Reading the Tea Leaves and Cerner

Reading the tea leaves, I notice the following
Alcon – Down 5% in just 3 days. 7% off its high. No news amid heavy trading.
Gilead – 6% off its high. No real news and trading is formidable. Looks like we are hovering between $50~$54 until real news.
Cerner – I mentioned last week that Cerner looked like it was slowing down. We hit our stop loss of $93. Cerner hit a high of $98 before getting downgraded and falling ~10%. We may buy back in if there is more weakness. We netted 5.7% on this investment.
JetBlue – Lately it has been touching $19 and backing off. I take that as a sign of better things to come.

In general, I am seeing a lot of softening in all stocks that I track.

Apple and Hansen puts – Well, I waited too long to move. Hansen was down $7 this morning. Apple was downgraded yesterday.

Love Apple, Hate the Stock Price
Before the iPOD, before music went digital with flash players, there was the Walkman. An estimated 200M units were sold worldwide over 10 years until sales began slipping after market maturation. Sales continue today around 10M units annually.
I believe price is the biggest obstacle to reaching 200M unit sales. Walkmen are <$100, iPODs are $300~$400. They would be cheaper but they include an I-AM-COOL tax by Apple.

I believe Apple will crack 10M unit sales this holiday quarter. That makes it close to 45M units sold to unique users (there are a few million multiple or repeat users). I believe that the high-end market is maybe 150M users, and Apple has already hit ~30% of that market. If sales continue at the 10M+ quarterly pace, Apple will have saturated the market in 2 years. That also assumes that no-one else will offer a rival product.

If Apple can drive greater convergence so that the iPOD is more than a mobile audio player, then there is more opportunity. With a tiny screen and weak battery life, I don’t see the video iPOD as a portable DVD player killer. But as a DVD & TV library , there is a lot here. In the next year, a 100GB iPOD will be standard, with 150GB+ on the horizon. That’s enough for a complete music and DVD library (100~130 movies). Throw in TV shows, and you can replace the TiVo. Now is it worth $400?

Well, that’s the problem – after awhile, iPOD really is just a portable hard drive with a nice GUI. Anyone can enter the market. A 1.8” 60GB hard drive retails for $130 today. That $400 iPOD is probably $150 in parts and dropping.

To drive value, Apple is driving content access. Hollywood and TV land are playing ball. But as soon as another player enters, it will be a free for all. And people will stop lining to pay Apple’s I-AM-COOL tax.

Other stocks

I spent some time looking at other stocks, many of them suggested by folks reading this blog.
Here are some toughts

GYI - Why didn't we get back in? GYI crashed 11% and rebounded after announcing that their sales for the year would be 0.3% lower than expected and next years sales would be 3% lower than expected. In other words they said that they expected 15% sales growth and ~57% earnings growth.
The stock rebounded strongly – closing just 2% below it’s high. And trading volume was 2X the average trading volume.
I think some of this is a bounce and frankly, I'm concerned about the sales deceleration. We want upside surprises, not downside surprises

Sunrise Senior Living (SRZ) – Primarily US based assisted living for the aged, especially those needed medical/nursing help (like alzheimers). It is the largest operator of senior living communities since it bought the Marriott’s. Our senior citizens are living longer and have a lot of wealth. Upscale assisted living facilities should do quite well, especially luxury developments. Sunrises’s recent announcement that it will build a 16 acre facility was followed by the news that 35% of the condos have already received deposits.
The Good:
PEG: 0.8
P/S: 0.9
Revenue & Earnings growth: ~25%

The Bad –
Slender margins
Debt/Equity: 0.4
However, compare this to a hotel chain like the Hilton. Debt/Equity is 1.4 and margins are comparable. I lik ethem for a long term play and would buy on weakness.

Intuitive Surgical (ISRG) – This is another winner. They make robotic surgical systems that are catching on. They are rising now based on upside expectations. They have a fine history of upside surprises and they have smashinggrowth: 78% sales y/y and 230% earnings Y/Y. They have done an excellent job of keeping SG&A flat while raising sales. But I don't like the 20 P/S. Still, this one is a contender.

Salesforce.com (CRM) – The stock price growth looks great but I don’t like the price. Even beating next year’s earnings expectations, and doubles earnings, it’s would have a forward P/E of 65 P/E. Yikes – too pricey.
Moreover, their earnings growth has been less stellar than would appear – the recent 300%+ gain included a one-time tax gain. Excluding this event, the earnings fall back in line with sales growth: ~70%. And the competition is growing....

Motorola (MOT) - Motorola’s stock price has done well this year: up 43%. Most of this is from renewed energy with it’s cell phones, especially the RAZR. I don’t like them for a few reasons:
Decelerating profit. While Revenues are growing 7%~8% sequentially, gross profit is decelerating from 10% Q3/Q2 to 5% Q4/Q3.
Me too - It is easy to copy the RAZR and Samsung et al will do so.
Flash in the pan – The iTunes phone flopped. The PEBL is also lame. Motorola does not really have a solid follow-on
If you want a semiconductor, you can do much better with Marvell.

Indian outsourcing. Is it too late or will it continue to surge? I think it will continue at a slower pace.
The big wave is ending. I have no proof for this, but I would bet that almost every Fortune 1000 company has outsourced what they can or is in the process of completing it.
The reality is that only a subset of jobs can be outsourced in a cost effective manner. There are some areas of growth, but not as substantial as offloading a billing department.
I would not write off these companies. They will find areas of growth. I just think that the bulk of opportunity has been tapped already. So no Infosys or other cousins.

Updated Portfolio

Today we purchased:
242 shares JOYG $55.76
55 shares ACL $144.90
211 shares MDR $42.74

Portfolio Changes

First, a revision of the Week 5 performance. The Friday ended a lot better than it began, as follows
Week 5 Performance
Dow -0.76%
S&P -0.4%
LIVEROCKET -2.33%

Performance since inception (Nov 4th)
Dow 1.78%
S&P 3.3%
LIVEROCKET 7.67%
-------------------------------------------------------------
We were cashed out of GYI, DESC, & PWR and turned $29,795 into $31,015. That’s a 4.1% gain in 5 weeks.

I continue to believe that the market has strength. I propose we use the cash as follows:
1. Reinvest $26K in equities
2. Purchase $5,015 puts in either Hansen or Apple at a future date
For the equities, I have considered 40+ stocks. I like the following best:
MDR - $9K
JOYG - $9K
ACL - $8K

We were in alternative energy (DESC) and we continue to need an energy play. This time 2. I have been looking for a good natural gas and coal play. Oil makes natural gas and coal much more profitable and this drives exploration and extraction. Wintertime increases energy consumption as well, adding near term benefits. I also like natural gas because it is spreading in use, making it a long term play as well.
However, I hate the daily oil-driven price fluctuations. And gas stocks are already leveling off. That’s why I prefer to find a natural gas/coal play without the volatility. The answer: equipment.

McDermott Industries (MDR) –
MDR operates and equips gas lines in the Caspian Sea, the Persian gulf, and the gulf of Mexico as well as some side businesses in superfund cleanup sites.
A few more reasons why I like the company
1. Accelerating Sales: Backlog has grown 30% to $1.7B (annual sales last 4 quarters were $1.9B)
2. Accelerating Sales pt 2: Last quarter’s business was slowed by hurricane Katrina and aftermath. Hurricanes have passed
3. Accelerating earnings: Sales have grown 12% Y/Y but earnings have grown 220%, with triple digit quarterly upside earnings surprises EVERY QUARTER for the last 4 quarters (and beyond).
4. Accelerating earnings pt 2: Babcock & Wilcox (a subsidiary) was completely written down due to burgeoning asbestos lawsuits is coming out of bankruptcy in 2006 and will add earnings
5. Low P/E: If earnings are kept flat with last quarter, the company has a current P/E of 13.

Joy Global (JOYG) - Manufactures mining equipment for coal mines. Surging interest in coal has driven sales higher: revenues up 37% and earnings up 89%. A stock spilt and dividend increase is driving near term stock price, but we will get in anyway

I like medical as a sector play during rising interest rates and possible economic slowdown on the horizon.
Alcon (ACL) – Another Medical company (we already have GILD & CERN).
ACL manufactures multiple products for the eye (something that fits well with aging boomers whose eyesight will continue to erode). Many well known products are a LASIK eye treatment and Opti-free contact lens solution. Margins have increased while the upside surprises have held consistently. They also offer a whopping 47% ROE.
I am concerned about the slowdown in LASIK machinery sales next year, and this is only a short term play. Indeed, it is richly valued, but I think the expanding earnings justify this for a short term play – we will ride the momentum of earnings season.

If ALC continues to perform, fine. If not, I have my eye on SRZ for a more long term play.