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July 31, 2006

Mad About Ads

The old paradigm was that the network was in control of what was watched and when it was watched. They constantly interrupted in the middle of the program to sell you something that’s irrelevant. In the new paradigm, you are in control of getting what you want, when you want it.

$500 billion a year is spent globally in an effort to inspire purchases, to create awareness, and to build brands. The old advertising truism is that 50% of all money spent on advertising is wasted; we just don’t know which 50%! The net changes this because now we do know.

Traditional network television and cable commercials, historically the preferred channel for advertisers, are being Tivo’d and remote controlled away. Moreover, network TV audience has fallen by 1/3 since 1985.

Newspapers are under attack on every front, with circulation and challengers impacting local advertising in material ways. By the end of 2004, circulation had declined 14% from 1987. We expect this trend to continue and accelerate with the introduction of more powerful, smaller and lighter next generation handsets, PDAs and notebooks.

Magazine circulation peaked in 2000 and is now at 1974 levels.

Traditional radio listenership is at a 27 year low, while commercial free satellite radio, led by XM and Sirius, are growing above 30%.

Telemarketers are being outlawed (thank God!) with 65 million households now on the “Do Not Call” Registry.

Digitization of media = digitization of advertising and marketing services.

As media becomes digital, all marketing services companies must become digital marketing services companies. The principles of targeted marketing, ROI (return on investment) and measurability developed from Internet Advertising will become the standard for buying all forms of media.

The new code of advertising will be driven by analytics and metrics, disciplines that are counter-culture to the creative-oriented, traditional model.

In 2005, $13 billion was spent on online advertising – which is 4% of all spending on marketing in the US. While this is up dramatically from historic levels, it is significantly below the proportional amount of time consumers spend online, which is now 18% of their free time.

The combination of the internet continuing to grow in terms of usage vis-à-vis other mediums, fueled in part by the broad adoption of broadband and the dislocation of the other mediums, will provide gigantic growth for the foreseeable future for online advertising companies.

The democratization of media giving consumers more access, choice and involvement will favor advertisers that will be able to provide “one-on-one” marketing – messages that are highly relevant for me.

Blogs represent an entire new emerging area of threat to traditional media and an opportunity for those that take advantage of it.

The market, as is its peculiar nature, often acts in accordance with confounding the most people at a given time. Consistent with this, the Dow had its best week in over a year and was up +3.2%. Leading all indices was the Russell 2000 up +4.2%, the NASDAQ was up +3.7% and the S&P 500 was advanced +3.1%.

Part of the catalyst for the positive stock movement was 2nd quarter GDP was up +2.5%, below the +3.0% expectation and 1st quarter GDP was up +5.2%. The 10-year note yield dropped to 5.0%. Hope springs eternal that the Fed will finally be done raising rates.

As we look ahead, we remain optimistic for growth companies given valuations, fundamentals and sentiment.

Posted by Michael T. Moe at 11:51 AM | Comments (3)

July 24, 2006

What's the Claim to Fame?

In searching for great growth companies, I am looking to invest in companies that are leaders in what they do. Attractive companies need something that makes them special or great - they need a claim to fame. Starbucks (NASDAQ: SBUX, $33.41, Buy - Price Target: $44) is the preeminent provider of gourmet coffee. Callaway (NYSE: ELY, $12.31 - Not Rated) is the leading innovator in designing and manufacturing premier golf clubs.

"Me too" companies, businesses that participate in the leader's industry, but due to market share, growth and or quality are imitators rather than innovators, are of zero interest to me. In the business world, it is ultimately the survival of the fittest - I want to be involved with the companies that not only survive, but thrive, during their corporate evolution. Ultimately, companies that aren't leaders fall into oblivion.

Companies that dominate a niche and help shape its future are leaders. Companies that may be smaller than the gorilla but have better products, better and more sustainable margins, and/or higher and more visible growth can become leaders. Watch out for them.

The best of all situations is a "one of a kind" company that has no real competition. eBay (NASDAQ: EBAY, $24.66 - Not Rated) is a "one of a kind" company. Apple Computer (NASDAQ: AAPL, $60.50, Buy - Price Target: $90) is a "one of a kind" company with its iPod. Harris & Harris (NASDAQ: TINY, $9.88, Buy - Price Target: $18), a holding company of early stage nanotechnology companies, is a one-of-a-kind business.

In evaluating a company's leadership position within an industry, there are many things to analyze. For example, what is the company's market share? Is it increasing or decreasing?

For a company to be a leader, it needs to be expanding its market share profitably. Generally, this means that a company is gaining share amongst its competitors without decreasing margins. Great growth companies have pricing elasticity and control over their margins. Starbucks has been increasing the price of a cup of coffee for 15 years amidst increased competition, but hasn't missed a beat. Coffee prices have fluctuated greatly but Starbuck's margins have steadily increased.

There are exceptions to this -- I call it the Wal-Mart doctrine. Wal-Mart (NYSE: WMT, $44.29, Accumulate - Price Target: $58) became the largest retailer in the world by charging its customers less so it would make more. For years, Wal-Mart made less in gross margins but actually did make it up in volume so that operating margin remained stable while market share soared.

Here's the quick math on how this strategy works. Wal-Mart had been shaving margins for almost a decade so that by the end of the 1990's, Wal-Mart's gross margin was 23-24% versus Kmart (NASDAQ: SHLD, $139.55 - Not Rated) its main competitor, at 29-30%. By this time, Wal-Mart's sales per square foot were almost $400, more than double Kmart's $178.

Wal-Mart made almost twice in gross profit for the same theoretical square foot of retail space, while at the same time delivering superior value and selection to its customers. Coupled with the superior efficiencies that Wal-Mart derived from its high productivity, Wal-Mart produced vastly more profit per square foot (and more profit per dollar of investment) than did its key competitor.

Dell (NASDAQ: DELL, $22.10, Sell - Price Target: $18) thought out of the box selling computers directly to consumers and building them to order. Apollo Group (NASDAQ: APOL, $46.63, Buy - $66) built the largest private university in the United States because it treated working adults like customers - radical versus most colleges and universities. Thinking differently is a key quality of most big winners.

Costco (NASDAQ: COST, $53.35, Buy - Price Target: $64) is another brilliant business where the Wal-Mart doctrine applies, but Costco has gone one step better.

Costco's goal is basically to sell as much merchandise as can be optimized by pricing its product very aggressively (at less than half of Wal-Mart's discount store gross margin) and being so efficient (partly because of the volume) that the company earns only slightly better than a 1% pre-tax margin on sales of merchandise. Don't get Costco confused for one of those internet era business models like dog.com that the more they sold, the more money they lost. For Costco, earning 1% on merchandise sales is more than enough.

Costco's business model works in some ways more like an insurance company than a traditional retailer. An insurance company's objective is to "break-even" on the policy itself but make its profit on the "float"--the use of that money until it has to be paid out. For an insurance company, you pay your $1,000 in auto premiums in January, and the insurance company expects by December, on average, it will pay out $1,000 of claims and claims expense. The insurance company makes its profit by having the use of your money and investing it during the year. If it makes an 8% return, its profit is $80.

One of Costco's objectives is to get the "float" on the money you give them today to purchase jumbo Corn Flakes with Costco paying the vendor about 30 days later, by which time Costco has had the use of the cash proceeds from the sale of the vendor's inventory. Selling gas at only the slimmest of profit margins makes sense if the total investment required to sell gasoline can "turn," as it does for Costco, more than 300x/year or almost every day. Turn is the number of times a company's inventory is sold during the year. With investment turning like that, it's possible to see at triple digit ROI with hardly any profit margins at all. It also makes sense if the business model creates free cash today that doesn't need to be used for new capital expenditures.

The profit margin on the merchandise sale may not appear very attractive, but the return on investment is. It's even more attractive overall: Costco members also pay a fee to support their addiction to Costco's low prices.

The American Express (NYSE: AXP, $51.97 - Not Rated) Traveler's Check was a classic "float" business. Travelers would deposit money with AMEX before going on a trip and AMEX would have use of that cash to invest until it was redeemed (often much later, and sometimes not at all). AMEX cost of capital was negative.

The facts are while it's exceptionally difficult to find truly world class management teams, it's just as difficult to find companies that have a truly great or unique product. The only way to find them is to do a lot of digging. You have to kiss a lot of frogs before you are going to find a prince.

With companies that provide a service, three metrics tell the story of whether I have found a star or not:

1) Revenue per employee

2) Recurring revenue from existing customers

3) Non-forced employee turnover

Revenue per person is a critical metric for comparing a company to others in the industry because it shows productivity and value ascribed to the provided service. The higher revenue per person is vis-a-vis competitors, the better indication of quality of people and non-commodity service. Also, having the highest revenue per person suggests that the company can pay their people more, which will help in keeping them.

Goldman Sachs (NYSE: GS, $144.83 - Not Rated) has the most envied brand in investment banking, and not coincidentally, its revenue per person is the highest in the industry. Lehman Brothers (NYSE: LEH, $62.13 - Not Rated) has leapfrogged others in its stature, with a corresponding rise in revenue per employee.

Recurring revenue is an important metric as it is a leading indicator of how customers perceive the value of the service and whether it's viewed as fungible or not. It depends on the business, but companies that have 90% or greater recurring revenues are terrific. Companies with a high proportion of recurring revenue almost always sell at higher multiples to their growth rates. A red flag for a service business is when its recurring revenue is decreasing or it's losing a disproportionate amount of customers.

For companies in general, but in particular for service companies, having low non-forced turnover is a good thing. On one hand, great companies do ask people that aren't performing or are killing a culture to leave. At McKinsey, you could be a partner for 20 years, but if you aren't carrying your weight, they will politely make you an alumna. On the other hand, having a big percentage of service employees, or knowledge workers, walk across the street because they perceive it a better opportunity is a big problem. Generally speaking, a professional services firm should have less than 15% non-forced turnover. The better the company, the lower the non-forced turnover.

Another leading indicator to the quality of the product is the quality of the sales force. Sales people are generally a very fluid group and they migrate to where they will have the best product to sell and make the most money. Seeing experienced sales people leave a blue-chip company for a relatively new company may be a sign that something is going on.

Well before it became obvious to everybody that Google (NASDAQ: GOOG, $387.12, Buy - Price Target: $550) was a special company, top salespeople from the Valley were flocking there in droves. Foxhollow (NASDAQ: FOXH, $26.91 - Not Rated), which has been a rocket ship since going public in 2004 in the medical Device area, was attracting leading medical device salesmen before anybody in the mainstream had heard of the company.

With technology companies, tracking where the top engineers are heading provides a window to who has the leading edge product. In the 1980's, the electrical engineers were all heading to Seattle to work for Microsoft (NASDAQ: MSFT, $22.85 - Not Rated). Now they are going to Google and Apple.

Analyzing the percentage of revenue committed to R&D is also important to understand a company's commitment to quality and innovation. The rule of thumb for a technology company is that they spend 7% or better for R&D.

Understanding a company's commitment not only to maintaining its competitive position, but also enhancing it, is critical. The best companies are leaders in investing in innovation through R&D. Google has its people spend 20% of their times dreaming up new ideas. 3M (NYSE: MMM, $71.10 - Not Rated) expects 25% of its revenue in 5 years will come from products that currently don't exist. New products are often key to fueling growth.

Posted by Michael T. Moe at 10:23 AM | Comments (0)

July 18, 2006

Thought Provoking New Book by Andy Kessler

A fun and thought provoking new book is out by Andy Kessler, a former technology analyst on Wall Street, called The End of Medicine: How Silicon Valley (and Naked Mice) Will Reboot Your Doctor.

Andy’s promo includes the following: “What the heck is a tech and finance guy like me doing sniffing around medicine? Well, I think I figured out that the way to save the $2 trillion healthcare industry. It’s for people to not get sick - by getting doctors out of medicine.

The book is a bunch of funny stories, following doctors around, reading mammograms with radiologists, visiting research centers, trying to be my own doctor and spending time watching mice get poked and prodded.

I think the way to fix healthcare is to embed the expertise of doctors in silicon and software and get prices to drop every year instead of rise in double digits. Early detection will be cheaper than chronic care and in the end, Silicon Valley will do to doctors what ATMs did to tellers. (I have a feeling doctors aren't going to like this - my publisher told me to not get sick for the next 5 or so years.)”

Andy raises a great point that was punctuated by my spending hours this week with my daughter in a hospital trying to figure out the cause of her vomiting. This has been going on for a while and essentially the GI docs look to the GYN docs and then the GYN docs look to the GI docs and about by then, the vomiting stops and she goes home and the whole process reconvenes on the next episode. I asked the GYN and GI as they conferred in a very expensive huddle of ‘multi-disciplinarity’ the question: “Did we ever think about trying to stop the vomiting in the first place as opposed to treating the episodes?”

The looks on their faces were like I had just head-butted them in the World Cup Final! Prevention is not really the mantra of our medical system, is it?

As we tie these thoughts into the emerging ability of pharmacogenomics to predict which patient will respond to a particular medication, and who won’t, it becomes ever clearer that the way the industry is structured today, it is more economic for a pharmaceutical company to sell its drugs to people who they will not work on rather than target those that they will. This is a rubber band that inevitably will snap and once the first company blinks and starts to market their drug in this way, their competitors are bound to follow.

Andy’s book is provocative and entertaining in looking at the dynamics of healthcare with a technology bent. The issues he raises though, are far from funny!

Posted by Pascal Besman at 02:47 PM | Comments (1)

July 17, 2006

The Devil Wears Platforms

Growth stocks are the ultimate proxy on investors’ confidence in the future. When investors are bullish on tomorrow, they are willing to pay a higher multiple on a company’s future earnings. For a growth stock to go up, investors need to be looking ahead.

Given the free-for-all in the Middle East, lingering concerns about the kook from Korea, and surging oil prices, it’s not a shock that stocks have been whacked. Investors care more about what’s going on today than being optimistic about tomorrow.

From the market high on May 8, of the more “future oriented” indices, the NASDAQ is down 13.7%, the Russell 2000 is down 12.1% and the ThinkGrowth Index is down 18%. In comparison, the Dow is down 6.4% and the S&P 500 is down 6.7%.

Is this a bear market, or just a healthy (but painful) correction? We’re not sure, but we do know that buying shares in rapidly growing companies at discounted prices will be rewarded over time. We also know that markets generally turn when it is least expected and being out of the market can result in missing out when the surge occurs.

Rather than say, “the world’s too scary – I’m going to put my money under the mattress until things get more normal” – we want to look ahead and look for where the opportunities will be when the sun comes up in the East again.

Putting things in perspective, Kim Jong (mentally) Il’s medieval kingdom and economy is mostly a threat to itself. The high heels Mr. Kim dons – the Devil wears platforms – don’t give him the stature he wants, but just makes him a taller buffoon. The regional war escalating in the Middle East is awful, but the instability there is hardly a new risk factor, perhaps just a more obvious one.

Given the “sale” that’s taking place in the growth marketplace, we think it is particularly timely to highlight our fourth annual growth conference, G4, from September 11-14 in San Francisco’s Ritz Carlton this fall. We will have 200 of the fastest-growing companies in the growth world present.

For more information about the conference and the registered companies, please go to www.thinkequity.com/about/conf_Growth_06.html.

The median expected growth rate for the companies presenting at the conference is 24% and the median market cap is $292 million. Of the companies presenting, 15% are consumer, 9% are business services/education, 11% are media/entertainment, 24% are healthcare, 31% are technology and 10% are nanotechnology and alternative energy.

We are particularly excited to have keynotes from legendary venture capitalist Vinod Khosla, who is on the forefront of investing in “greentech” and Ron Johnson, SVP of Apple (NASDAQ: AAPL, $52.25, Buy – Price Target: $90), who is responsible for Apple’s wildly successful retail strategy that has gone from $0 to $2.4 billion in the past 5 years.

While we have gotten clobbered with the market, we remain optimistic about the intermediate and long-term outlook for growth companies. Valuations are attractive, fundamentals are good, and the fear in the air creates the “wall of worry” stocks often climb.

Posted by Michael T. Moe at 12:39 PM | Comments (1)

July 10, 2006

Buyers Strike

Often, what is the most predictable about the stock market is its unpredictability. Except for its ability to do exactly what will impart the most pain to the most people. For example, good cash being invested in bad internet companies reached a peak in March of 2000, at the precise time the market imploded, destroying $8 trillion of capital.

It makes sense, however, that consumer and consumer-linked stocks are “heavy” because consumers are getting clocked. The Bernanke-led Fed hasn’t missed a beat, and despite hope in its language that the end was near, has raised short-term rates 17 times in 2 years.

Since 2000, approximately 50% of mortgages have been adjustable-rate. Given the fact that the ratio of house prices to median family income was at a 25-year high in 2004, the impact on a family’s wallet has been huge. Add gas prices of more than $3 per gallon, and consumers are getting consumed.

65% of the economy is the consumer versus business. With the introduction of products like iPods, smart phones, game players and plasma TVs, technology, once enterprise-driven, has become more like the consumer-driven overall economy.

Second quarter earning season starts (believe it or not!) next week and if analysts are right, it will be the first quarter in 17 that the S&P 500 reports less than double-digit growth (9.11% is the consensus guess). Obviously, energy and utilities are expected to be up the most (up 26.7% and 28.1%, respectively) and not surprisingly, information technology and consumer staples are expected to be the weakest (-1.9% and 0.7%, respectively).

In technology, our research analyzing the “food chain” shows that 2nd quarter results may be worse than projected. We see softness generally in PCs, handhelds, semis and communications.

While this isn’t good, the market is reflecting this. Bearish sentiment and short interest are at levels showing a negative mood. Stocks are like water, they boil when you’re not watching them. Moreover, we are very optimistic on the long-term trends for technology and for global growth.

For the week, the technology-laden NASDAQ was down 1.9%, the ThinkGrowth Index was down 3.2%, the Russell 2000 was off 2.1%, the S&P 500 was down 0.4%, and the DOW was down 0.5%.

This week we did our annual reconstitution for the ThinkGrowth Index which is made up of the 300 fastest growing companies in the U.S. Exchanges based on long-term consensus estimates. Interestingly, the reshuffling resulted in a P/E of 32.6x based on 2006 earnings and an average growth rate of 30%.

Overall, the index sells at a P/E of 26.6x and a P/E/G of 92% based on 2007 earnings. The cheapest sector on a 2007 P/E basis is now Consumer/Business Services selling at 24.6x and a 27% growth rate. The cheapest on a P/E/G basis at 50% was “Emerging Growth” which includes alternative energy and Green tech companies, a new addition to this year’s index.

This year’s index has 19% Consumer/Business Services, 30% Health Care/Biotech, 35% Technology, 14% Media/Internet and 1% Emerging Growth versus last year’s 18% Consumer/Business Services, 25% Health Care/Biotech, 30% Information and Communication Technology, 6% Media and Education, and 19% Other.

While the market is currently muddled, it ultimately is a futures-based market and we are optimistic on being an investor in emerging growth. Valuations are attractive, long-term fundamentals are good, bearish sentiment is a positive indicator for stocks and the over $6 billion of inflows into mutual funds last week add ammunition ready to be directed back at stocks.

Posted by Michael T. Moe at 11:09 AM | Comments (0)

July 05, 2006

Timeless Insight from the King

I’ve got a book coming out this fall – Finding the Next Starbucks – that is a guide on how to identify and invest in the fastest growing, most innovative companies (a.k.a. the Stars of Tomorrow). For the book, I interviewed 35 leaders in the investment and business world including stars like Howard Schultz, Michael Milken, Vinod Khosla, Tim Draper, Jack Laporte, Richard Driehaus and Bill Campbell. Their insights were fabulous and I think they make the book.

Regrettably, I was unable to get one of my heroes, Peter Lynch, to do an interview as even 15 years since he “retired” as the manager of Fidelity Magellan, the requests for his time are unimaginable.

Nonetheless, I sent him a draft manuscript hoping he might glance at it at some time (even though his assistant told me, “don’t waste the postage”).

So it was much to my delighted surprise when I got a phone call from Peter to give me his comments on the book. His wisdom and wit were exceptional. When I hung up the phone, I went to my Peter Lynch file because I wanted more. Amongst a number of writings, I came across one that was classic Peter Lynch and seemed particularly timely (and timeless).

The following is a letter Peter Lynch wrote to clients of Fidelity. I omitted the first paragraph as it speaks to the specific events of what prompted the letter, but the body is a classic for the ages. At the end, I’ll reveal when this was written:

So What’s Next For The Stock Market?

Although I have been in the field for more than 30 years and have seen many difficult times – the market crash of 1987 (a 23% decline for the down in one day) and 5 recessions – I still don’t know the answer. I never have. No one can predict with any certainty which way the next 1,000 points will be. Market fluctuations, while no means comfortable, are normal. But it’s important for us not to lose focus on why we invest in the stock market.

• When we invest in the market we are buying companies. We have had hundreds of great companies in our history. Now I’m not making a recommendation on any individual company here. Some may continue to be stalwarts and some may fade, but consider the following examples. In past decades, companies like Johnson & Johnson, General Electric, Coca-Cola, Wal-Mart, Disney and McDonald’s have had a history of earnings growth. And consider that there are dozens of companies that started out only 20 years ago that developed into successes with impressive historical earnings growth. Companies like Microsoft, Dell, EMC, Home Depot, Amgen and Staples, to name a few. There will be dozens of new companies created with superior earnings results that will help lead the market in the coming decades.
• Since World War II, despite nine recessions and many other economic setbacks, corporate earnings are up 63 fold and the stock market is up 71 fold. Corporate profits per share have grown over 9% annually despite the down years. Nine percent may not sound like a lot but consider that it means that profits mathematically double every eight years, quadruple every 16, are up 16 fold ever 32 years and are up 64 fold every 48 years. Even if earnings rates slow to 6-7%, the compounded gains will still be impressive over 10-20 years.
• What I do know about the stock market is that it looks forward. That’s right, forward. Right now we are looking at some difficult situations. But every economic recovery since World War II has been preceded by a stock market rally. And these rallies often start when conditions are grim.

Certainly, recent events will affect the earnings of certain companies and sectors of the economy more adversely than others. But over the long term, I believe corporate earnings will be higher in 10 years than they are today and dramatically higher in 20 years. And the markets will follow accordingly.

What’s Next For The Economy?

A lot of economists have said we are on the verge of a recession. I’m not an economist but I do study history. I can’t tell you if we will go into a recession or not. But I can tell you that we have been tested by many recessions before and they have always been followed by recoveries.

In the last 50 years we have had many periods of economic prosperity and many periods of uncertainty. Despite 9 recessions, 3 wars, 2 Presidents shot (on died and one survived), 1 President resigned, 1 impeached, and the Cuban Missile crisis, stocks have been a great place to be. The last 12 months have already shown a slowing of the economy. Many hard-working people have lost their jobs and it has been painful. There probably will be more. The background noise and news coverage will scare people and consumer confidence will be challenged. But there are some critical factors we have to keep in mind:

Since WWII, recessions have become less severe (the severity of jobs lost has trended down during recessions from 1948-1991), are shorter (average duration is one year and average recovery is 4-8 years) and none have gotten out of control.

The United States historically has had a perfect record when it comes to rebounding from the most difficult times. With those nine recessions, we’ve had nine recoveries. There are many reasons why our downturns don’t get out of control. Here are a few that help explain why our economic system remains strong and how these factors help keep our economy moving:

• Government spending: it goes up every year. It always does. When consumer and corporate spending declines in difficult times, government spending acts as a buffer for the economy. And currently, the federal government has a major budget surplus, helping to ensure government spending can continue, even when tax receipts decline.
• The housing market: the price of the average house has not fallen over the last 30 years. In fact, the average house has increased 5-6% over the last three years. That has created $2 trillion in additional equity for homeowners, which is approximately what individual investors have lost in the stock market in the last two years.
• The banking system: this is an incredibly important pillar of our economy and it is in good shape. It is regulated, has ample liquidity and is backed by a solvent FDIC insurance program for deposits.
• Unemployment buffers: the majority of families have dual incomes, providing income if one spouse gets laid off. Cyclical and manufacturing jobs, which are more prone to layoffs, are a substantially smaller percentage of the work force than they were 30 years ago. And unemployment insurance supports people as they look for new jobs.
• Economic downturns lower interest rates: this reduces interest expenses for consumers and businesses and improves the affordability of purchases and capital investments (physical plants, equipment, research and development).
• Retiree benefits: pension payouts and Social Security checks provide a consistent stream of income for more than 30 million Americans.
• The college factor: we now have more than 14 million students in our universities. Their spending, tuition and college-aid programs are relatively unaffected by either a good or bad economy.
• Healthcare spending: over 10% of our GNP is related to the healthcare industry, another area that is much less affected by economic changes. People still need to see their doctors and buy prescription drugs. And we didn’t have Medicaid or Medicare 50 years ago.

What Should We Do Over The Next Few Days And Weeks?

My advice hasn’t wavered from two weeks ago, two years ago or 20 years ago. It won’t two or 20 years from now. The money you need for the short term to pay for a wedding or put down a payment on a house or send a child to college next year shouldn’t be in the stock market. But if you’ve set aside adequate funds for your short-term needs, time is on your side and the stock market has historically been the place to be. And when I say long term, I don’t mean three weeks from Wednesday. I mean a minimum of 5, 10, or 20 years. The market goes through difficult times; this is one of them. But if you’d been in the market for the past 15, 30 or 50 years, you’d be quite happy despite the many painful periods.

It’s no secret that traders and market timers who come in and out of the market will miss some of the bad months, but they will also miss some of the good ones as well. When the market goes up, it often goes up rapidly. If you jumped in and out of the market and missed the best 40 months during the last 40 years, you would have reduced your average annual return from more than 11% at around 3% (less than you would have gotten from a money market fund). Market timing is speculating and it rare, if ever, pays off.

As I said earlier, which way the next 1,000 to 2,000 points in the market will go is anybody’s guess, but I believe strongly that the next 10,000, 20,000 and 40,000 points will be up. We have had incredible innovations in health care, manufacturing and technology. We have seen the demise of communism, the rise of free-market economies. We now have anti-lock brakes, supermarket scanners, profound improvements in heart surgery, artificial hips and knees, and prescription drugs that treat high blood pressure, cholesterol and other serious health problems. These cures, inventions and innovations create jobs, make business more efficient and add to worldwide prosperity.

If you believe in the strength of the American resolve, hard work and innovation, then take a long-term view and believe in our economic system.

I certainly believe.

When did he write this?

A) October 1987
B) October 1990
C) September 1998
D) September 2001
E) June 2006

The point is, if you ignore references to some dates, this letter could have been written at any time. It happened to be D) September 2001, but it works for July 5, 2006 just as well.

The market had a pre-July 4th fireworks display on Thursday after the Fed provided language that the end was near for raising rates. The NASDAQ shot up 3% and the S&P 500 up 2.2%, the most either index has been up in a day for 3 years.

For the week, the Russell 2000 led all indices advancing 5.0%, followed by the NASDAQ up 2.4%, the S&P 500 up 2.1% and the DOW up 1.5%.

With half of the year done, the Russell 2000 is out ahead up 7.6%, the DOW is up 4.0% and the S&P 500 is up 1.8%. The NASDAQ and NASDAQ 100 are off 1.5% and 4.3%, respectively.

When big moves occur in the market, it generally signals something. It’s early with the current move, but we are looking for new leaders, industries that are breaking out, and companies that are showing accelerating fundamentals and outsized stock performance.

For the first half of the year, in looking at our universe of companies, there are some companies showing signals of leadership. Zoltek (NASDAQ: ZOLT, $29.89, Buy – Price Target $40) is up 240% year-to-date, GigaMedia (NASDAQ: GIGM, $8.88, Buy – Price Target: $13) is up 212%, Smith Micro (NASDAQ: SMSI, $16.02, Buy – Price Target: $16) is up 174%, Advanced Magnetics (NASDAQ: AMAG, $30.22, Buy – Price Target: $63) is up 173%, RSA Security (NASDAQ: RSAS, $27.10, Buy – Price Target: $25) up 142%, Cbeyond (NASDAQ: CBEY, $21.81, Buy – Price Target: $30) up 112% and Emisphere (NASDAQ: EMIS, $8.53, Buy – Price Target: $15) up 97%.

We are bullish on stocks in general and specifically on growth stocks. Valuations are attractive with the ThinkGrowth Index selling at 20.9x 2007 EPS versus 30% EPS growth rate, inflation in check from the Megatrends of globalization, outsourcing and the internet and pessimism in the air (which is bullish).

Posted by Michael T. Moe at 11:38 AM | Comments (0)