesday by CEO John Chambers dashed those hopes. He stated "I think most of us realize that it's probably going to be a little bit longer than the one to two quarters that some people had hoped for.”

In reaction most analysts cut their forecasts for CSCO citing that both the remainder of 2008 and 2009 could be challenging for the company.

Cisco stock dropped to $21.76 late Wednesday afternoon. Despite the bearish trend of CSCO and the overall market recently; a basic predictive analysis spreadsheet that utilizes volatility, mean return, standard deviation, trend, and other factors indicates the future is not so gloomy. A quick run of the spreadsheet shows that CSCO has a 5% chance of hitting $30 in the next 90 days and only a 1% chance of hitting $16.

This shows that a basic short-term analysis is leaning towards a more bullish case for Cisco stock – hopefully the market follows through and provides shareholders with some type of short-term rebound. However the long term price is always driven by the fundamentals, which in this case is dependent on an overall tech sector recovery.

At minimum a soft economic patch will provide the 800lb gorilla Cisco the opportunity to shake some of the smaller competing monkeys out of the trees. Cisco has tradition of leaving competitors in the dust; especially taking advantage of downturns to enhance their position in both existing and newly emerging markets.

Screening for the Top 2%

How does an investor land up ranked in the top 2%? It takes a serious approach to screening the universe of stocks to sort out the wheat from the chaff. Screening a list of potential candidate stocks is just the first step.

GregB is now ranked 284 out of 17989 players in the Wall Street Survivor Contest (Traders Wanted - Play $50,000 Stock Trading Game). The evening before the contest, I ran the HingeBuy and HingeSell screens in the HingeScreen 1.5 product. These screens normally produce 30 to 50 results. HingeBuy provides a list of stocks that have the potential to out-perform the market; while HingeSell produces a list of stocks that are likely to under-perform.

The next immediate question is how did I narrow these lists down to 5 stocks as longs and 5 stocks as short to use in the Wall Street Survivor contest.

In terms of the five stocks I selected from the HingeBuy list for the contest. I pulled up each stock on the list at the time (there were about 30 to 40) and took a detailed look at the charts, industries, fundamental info, and technical indicators to narrow down the selection. For the HingeSell (short) candidates I basically look for the inverse of the outline below.

Basically the following were evaluated for each potential long stock:

1) Strength of the chart over the past year. Look for a chart where the stock is continually rising with some minor pull-backs. Look for strong increases in the past six months. Do not want a stock where the stock price had a one time big bump due to a news event; nor a stock where the chart is basically flat but still outperformed the associated indexes.

2) Evaluate the industry that the company is in and the industry performance over the last six months compared to other others.

3) Rank the stock within the Industry from a relative performance perspective.

4) Fundamental information evaluation with a focus on earnings growth, revenue growth, cash flow, debt and their associated ratios. Do not focus on forward P/E etc. because many times the projections are nonsense.

5) Technical evaluation of the price chart looking for divergence between the price action and technical indicators (MACD, RSI, etc.). Divergence may indicate an impending change in price action. Also look for extreme readings in oscillator-based indicators which may show that a bounce-back is overdue. Keep in mind that technical indicators are good for evaluating short term action; long term price is driven by fundamentals.

6) Take a look at news from corporate press releases. Look for management churn, re-orgs, layoffs, product cancellations, guidance (vs. price reaction), and regulatory action. These are generally not positive developments.

Basically rank all the stocks on the HingeBuy candidate list from 1 to 5 using the criteria above. Five being the strongest. Select the five stocks with the highest rating.

For HingeSell and shorts - look for the inverse.

Note in my terms, the outline above is my light-weight starting point evaluation. I normally dig into the 10Q / 10K reports when selecting stocks for my actual portfolio. I would urge everyone else to do the same. A stock screener is a tool to find stocks that meet your basic criteria - a more detailed follow-up analysis is needed to find the best stocks for your portfolio that meet your diversification and risk-tolerance needs.

Disclosure: These stocks have been selected in a fantasy stock selection contest. They are not held in my real portfolio. Investing involves risk. Your results using software screening informational tools may vary. Proper portfolio diversification is important and any outlined investments may not be appropriate for your financial objectives or risk tolerance. This is not a solicitation to buy or sell securities.

Circuit City: So Toxic that Nobody Wants It

Is there such a thing as a bride so ugly that no one will marry her? Apparently there is such a thing as a business so toxic that everyone steps away from buying it.

One of the great fears of any party seeking to close a deal to purchase Circuit City (CC) is that the due diligence would reveal information so negative that potential acquirers would drop their bids. Apparently this scenario is playing out.

Blockbuster (BBI) dropping its bid may be due to other bidders pushing up the price; more likely it is that further disclosure revealed that Circuit City is already deeply entangled in its death throes. Blockbuster's Chief Executive Jim Keyes cited "market conditions" as a reason for withdrawing its offer, valued at up to $1.3 billion, and said the deal was not in the best interests of its shareholders.

Circuit City dropped over 16% on the open on Wednesday after this news. Blockbuster climbed over 12%, the shareholders gleeful that this proposed merger has been dropped. It is interesting to note that Blockbuster had offered at lest $6 per share for Circuit City. CC stock now sits at $2.19; effectively the proposed deal was at triple the price of Circuit City stock. The failure of Circuit City management to grease the skids on this deal will probably go down in financial history as one of the worst executive decisions ever; unless some other suitor actively closes on a transaction.

Philip J. Schoonover, the CEO of Circuit City, kept hope alive for a deal by commenting, "Our exploration of strategic alternatives is intended to serve the interests of our shareholders by considering every possible alternative to enhance shareholder value. The board's review was not dependent on Blockbuster's (BBI) participation. We are diligently working with the parties involved in the process, and intend to continue our thorough approach until such point as the board determines upon a particular strategic course of action. The board has not established a deadline for completing the review."

Loosely translated this means, “We are trying to find a deal that will leave the existing management team employed with large compensation packages despite our ruinous track record. The board is hoping some magical deal materializes shortly with a private equity fund. If something does not pop up soon; the company will be dead as we complete the review of the bankruptcy paperwork.”

The only constant is that the long suffering Circuit City stockholders will continue to be disappointed.

Who wants to buy Circuit City?

An earlier summary regarding Circuit City outlined how all of the vultures that have been sitting on the sideline would be drawn out once Blockbuster started bidding. It is time to either fish or cut bait for all other potential suitors.

An article from Reuters today stated that Circuit City has received buyout interest from several strategic and financial bidders. A sale is expected to be announced over the next month.

The only question at this point is how much the carcass of this poorly managed electronics retailer will go for? I believe that many long suffering stockholders will be sadly disappointed at the price.

Does HingeBuy and HingeSell really work?

Yes, you better believe it!

At the beginning of May, I entered the latest Wall Street Survivor contest.

I selected 5 stocks from the HingeBuy list as longs and 5 stocks from the HingeSell list as shorts the night before the contest opened. Wall Street Survivor provides each player with $100,000 in “cash” for investing in the contest. I placed $10,000 into each stock on the first day of the contest and have not made any trades whatsoever since this time.

The longs were:
Symbol Return
------------------------
MOS +24.77%
XEC +11.44%
AXYS +6.47%
DAR +5.11%
BMI -7.16%

The shorts were:
Symbol Return
------------------------
FSNM +25.89%
GSAT +13.29%
CIX +12.48%
LYTS +9.82%
MEDX -2.73%

I did not use leverage (i.e. excess margin) in the contest. The portfolio is currently worth $109,847.18; this is a 9.85% return over a few weeks (or 79.78% on a yearly basis).

Player GregB is currently ranked 373 out of 13850 players. Most other players in the contest trade regularly. My result is not bad for simply picking ten stocks, not trading them, and not using leverage. This shows the power of the HingeBuy and HingeSell automated selection process.

FREE TO PLAY - Fantasy Stock Trading Game

Is Lehman Next?

Lehman Brothers has plunged over the past few days as Wall Street is speculating if it is the next Bear Stearns. The bank has fought these allegations with a string of press releases and appearances stating that it is properly capitalized and reducing debt. (Wait a minute, this sounds familiar – didn’t Bear do the same thing).

A string of major articles outlining Lehman’s woes has not helped the situation. The Wall Street Journal stating that the bank’s “balance-sheet troubles threaten to harm the wider financial system unless the bank takes decisive action”. The paper went on to say the firm will be forced to sell all or parts of itself to stay above water. Naturally this news has LEH stock targeting 52 week lows.

Lehman’s has not taken the press sitting down; it has come out swinging at parties that portray the bank in a negative light. At the top of the list is head fund chief, David Einhorn, who runs a $6 billion hedge fund called Greenlight Capital. (Lehman Battles an Insurgent Investor). He has been a vocal critic of Lehman’s and has profited on their pain by shorting the stock. According to most market watchers, “Mr. Einhorn instigated the latest dive in Lehman’s stock price two weeks ago when he encouraged other investors to short the stock at a large conference in New York”. He followed this up by agitating for a reduction in debt ratings for Lehman Brothers.

The firm is trying to portray Mr. Einhorn as a short-seller who is simply trying to pad is pocket by spreading negative news about Lehmans. Many on Wall Street simply point to the many times he has been correct in the past. In any account, the situation will play itself out over the next few weeks. It is unwise to underestimate the headwinds facing Lehman Brothers, their eroding mortgage portfolio represents a systemic risk not only to themselves but other Wall Street firms. The media is most likely right on target when stating that a merger is needed and the bank is at serious risk.

The question remains of how much LEH will sink below $31 in the next couple of months. Will the firm regain investor confidence or is it doomed for a big fall?

What Stocks could potentially rise 100% in price?

Once in a while an article about picking stocks floats by that contains enough practical information to be useful – despite the rare occurrence of this type of event. Today’s news stream brought forward an article by BusinessWeek - Stocks: The Double-Your-Money Club

The article does touch on several truths which HingeFire has outlined in the past including:

• The best opportunities are in small cap stocks for explosive growth. Purchasing mega-cap stocks will not enable your portfolio to quickly grow.
• Simply shifting through stocks looking for “cheap” is like “catching a falling knife”. It is important to use technical analysis in conjunction with fundamental valuation to find winning candidates.
• Looking for strong future revenue and earnings growth compared to current valuation is helpful. However relying on this form of bargain hunting can lead to failure when the expectations don’t play out, which is a very common scenario.

Screening to Win: The Value Trap

One of the issues with trading the “Value Trap” many traditional fundamental investors fall into. Many investors buy into a stock because it appears cheap, only to watch it decline in value. At the stock drops further it looks cheaper, and the investor attempts to average in and buy even more shares because it now looks even cheaper. “If you liked it at $30 then you are going to love it $20,” goes the old expression.

Many investors screen simply on valuation criteria attempting to find stocks that look “cheap”. If the P/E, P/B, and other factors look good compared to other companies in the same industry then the stock is “on sale”; which is an invitation to hit the “buy” button. Warren Buffet and others talk about value, and many small investors attempt to imitate their “style”. However most of the institutional big boys are normally selling their portfolio about the same time smaller valuation investors are looking to buy in.

The problem with most value driven purchases for individual investors is that 70% of them do not pan out; the bulk of these failures incur significant losses. Most investors do not mine gems in their fundamental searches, instead they are digging up the debris from the discard heap. Many of these stocks are cheap for a reason, the reality is that they are either declining industries, are poorly managed, or are facing business challenges. The stocks hyped in the financial press as value plays are often the worst examples. Despite screening for both forward and backward fundamental ratios; many times the underlying problems are not apparent to value investors.

What are these investors missing?

The primary attribute the investor is forgetting about is price action when screening the universe of stocks. Simply scanning for “cheap” leads to a pile of probable losers. There is normally a reason a stock is a “value play”; in the same way there is a justification of why a used Yugo costs less than a Mercedes.

Investors need to take a firm look at price action as part of their valuation analysis; this means having a compete understanding of charting, technical analysis, and relative strength. In the example above, any basic analysis of moving averages, relative strength of Citi compared to other financial stocks, or evaluation of the chart would have quickly revealed that Citi was doomed during this time period – despite an “appealing valuation” at multiple points.

In order to avoid the 70% of the stocks in the scrap heap, value investors need to screen for more than just fundamental factors as part of their overall evaluation of candidates. The Hingefire stock screener provides a tool that supports evaluation on multiple fundamental and technical criteria which helps put the market edge in the corner of investors.

Brokers to reduce Technology Spending

According to market researcher Celent, brokerage firms plan to cut spending on technology. The spending on technology will be reduced to an annual growth rate of merely 1.3% from 2008 to 2011, compared to a growth rate of 8.5% from 2004 to 2007.

Many new projects are going to be scrapped, and existing projects placed on hold. One area where spending will still remain strong is security as the financial industry struggles to stay ahead of online attacks.

This reduction in technology spending in the brokerage industry is reflective of the overall turmoil in the financial sector. More importantly it does not spell good news for technology providers. This dims the outlook for firms providing network equipment such as Cisco, as well as companies like Sun, HP, and Dell that provide workstations to the financial industry.

CSCO: Rising Expectations

Cisco stock has risen over the past days in expectation of the upcoming earnings announcement on Tuesday (May 6th). CSCO has a habit of rising into the quarterly report then sinking in after-hours trading during the middle of the call when forward guidance is provided. One can only hope that in midst of a fairly dismal earnings season that the guidance provided by CEO John Chambers outlines an expected rebound in U.S. IT spending for the remainder of 2008. Otherwise history may once again repeat itself.

Cisco is expected to report earnings of 36 cents on revenue of $9.74 billion, compared with 34 cents a share on revenue of $8.9 billion for the year-earlier period. Guidance has been provided for a 10% growth in revenue for the quarter in an uncertain macro environment. Analysts will look to the company’s comments as a barometer on the tech industry. [note: corrected]

CSCO stock has been showing strength over the past few weeks. Any type of quantitative analysis now shows that the probability of the stock going to $30 is greater than sinking to $20. This is positive news for Cisco bulls. However many are left wondering if the current price action is reflective of the traditional pre-earnings rise or if the stock is building a base for significant increases over the coming year.

The charts of CSCO provided below reflect the support floor at $22.80, and improving technicals. The stock has risen above its 50 day moving average and is approaching the 200 day moving average with increasing volume over the past days. RSI has increased from under 30 in mid-January to nearly 70 today reflecting the relative strength of the stock. The MACD indicator is above both the zero line and signal line, and appears bullish as the gap above the signal line is accelerating. Chaikin Money Flow (CMF) has turned positive as more money as flowed into CSCO stock over the past few weeks.


Of course, the quarterly earning report at Cisco always tends to throw a wrench into the technical evaluation of CSCO stock.

Fundamentally Cisco is still a cash generation machine. However institutional investors want to see the cash put to work in the form of large sized acquisitions or a dividend. Don’t hold your breath waiting for a dividend, but further sizable acquisitions that drive growth are likely given the history of the company. Investors hope for some meaningful insight about the company’s growth plans.

Investors are looking for something new to spark their enthusiasm for Cisco stock, otherwise most will simply hold their existing shares while listening to CNBC commentators muttering the now traditional quote, “Love the company, hate the stock” – and praying that the next quarter will bring some new magic.


Disclosure: Author holds CSCO long.

Investools hit with SEC inquiry

Most people regularly see Investools commercials on television parading a string of allegedly successful investors across the tube singing praises of how they made globs of money from the program. These commercials seem to magically appear on every cable channel right before the company sponsors one of its sessions at a local hotel.

In a regulatory filing, the company said it was cooperating with an "informal inquiry" by the Securities and Exchange Commission. The regulators are looking at "representations by certain presenters in certain portions of their presentations at some of the company's seminars," the filing said.

The announcement of the SEC inquiry was made at the same time as an earnings miss. Shares of Investools (SWIM) fell sharply to below $9 on the news as numerous analysts downgraded the stock.

Investools combined with the brokerage ThinkorSwim in February 2007. The company was not profitable for the 10 years prior this integration (except in 1999). Since the combination the company has been profitable during 2007. In the new model, the company educates people at its seminars and then funnels them over to the online brokerage to set up new accounts. Certainly this is an improvement in business model.

You also have to give credit to Investools for its marketing muscle. The company’s logo and advertising is pervasive on the web, in print, and on the airwaves.

The concern of most detractors is if there is anything beneficial behind the hype. Many of the resources pushed as the “Investools method” can easily be found for free on the web. A number of websites including MSN Money, Yahoo, and HingeFire provide outstanding fundamental and technical analytical software for free that enables investors to successfully put the market edge in their corner.

According to David Phillips at 10Q Detective the problems with Investools includes using independent contractors who aren't licensed advisors, being an unaccredited educational institution, and providing coaches with less than 10 years investing experience. He also sites cite numerous accounting red flags in a 10Q Detective blog post in December. According to 10Q Detective, Investools is a Seminar Selling company, with no magic under the hood.

A recent summary states that it is Too Late to Cry “Wolf” at Investools. Only time will tell the end result of the SEC inquiry. Investools may need to reform its seminar tactics, which will break the revenue model of the company. Certainly the stock price is not likely to climb significantly until the situation is resolved.

I regularly urge investors to read and learn about investing on their own. There is a lot of high-priced snake oil promoted in the financial industry. No magic system with green and red arrows is going to suddenly make an investor rich, only hard work and a deep personal understanding of how the market operates will enable you to excel.

Most investors are best off focusing on the long term using low-cost mutual funds & ETFs; only active investors with profound grasp about the dynamics of the market beat the indexes over the long term. These active investors did not obtain their edge by attending high-cost seminars.

Tax Cut leads to surge in Chinese Indexes

Attempting to tackle a sharp decline in the indexes over the past months, the Chinese government reduced the tax on equity trading. In response the Shanghai Composite index surged 9.3% - an increase that is almost certainly temporary. The broader issues with lofty valuations, lack of transparency, and macro-economic issues driving the fortunes of companies in Asia remain unaddressed by this regulatory action.

Investors were delighted with the government action; however it did not boost the long term confidence in the stock market for most individuals. Smart investors will take advantage of the surge to exit their positions over the next week. Slower earnings growth and higher costs do not bode well for company results in upcoming quarters.

“The government is clearly concerned about the meltdown,'' said James Liu, Shanghai-based deputy chief investment officer at APS Asset Management, which oversees $1 billion. ``It's positive for the market in the short run.''

The primary words to focus on are “short run”. Simply reducing the stamp duty on stock trading to 0.1 percent from 0.3 percent will not eliminate the headwinds facing the market, nor change the primary trend of the stock market which is down.

Despite the optimism expressed from financial pundits, the proclamations that this denotes the market bottom are likely to backfire within the next couple of weeks. Certainly the government is pleased with this cheerleading from the financial sector, because after all markets are in reality a confidence game.

Chinese stocks soar after tax reduction

Few analysts believe share prices will reach a new high this year, but many investors and analysts are hoping the worst is over. Hoping and reality normally run on diverging tracks.

What is an Analyst worth? Nothing!

It has become clear to most knowledgeable investors that analysts are nothing more than cheerleaders for the stocks touted from their firms. This was made obvious in the lawsuits after the NASDAQ implosion which found that leading analysts publicly touted tech stocks while privately calling the companies garbage (and worse terms).

Most of the stock portfolios pushed by analysts under-perform the market, while at the same time the Wall Street firms have cozy relationships with the promoted companies that drive millions in fee revenue.

A recent Bloomberg article, What's Analyst Worth? Not a Penny as Estimates Miss, touches on the failure of analysts to properly analyze the prospects of firms rather than simply relying on guidance. The article discusses the “management” of quarterly earnings and other dubious practices, while questioning if “buy” ratings have any value whatsoever.

Another good read about the manipulations of Wall Street is the book - Full of Bull: Do What Wall Street Does, Not What It Says, To Make Money in the Market by Stephen McClellan. The author highlights the shady practices of research analysts and how individual investors should look at their recommendations.

Chinese markets plunge 50% in six months

Earlier HingeFire articles outlined the risk of the Chinese stock market (see The Plunge Continues – China, Shanghai Index Double Top, ETFs to short China) and the probability of the bubble would implode. A summary from early April outlined the rapid deflation of the Chinese indexes. In the past week, the Shanghai index dropped another 11%.

The deteriorating situation has caught the eye of the mainstream press. The WSJ outlines the 50% fall of the Chinese market in a mere six months as a front page article. With the P/E ratio of the composite Shanghai index still at a frothy 35, the market still has plenty of downside. To reach a nominal P/E of 20, the index would slide to 1700; a 72% crash from the Shanghai market peak. A situation that is very reminiscent of the NASDAQ in 2002.

Dollar’s plunge enables corporate earnings

The recent round of earnings reports from large companies with international operations on the surface appear to be solid. Coca-Cola, IBM, Caterpillar, eBay, and others all hit the ball out of the park. A more detailed look reveals the weakness; the strong earnings were built on the back of the falling greenback. International sales did not explosively rise, they simply look much better in dollar terms as the greenback continues to steeply slide.

Understandably growth outside the U.S is stronger than domestic increases, with the economy on the brink of recession. The outsized 1st quarter earnings from international sources are more reflective of the greenback’s slide than improvements in non-U.S. sales. In actuality, it is possible to make a case that overall international sales are deteriorating as consumers become more cautious world-wide.

While the profits are reported in dollars on quarterly balance sheets, most of the currency remains offshore and is not converted into greenbacks. In many ways, this serves as paper tiger that helps the quarterly report look solid, while no real benefit is accrued to the company. If the effect of currency rate of conversion was backed out of the earnings, in some cases the international profits would look just as bleak as the domestic situation.

Additionally, most of these overseas profits are difficult to repatriate to the U.S. and put to work. This means that the cash will be put to work internationally or simply sit in offshore accounts; neither scenario helps drive growth or increase jobs domestically.

At some point the trend in the dollar will reverse; at this point many of these firms that excelled in previous earnings will have to mark their offshore cash hordes to market. If not properly hedged in the forex markets, these companies are likely to announce future write-downs in their cash and equivalents.

Dollar's plunge becoming lynchpin in 1Q earnings discusses this situation in more detail.

Wachovia: Take Three Steps

In a week in which North Carolina is celebrating the tradition of pirates like Blackbeard; articles are appearing asking if the Wachovia CEO will walk the plank? Ken Thompson the CEO of the Charlotte, North Carolina based bank appears to be stuck between a rock and a hard place.

Despite earlier statements that the bank would not cut dividends and was not facing a wave of mortgage trouble; this illusion was shattered in the recent first quarter report. Wachovia cut the dividend from 64 to 41 cents, while adding write-downs of $2 billion. The highly-touted acquisition of mortgage broker Golden West in 2006; has turned out to be a fiasco.

"Everyone points to the acquisition of Golden West, and I do, too," Townsend said. "Certainly that has to be viewed, in retrospect, as one of the most boneheaded decisions of recent times."

Will Wachovia’s CEO weather the storm or be forced to take three steps down the plank? If thrown overboard, he can join the cast of executives from large banks recently cast adrift.

Circuit City: The vultures swoop in

Circuit City (CC), the electronics retailer in dismal shape due to gross mismanagement received a take-over bid from Blockbuster (BBI), the video rental retailer that has an existing set of problems. Vultures have been eyeing the carcass of Circuit City for a good period of time; it should not be a surprise that another retailer has swooped in to take a peck.

In terms of business intent, a combination with Blockbuster may be one of the better proposed deals placed on the table. Certainly better than simply selling out to a private equity firm. In reality, many would look at Blockbuster as being more of a white knight than a vulture.

Highlights of the offer include $6 to $8 per share in cash, a total of up to $1.3 billion. It appears that the chronically mismanaged Circuit City has effectively ignored earlier private proposals, so Blockbuster took the step of making this bid public and engaging shareholders. The press releases indicate that Blockbuster is proposing to use a rights offering, a mechanism that allows existing shareholders to buy additional shares of a company, in order to complete the transaction. Rights offerings are rare in the United States and typically occur at a discounted price.

Blockbuster has emerged as a survivor in a movie rental industry that is undergoing sharp transition. Over the past couple of years, several competitors such as Movie Gallery and Hollywood Video filed for bankruptcy or have been shuttering stores. Competition from online firms, delivering rentals via mail, such as Netflix (NFLX) have stepped up the bar in the industry. Pay per view films offered by cable operators have also deeply cut into the rental business. Being strictly a corner store video rental business is no longer a viable business model.

Blockbuster touted the synergies of the proposed combination; pointing to the ability to cut costs, exploit the growing convergence of media content and electronic devices, and benefit from selling complementary products. Circuit City stores are typically larger than Blockbuster storefronts; one could expect to see “Blockbuster super-stores” that sell electronics and rents movies. However, even if the deal is completed the expectation is that is would take over 12 months to see viable traction with the combination. A large number of existing neighborhood Blockbuster stores would probably be shuttered; frustrating consumers who have to drive longer distances to the new “super stores”, many which are located in crowded malls.

Investors also appear to be skeptical as they drove Blockbuster stock down over 10% in trading on Monday. Many doubt that Blockbuster can cure the problems plaguing Circuit City without causing a tremendous distraction to the company’s primary business. The financing for the transaction is also in doubt and may be dilutive.

Circuit City, winner of the dumbest retail business move of 2007, is a poorly managed underperformer. Its closest competitor, Best Buy (BBY), has been dominating the electronics retail segment. In a continuing sad saga, Circuit City handed out sizeable bonuses for executives while cutting top-performing employees at stores because they were “over-paid”. In response both the sales and stock price tanked. The ills of Circuit City can only be resolved by the replacement of the current management team, and a complete re-focus on the consumer.

Circuit City stock rose nearly 30% on Monday when the news hit the wire. The bid by Blockbuster may be just the front end of a chain of bids for the company. Other players, who have been sitting on the sideline, now may be forced to show their hands and open their wallets. Setting the table for a possible bidding war, an event that would please many long-suffering Circuit City stockholders immensely.