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October 30, 2006

A Dickens of a Market

"It was the best of times, it was the worst of times... " So it is written in Charles Dickens' A Tale of Two Cities. Alas, today's market environment could be summarized by the same schizophrenic description.

Consider:

And the contrasts go on.

Where we come out is confusion creates opportunity. If it were obvious, it would be priced into share prices.

While we are concerned about some structural issues; i.e. Sarbanes Oxley, appropriate incentives for emerging companies and entrepreneurs, free market leadership in Congress, etc., we are wildly bullish on the outlook for the growth economy and growth stocks.

It's not a shock that US economic growth has slowed finally following the Federal Reserve's strangling of it with 17 successive rate increases, but we do find it encouraging that new factors are emerging to supplant the old guard.

Looking at 3rd quarter earnings, technology being up 9%, telecom up 14% and healthcare up 7% were encouraging, while non-secular growth financial services and energy enjoyed the strongest growth of 34% and 21% respectively.

Last week, stocks continued to climb with the DOW up 0.7%, the S&P 500 advancing 0.6%, the Russell 2000 up 0.5% and the NASDAQ up 0.4%.

Advancers beat decliners on the NYSE by over a 2 to 1 margin, but just 17 to 16 on the NASDAQ. Once again, and bullish, companies making new highs versus new lows was a huge 1,122 to 136.

We remain bullish on equities and in particular on growth stocks.

Posted by Michael T. Moe at 10:59 AM | Comments (0)

October 23, 2006

USA Population 300,000,000

Watching the World Series in Detroit in late October with 30° weather is a bit strange, like watching hockey in Miami. There's a reason they call baseball players "the boys of summer."

Generally, I don't pay any attention to the weather reports because I find them often wrong, and some general observation can basically prepare me for the day ahead. If it's raining outside, I'll grab an umbrella. If it’s 40°, I'll wear a coat. But I quit planning my activities a long time ago based on the weather forecast for the week ahead. I don't flip a coin to make decisions, and I don't listen to a meteorologist.

But, if I want to schedule a ski vacation in Colorado, I'll plan it for March. If I want to go waterskiing in Minnesota, I'll do it in July and if I want to watch the cherry blossoms in Washington, D.C., I'll arrange my trip for April.

While day-to-day weather is random, the seasons are predictable. It's cold and snowy in the winter, warmer and wet in the spring, hot and drier in the summer, cooler in the fall. The days are longer in the summer, shorter in the winter. I know these things and I can plan around them. You can predict it's likely the fans in Detroit will need a parka to watch the Tigers in October.

Similarly, understanding demographics gives investors a very predictable window to the future. While America hit 300 million in population last week, demographers have been forecasting this event with some precision for over a decade. It's like watching a slow-motion curveball - hanging ready to be swatted out of the park.

An aging population is going to require more healthcare, travel more and be looking for ways to enhance their retirements. Premium wines, beers and coffees benefit. So do financial services.

As women become a larger percentage of executives in business, nanny services and corporate childcare become more in demand, and take-out food and pre-made dinners are trends as are tutoring, maid and gardening services.

In the I-Generation, most kids can't remember when the Internet wasn't always on. To them, the cell phone is like the automobile was to our parents - a way to exercise their independence and exhibit self-expression. Ring tones, text messaging, games and movies, are what the I-Generation expects in one smart device.

The Hispanic population is the fastest-growing ethnic group in the United States. Currently 14% of the US population is Hispanic. 20% total is expected by 2020. With this growth comes great opportunities for target marketers, focused media and smart retailers.

Immigration will continue to increase rapidly, though likely it will slow from some parts of the developing world as liberalization improves opportunities at home. In the United States, minority populations will continue to rapidly grow into the mainstream, with the Latino population's growth in numbers and spending power being the first to meaningfully redefine the retail, media, and financial services industries.

Source: U.S. Census Bureau

The combination of an aging population and the events of 9/11 have provided a catalyst for a religious revival. In 1994, the Gallup Poll asked Americans whether they felt the need to experience spiritual growth - 20% said yes. By 1999, 78% said yes, and this was before 9/11! Rick Warren has sold 25 million copies of The Purpose Driven Life, and The Passion of the Christ is one of the most successful movies of all time, grossing over $600 million (to the great surprise of "the experts"). With up to 80 million Evangelicals, $7 billion in Christian music and $2.24 billion of Christian books was sold in 2004 according to Billboard. Christian music, books and media are obvious winners; family restaurants such as Potbelly's, family entertainment like Six Flags, and virtuous apparel retailers (the anti-Abercrombie & Fitch) win big too.

Demographic trends over the next 20 years will prove incredibly dynamic. The oldest of the baby boomer generation will begin to leave the workforce and enter retirement around 2008, but 90% of Generation Y (the echo boomers) will have entered the labor markets by that time, and thanks to the size of Gen-Y, the effects of the vanishing work force will nearly be offset. Of course, replacing seasoned employees with new entrants will present new challenges for companies.

Source: Census, ThinkEquity Partners

Generation Y will be the first generation of size to grow up with information technology - leap-frogging Generation X's mere comfort with technology - as a result of the Sony Walkman, Atari, Apple 2E, Commodore 64 and VCR. Beyond using technology, Generation Y's experiences will extend to understanding how information technology works, and can work, when applied to things so far untried by prior generations.

Across numerous industries, baby boomers and the younger generations will create polarizing forces: boomers frequenting stores to shop (and spending more time shopping), Generations X and Y bypassing them almost completely; travel industries seeing sharp growth in leisure demand, while business travel wanes; financial services restructuring to cater to retirees, while commercial, merchant and "venture banks" build out new capabilities to meet the explosion in new business ventures and restructuring of more mature industries.

Politically, baby boomers will face their first real challenges from outside of their own demographic, as the larger combined size of Generations X and Y begins to wield meaningful influence economically, technologically and socially.

In short, emerging demographic shifts will not only play a primary role, but, given the size and scope of the changes taking place, will prove disruptive to past technological, economic and social legacies. Forward-looking investors will find huge opportunities emerging where these legacies are fading away.

Yes it's the fall season. And for sport addicts, it's the football season and technically the baseball season. But for investors, it's EARNINGS SEASON!

With 139 or nearly 28% of the S&P 500 reporting, EPS is up 15.6% for the third quarter - roughly 4% higher than analysts' projections.

The Big Two - Apple (NASDAQ: AAPL, $79.95, Buy - Price Target: $100) and Google (NASDAQ: GOOG, $459.67, Buy - Price Target $580) - both had great numbers. Apple hit it out of the park with strong Mac sales sparked by Back to School. Google hit it out of the universe with 70% revenue growth and 79% EPS growth - crushing estimates. Not coincidentally, Apple shares were up 6.6% for the week and Google shares were up 7.6%.

The market mainly moved higher for the week with the DOW topping 12,000 and advancing 0.3%. The S&P 500 was up 0.2%. NASDAQ, which has been on a roll lately, declined 0.6%.

Advancers beat decliners 21 to 13 on NYSE and 16 to 15 on NASDAQ. Particularly noteworthy was companies making new highs were a whopping 1,058 versus just 98 making new lows.

For the second week in a row, cash inflows into mutual funds were strong with $3.9 billion heading into funds last week.

The IPO story for the week was the pricing of ICBC (The Industrial and Commercial Bank of China) raising $19 billion. Most noteworthy, these shares will be listed in Hong Kong on the Shanghai Stock Exchange - not in the United States (SOX sucks). Back in the States, the positive IPO trends continued with seven new issues pricing last week and six of them trading up.

We remain bullish on growth equities due to fundamentals, valuations, supply/demand and place in the cycle.

Posted by Michael T. Moe at 03:43 PM | Comments (0)

October 16, 2006

Buy GUBE

I've felt Google (NASDAQ: GOOG, $427.30, Buy - Price Target: $550) is the most important growth company in the world for some time. In fact, we recommended purchase of Google shares the day it went public at $85 a share in August of 2004 - the first Wall Street firm to do so.

Today, at $427 per share, it seems that in hindsight that was an easy call - a "no brainer." But at the time, skepticism about Google abounded. Cynics carped that this was another "bubble baby" with kids at the wheel and would end up like many of the car wrecks in the scrap heap before it.

Obviously, there are a number of outstanding companies that could stake claim to the "most important growth company in the world" title - Apple (NASDAQ: AAPL, $75.02, Buy - Price Target: $100), salesforce.com (NYSE: CRM, $40.98, Buy - Price Target: $45), Genentech (NYSE: DNA, $82.74 - Not Rated) and Starbucks (NASDAQ: SBUX, $37.92 - Not Rated) to name a few.

Source: FactSet, ThinkEquity Partners


For our money, however, no company has the attributes that are on the forefront of the future that Google has, or is closer to "First and Main" in terms of market potential. The company's mission - to "organize all the world's information" - is truly a BHAG (Big Hairy Audacious Goal) and as CEO Eric Schmidt has said tongue-in-cheek, they should be able to accomplish that in approximately 300 years.

Every era has a company that defines it. Ford Motor (NYSE: F, $8.13 - Not Rated) was the poster child for the modern Industrial Revolution and when it went public in 1956, it was a signature event. Apple Computer launched the PC Revolution with its IPO in 1980. Microsoft (NASDAQ: MSFT, $28.37 - Not Rated) was the defining company for the Information Revolution and was the stock when it went public in 1986. Netscape's IPO in August of 1995 was the starting gun going off for the Internet Revolution. Google's IPO is the defining moment signaling the preeminence of the Knowledge Economy and Web 2.0 - the Internet being the platform for communication, commerce, education, information and services.

Source: ThinkEquity Partners


Google thrives on pushing the envelope - as Fortune recently wrote - "chaos by design" is its management mantra. Sometimes that produces homeruns like Google Maps and Google Earth. Sometimes it produces perpetual "beta" programs like Froogle which despite a great name is a dud. Ditto with Orkut - Google's social network site which despite its success in Brazil, makes Friendster look like MySpace.

Source: ThinkEquity Partners

What Google has done, which if it can keep it up will be an ongoing advantage, is it has become the magnet for the smartest talent - people who want to be part of changing the world. Its leadership position in the Web 2.0 Megatrend gives it disproportionate competitive strengths, but what makes Google have a huge "moat" around its franchise is it's the Superpower in the War for Talent. There aren't many $130 billion market cap companies that still have a go for broke attitude like a start-up.

Last week's acquisition of YouTube for $1.65 billion took the breath away from many market observers. What it really did was cut the oxygen off from anybody who thought they could catch Google in the Web 2.0 decathlon. Given Google recently paid $900 million to syndicate MySpace, paying 60% more to own the hottest new property on the Web with YouTube makes a lot of sense to me.

Consensus EPS estimates for GOOG are $13.09 for 2007 and $16.87 for 2008, giving Google a P/E of 32.6x and 25.3x on 2007 and 2008 EPS estimates, respectively. We assign a 30%+ long-term growth rate and 40%+ long-term EBITDA margins. We would expect a "normal" growth company to sell at a P/E equal to its growth rate. Given GOOG's characteristics and open-ended potential, we think a P/E/G much higher is warranted.

Source: Graham and Dodd's Security Analysis, ThinkEquity Partners

Stocks continued to march upwards last week led by small-cap stocks. Catalysts were continued softness in oil/gas prices coupled with decent economic growth but muted inflation. Futures traders see basically zero possibility that the Fed will raise rates by January 31st, 2007.

For the week, the Russell 2000 was up 3.1%, the NASDAQ up 2.5%, the S&P 500 up 1.2% and the DOW up 0.9%.

Advancers beat decliners 2.5 to 1 and companies making new highs versus new lows was an impressive 944 to 141.

Also encouraging, cash inflows into equity mutual funds was a whopping $5.9 billion. IPO activity was modest, but the after market performance was strong with new issues Acme Packet (NASDAQ: APKT, $15.91 - Not Rated) up 68%, EHealth (NASDAQ: EHTH, $22.90 - Not Rated) up 64% and SAIC (NYSE: SAI, $18.18 - Not Rated) up 21%.

We remain bullish.

Posted by Michael T. Moe at 01:12 PM | Comments (0)

How to save a few billion dollars

Good clinical practice we come to learn involves testing potential new drugs in larger, randomized, double blind trials, often against a placebo. Depending on the disease indication this placebo effect can often push to levels over 50%. Why not save the healthcare system a load of money and in a number of these non-life threatening indications simply prescribe the placebo (read FREE) at least until the patient either progresses or their symptoms don't improve. It sounds slightly Orwellian but desperate times call for desperate measures, and it fits within the Hypocratic oath of doing no harm, possibly less harm than an active drug would. Plus, I gain a slightly Machiavellian sense of revenge on all those hypocondriacs out there.

Consider allergic rhinitis. Offering sufferers a simple saline solution offers 50% symptom relief. Other allergies show similar symptomatic relief at least over a short time with placebos or remedies that have been proven in large clinical trials to not work. Pain management would save the system bundles; typical pain relief offered by placebos approach 50%. Even nasty diseases like Crohn's see placebo rates of 30% or more. Psychiatry is another area where we could save bundles.

Our society demands that a visit to a doctor be rewarded with a scrip, and our doctors would feel that they were admitting defeat to not put pen to paper for every visit, similarly to how when you get stopped by a custom's agent, you know you are getting busted for something. Often these large clinical randomized double blind trials for potential new drugs fail just because the placebo effect seen in the trial came in higher than anticipated, meaning that whatever relative benefit was seen by drug over placebo was insufficient to hit statistical significance. Let's turn these failures to our advantage. I am filing a registration statement soon for my fledgling pharma company, PLACEBO Tech that will market all these non-drug drugs.

Our business plan is simple and clean. We don't have to run any clinical trials and we don't have to price in potential trial failure. We won't have to deal with the FDA and its quirks. We won't get sued for killing people since our drugs do nothing. We won't have to do complicated and expensive trials to show we are safe with other drugs or in any sub set populations since the drug is inactive. And we won't have to market at all since every doctor knows what nothing is. And our barrier to entry will be the same as the You Tube that led to their billions; be first and be trusted: Our motto will be : Placebo Tech: when only nothing will do. We will simply collect our fair share of the savings we are offering society.

Sometimes the simplest ideas are the best.

Posted by Pascal Besman at 12:58 PM | Comments (0)

October 10, 2006

MONEY

Sitting in Houston at MD Anderson, I was listening to a lecture by the head of their leukemia department, Dr Hagop Kantarjian last week, talking about his prediction of an explosion in cost for the relative minor and niche disease of chronic myelogenous leuekemia, or CML. Currently afflicting about 5000 Americans with newly diagnosed CML and with a treatment from the almost panacea drug Glevec sees a cost to treat of around $1 billion per annum. As the cures that Glevec engenders continue to survive and new drugs take over once it no longer works (7 years or more hence), we have the wonderful situation where the 5000 cases per annum will bloat to perhaps 50,000 patients on therapy within ten years costing perhaps $15 to $20 billion. Such is life in the brave new world where drugs actually work to extend survival.

A variation along this theme of 'money talks' was the controversy surrounding the editorial in this week's New England Journal of Medicine where very close efficacy was found for Genentech's (DNA - not rated) Lucentis which is approved for age related macular degeneration and their Avastin which is approved for various cancers. Both are anti-VEGF drugs derived similarly, only Lucentis costs about ten times what Avastin costs, primarily due to the relative doses used for ophthalmic as opposed to oncologic applications. Reacting quickly to the debate and furor, the National Institute of Health decided to foot the bill for a head to head study of the two to determine if they are essentially identical in the ophthalmic setting, allowing use of the cheaper Avastin. I am sure Genentech feels thrilled about that!

The last leg of my tripod was a discussion I had with another thought leaded about two experimental drugs in thrombocytopenia. He explained that one of them had an uneven safety profile, the other not. Both drugs were following a path to approval in a niche blood disorder, however, he explained that if the 'cleaner' drug got approved, not only would it quickly get off label use in other blood platelet disorders but that payors would be cheering it on, as the savings from using the drug in multiple co-morbidities would be clear net net win for them.

As our society enjoys the benefits of many new drugs that truly to extend either quality or quantity of life, we are facing more and more the issues of rationing our healthcare costs, making tough decisions about which drugs really are worth paying for, and forcing efficiencies in the system. If we don't do this now, it is clear that our successes will quickly overwhelm us.

Posted by Pascal Besman at 12:04 PM | Comments (0)

October 09, 2006

The Luck of the Irish

My week began with a Los Angeles to Dublin Aer Lingus flight and ended watching Notre Dame trounce Stanford 31-10. In between, I saw a lot of green.

The island that St. Patrick converted pagans to Christians has gone through a recent economic conversion that has been called the "Celtic Miracle."

20 years ago, Ireland was considered "the beggar of Europe" with unemployment of 20%, and the highest level of debt per person in the world.

The educated and the ambitious emigrated from Ireland to where the opportunity was and many who remained were the unskilled and unmotivated.

Today, it's one of the most thriving economies in the world and has become the country of choice for many international companies doing business in Europe. Over the past 10 years, its economy has grown 7.9%, placing it 6th amongst all countries and its GDP per person is a remarkable 5th highest.

Source: The Economist, "Pocket World in Figures," 2006 Edition.

What happened?

In October 1987, a comprehensive plan was implemented which included a dramatic reduction in corporate taxes, focus on attracting foreign investment and an increase in emphasis on education and training its workforce. In fact, Ireland's realization that an educated population was a key to its revitalization began with making post-secondary education free during the 1960's.

Ireland's early embrace of the European Union and its currency was another factor which, coupled with its favorable tax system, educated workforce, low compensation environment and English-speaking people, made Ireland the choice of leading companies like Dell and Intel in setting up their European headquarters.

The optimism and confidence one hears on the streets of Dublin today is that of a people who feel like they have a tiger by the tail. And they do.

Alas, a bounce in the step isn't all that success has brought the Irish; wages have skyrocketed and real-estate prices in Dublin are becoming as expensive as other high-cost cities like London, Tokyo and New York.

So, 10 years ago, corporations came to Ireland because there were low corporate taxes; a highly educated, English-speaking population and a low cost structure. Today, corporations are still coming to Ireland because there are low corporate taxes and a highly educated, English-speaking people, but now it's high cost.

There are numerous reasons to be bullish on Ireland in continuing to be an important center for commerce and investment. And while Ireland has boomed, its stock market sells at a market cap to GDP of just 55% versus the US at 130%, the UK at 133% and Switzerland at 227%.

Source: The Economist, "Pocket World in Figures," 2006 Edition.

In the global marketplace, investment and entrepreneurs will seek out geographies that provide the greatest return potential and optimize capital and time. There are numerous emerging economies that will benefit from this trend (and suffer), in particular China and India represent enormous potential for investors and entrepreneurs.

In just 27 years, China has grown its economy from $44 billion to $1.7 trillion or a CAGR of 16%. China is now the 7th-largest economy and is projected to be the world's largest in 50 years. Over 10,000 IPOs are expected out of China in the next 20 years.

To highlight the potential, China is already the #1 handheld cell phone market in the world with nearly 280 million users, but this is just 21.5% market penetration. To contrast, in Ireland 88% of the population has a cell phone, but it's a country with just 4 million people!

Source: The Economist, "Pocket World in Figures," 2006 Edition.

India also represents an important geography. India is the second-largest English-speaking country in the world and the largest democracy. The confluence of a growing population (it's expected to be the largest country by 2050), huge increase in middle class, strong education system and significant foreign investment will fuel opportunities for decades to come.

The market saw "green" last week with continued positive action in stocks. For the week the Russell 2000 was up 2.0%, the NASDAQ advanced 1.8% and the DOW reached an all-time high and was up 1.5%.

Market breadth was good with advancers beating decliners 2 to 1 and companies making new highs was 787 versus 263 making new lows.

The trends are your friends and we remain bullish.

Note: In the ThinkThoughts dated 10/02/06, the legend for Chart #2 should have read:

Posted by Michael T. Moe at 07:12 PM | Comments (0)

October 02, 2006

The Quiet Bull

You would think that with the DOW finishing its third best quarter in 9 years (+4.7% this quarter) champagne toasts and caviar dreams would be the order of the day with investors.

Moreover, the DOW is now up 9% for the year approaching the seven-year anniversary of the popping of the Bubble of all time (our friend Joe McNay of Essex called it the "double bubble"). Finally, the DOW has clawed its way back to where it was in January 2000.

The S&P 500 had an even better quarter, advancing 5.2%, and is 15% from its January 2000 high-water mark. NASDAQ, up 4% for the quarter, is still 55.0% below its March 10, 2000 apex.

In fact, stocks have been on a quiet, steady march for nearly 4 years. Since the market bottom October 9th, 2002, there hasn't been a market "correction" (defined as a 10% or greater drop in stock prices). In this period, the DOW is up 60.3%, the S&P 500 is up 72.0%, the NASDAQ is up 102.7% and the Russell 2000 is up 121.9%.

Yet mutual fund managers aren't on the cover of Time or Newsweek (they aren't even on the cover of Business Week!) Hedge fund managers are "rock stars" within the investment community and with real-estate brokers in Greenwich, but to the general public they are as important as the Dalai Lama (you know they are supposed to be cool but you don't know or care why). The meltdown of Amaranth was big news in the Wall Street Journal - not the USA Today. Many more people would care if something happened to Johnny Depp than Pirate Capital.

Why?

Well for starters, except for the most extraordinary of times, stocks for most people aren't that interesting. Sports are interesting. Hollywood is interesting. Even the weather can be interesting.

And stocks for many people that found them interesting for a brief period of insanity bring back a painful memory, like a bad trip to the dentist or worse. Following the stock market crash in 1929, "stocks" were four letter words for a generation of investors. Stock yields from dividends for blue-chip companies were often higher than bond yields because of the risk premium associated with them. T. Rowe Price created a money management colossus by benefiting from investors' risk aversion and loading up on growing businesses that also happened to pay a fat dividend.

While stocks in general have mainly recovered from the new millennium crash, growth equities, proxied by the NASDAQ, are still out of favor. 4 letter stocks are 4 letter words for John Q. Public.

Source: FactSet, ThinkEquity Partners.


While it's fair to call me a "perma bull" on growth stocks - over time, earnings growth does drive stock prices - there are often extended periods where this group underperforms. We've generally been in that environment since March of 2000.

We now see a variety of factors that gives us optimism that growth stocks are entering their time in the sun. These reasons include:

1) Growth stocks are due for outperformance. The Russell 2000 Value index has outperformed the Russell 2000 Growth index by 122% since July 26, 2000.

Source: FactSet, ThinkEquity Partners.


2) Technology is the driver of the growth economy and technology fundamentals and spending are showing an up tick.

3) Buyouts in the technology and health care sectors fueled by the flood of capital in private equity and hedge funds will provide downside protection and increase multiples.

4) The wave of strategic M&A activity in software, semiconductors, new media, biotech, life sciences and services provides an additional catalyst for upward valuation bias and downside protection. It also shows managements are optimistic and want to play offense.

5) Money flows out of cyclical energy issues into secular growth companies.

6) Continued negative sentiment evidenced by all time high short interest in NASDAQ providing the "wall of worry" stocks often climb.

7) Positive market reaction to recent IPOs of "future" stories such as DivX and Riverbed Technologies.

8) Valuations which support meaningful upside versus growth potential.

9) An interest rate and inflation environment which is in check. This coupled with a slower growth overall GDP outlook for 2007 makes true growth companies earnings that much more valuable.

10) The SEC coming out last week adopting the advisory panels recommendation to provide relief for small companies from Sarbanes Oxley.

All this, and I believe we are in an increasingly great environment for growth companies.

Last week, stocks of all types performed well led by the NASDAQ 100 which advanced 2%. Winners beat losers by a 2 to 1 margin. Companies making new highs versus new lows was a healthy 652 to 265.

Posted by Michael T. Moe at 12:18 PM | Comments (0)