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June 27, 2005

King of the Hill

It's no remarkable coincidence that a number of great investors are also mountain climbers. I always enjoyed reading Barton Biggs' observations from his treks with clients. In climbing, as with investing, it takes a lot of discipline to be successful. Having a strategy, plotting a course, creating alternatives, and having a margin of safety are common denominators of both endeavors. It's hard work and often lonely - one casual mistake and you can be dead.

Being a growth investor for much of the last 18 months has felt like we've been on an "into thin air" expedition. It's seemed like anything that could go wrong, would, and with investors so consumed by survival, it was hard to think about the spoils on the other side of the mountain.

For the past 8 weeks, it has felt like we were slowly and methodically making our way up the mountain with the NASDAQ approaching breakeven for the year, up +7.8% since April 28th and the S&P 600 reaching all time highs. Then last week, just as we were able to get a "peak" at paradise - whack - the avalanche of oil prices reaching $60 a barrel hit and "look out below!"

Tumbling down the mountain we went with the Dow off -3.1% last week, the S&P 500 down -2.1% and the NASDAQ off -1.8%. Advancers trailed decliners 13 to 21 on the NYSE and 3 to 5 on the NASDAQ. Encouraging, companies making new highs versus new lows was 622 to 188.

Most impressive is the action of the new "King of the Hill" a.k.a. Google (NASDAQ: GOOG, $296 - Buy, Price Target: $330). Despite lots of market adversity and challenges from pundits, Google remained on top and eventually advanced +6% for the week. From its not elegant auction IPO less than a year ago at $85, it's climbed to almost $300. More importantly, as it has ascended, it's become stronger and stronger and is at the epicenter of the Internet economy.

Other new leaders who are rising to the top of the heap are salesforce.com (NYSE: CRM, $20 - Buy, Price Target: $25), whose business is on fire and its stock is finally responding in kind. salesforce is on the right side of the future with its on-demand model. Additionally, Intermix Media (NYSE: MIX, $8 - Buy, Price Target: $11.50), Peet's Coffee (NASDAQ: PEET, $33 - Buy, Price Target: $36) and Bright Horizons Family Solutions (NASDAQ: BFAM, $40 - Accumulate, Price Target: $41) are all companies that look like they are well on their way to establishing themselves at the top of this bull market's class.

We remain positive on the market in general and in particular for small cap growth companies. Valuations are attractive with the S&P 600 selling at 15.5x 2006 estimates with a 20% projected earnings growth. Despite raging oil prices, inflation is dead and interest rates have a lid on. It's a great time to be making an approach!

Posted by Michael T. Moe at 02:19 PM | Comments (0)

June 20, 2005

Whole Lot of Shaking...

Here in California, we had not one, not two, but FOUR earthquakes last week! Supposedly, talk around town was that "the Big One" is coming, which will turn "the OC" into "the ER." Funny thing is, I didn't hear anybody talk about it. I read about it in The New York Times and saw it on CNN, but at least in my little galaxy, it was like "the sun came up in the east today - so what."

Here in California, we had not one, not two, but FOUR earthquakes last week! Supposedly, talk around town was that "the Big One" is coming, which will turn "the OC" into "the ER." Funny thing is, I didn't hear anybody talk about it. I read about it in The New York Times and saw it on CNN, but at least in my little galaxy, it was like "the sun came up in the east today - so what."

Friends of mine from the Midwest and the East Coast ask why I would live in an area subject to such uncontrollable acts of nature, and I ask them about tornadoes and hurricanes, respectively. The answer back is that those somehow are different - they really aren't things to worry about.

Yet people do. It consumes them. They worry about all sorts of things they can't control which prevents them from acting on things they can do something about. Today investors worry about the war in Iraq, oil prices, the trade deficit, the budget deficit, outsourcing, General Motors, the Yankees, and much, much more.

In that the stock market reflects its participants' hopes and fears, it's been paralyzed by investors' worries. As Art Samberg said in this weekend's Barron's Roundtable, the stock market has been as exciting as "watching paint dry."

Three interesting facts that are notable against that malaise: 1) In the short term, the market is a function of investors' moods. In the long term, it's a function of companies' earnings. 2) Stocks are quietly and classically acting well, and climbing the proverbial "wall of worry" led by small cap growth companies. 3) While investors are in a funk, the companies whose fortune will drive prices over time are very bullish.

The point being, while all the market observers are worried about earthquakes, tornadoes and hurricanes, the people actually running the businesses are oblivious as they are too busy making sales, doing deals and growing their business.

Additionally, the small cap S&P 600 is at an ALL TIME high and was up +2.6% for the week, the Russell 2000 was up +2.9% and the NASDAQ was up +1.3% and has now appreciated +9.8% since April 28th. Market breadth was great with advancers beating decliners 3 to 1 on the NYSE and 2 to 1 on the NASDAQ. Most encouraging, companies making new highs to new lows was 823 to 180. Also notable, despite oil prices reaching record highs at $58.60 a barrel, stocks ignored it. Earnings are once again leading stock prices, not the inverse direction of oil prices.

We remain bullish on stocks in general and in particular small cap growth stocks. Valuations remain attractive with the S&P 500 selling at 14.6x 2006 EPS estimates and the S&P 600 selling at 15.0x 2006 estimates with a 20% growth rate. There is a persistent demand imbalance for equities with $1.3 billion of inflows last week and little supply manufactured by Wall Street. Lastly, inflation remains in check with globalization, the Internet and outsourcing keeping a secular lid on it.

Posted by Michael T. Moe at 11:12 AM | Comments (0)

June 13, 2005

Present, Future and Past

Here we are nearly halfway done with 2005 and it feels like we're trapped in Never-Neverland. (Hopefully, without Michael Jackson - we couldn't take that.)

Most of the stock averages are down slightly for the year. Interest rates remain low. Inflation remains (mainly) dead. Valuations are low - certainly in light of interest rates. Oil prices are disturbing but overblown. But what's really the problem is there is NOTHING people are excited about. Nothing!

I'm not much good at watching paint dry which is what it's been like to be in the market recently. So I figured I would get out to see if I could gain some perspective on things.

Last Tuesday, I got a chance to hear New York Times celeb Tom Friedman give his thoughts on the world (which you can get in his terrific new book The World is Flat). His main points were that in a world of globalization and the Internet, there is nowhere to hide. Open-ended opportunity and never ending competition - that's the reality of a flat world.

Bangalore is a suburb of Boston. Education is more critical than ever to be part of the new world (it used to be you were better off being a C+ student living in Chicago than being an A student in Beijing - no longer.) Creating a real energy policy is urgent. The war in Iraq is about much more than Iraq - it's about the future of radical Islam. And perhaps the phrase that sums up most of Mr. Friedman's thoughts : "There is no room for vanilla in a flat world."

I went from there to my daughter Maggie's 8th grade graduation. I don't know about you, but I'm pretty sure my 8th grade graduation was a much simpler event - I think I just went home after my last class. This was a bigger deal than my college graduation! Three days of events, ceremonies and parties. But it is interesting what 14 year old kids think about (besides "the OC" and the opposite sex.) They have huge optimism and feel the world is their oyster but they are fearful of terrorism. They are extremely social but they will sit in a group and talk on their cell phone or would rather communicate via IM than with actual conversation. They don't think about being digital - THEY ARE DIGITAL!

Since the 8th grade graduation was the mega-event - generations of families came to celebrate the grand occasion. Listening to stories of grandparents and great grandparents who were the first in their family to go to college. Or came to this country from Norway or Poland or China with an 8th grade education so they could be in the land of opportunity. I literally sat next to a 75 year old man who came to San Francisco from Italy when he was 16 so he could pursue his dreams. He was complaining about Sarbanes-Oxley (Scout's honor!).

My point in this is I'm an optimist but I'm worried. We've become comfortable and risk averse. We need to be able to support the wild eyed entrepreneur who wants to change the world. We need to get into gear and get into the action. NOW!

Posted by Michael T. Moe at 09:08 AM | Comments (0)

June 07, 2005

Why We're Bullish

In talking to our friends in business and the investment industry, we feel like we are caught in between two different worlds. Our business relationships are as optimistic as in recent memory. Opportunities abound. Customers are looking for products that will propel growth. Acquisitions are on the table that will help companies play offense and create an outsized value proposition. Interest rates are low and human capital is available. Innovation is alive and well after its premature obituary.

On the other hand, when we talk to our investment friends you would think the world is coming to an end. Gas prices going to the moon, the trade deficit, the budget deficit, the crisis in confidence in our leadership as it relates to the world stage. Yada, yada, yada.

In spite of this, or perhaps because of this, stocks are quietly, by and large, marching upward. While only the Russell 2000 of all the major indices we track was up for the week (+0.6%), advancers beat decliners on the NYSE 23 to 15 and on the NASDAQ 17 to 15. Most encouraging were the companies making new highs versus new lows was a bullish 588 to 158.

It is our primary philosophy that earnings growth drives stock prices. It's not a shock that the companies that are performing the strongest are the ones with the strongest earnings growth. Classically, stocks climb a "wall of worry" that seems counter-intuitive but actually makes perfect sense. When everybody is optimistic about the market, the economy, the world, etc, that sentiment is already reflected in stock prices - the buyers have already bought. When investors are worried, they have already sold their positions so as the sellers are already gone, incremental buying lifts the markets.

Right now investors are worried about everything yet the market keeps going up. There are always things to worry about but the best opportunities are to buy great companies when the world has a "buying strike".

There are some subtle shifts that have taken place recently that might seem trivial but we see as material. Specifically, the Arthur Andersen ruling by the Supreme Court was essentially an admission that the witch hunt had gone too far. Secondly, Bill Donaldson's leaving the SEC is another good step towards a more constructive environment - Mr. Donaldson is a great man and he made a number of positive contributions to the SEC, but it is time for America to get back to being America.

As we look out at the problems and opportunities, the key ingredient we see missing from companies, banks, government officials and investors is to unleash the amazing innovative spirit that has built our country.

We are wildly bullish, partially because of the facts relating to market data, fundamentals of companies and relative valuations - but the most compelling reason for our optimism is that companies are on the move again and over time stock prices correspond with the companies success.

Posted by Michael T. Moe at 07:37 AM | Comments (0)