WASHINGTON, Dec. 16 (UPI) -- Three times in the past two years, in January 2001, December 2001 and June 2002 I have listed three stocks that in my opinion were "Bear Food" -- more likely than most to decline sharply. The time has now come for a fourth such meal, and for a review of the first three.
My definition of "Bear Food," set out in the first piece, is a stock that, at some point in the three years following its selection, trades at 80 percent below its price on the day on which it was selected. None of the stocks in the three Bear Food portfolios so far have met this criterion (there is just over a year left for the first portfolio) although several have, at one point or another, traded at more than 50 percent below their initial price.
The overall performance of the three outstanding portfolios in the six months since the last review, however, is an alarming support datum for the Efficient Market Hypothesis, suggesting that this stock picker, at least, may be incapable of better than random performance against the market. Of course, just as it is very difficult for fund managers to beat a roaring bull market, so it is equally difficult for Bear Food stock pickers to beat a slumping bear market. The Standard and Poor's 500 Index was down by 17.3 percent during the period, from 1,075 to 889, which is a very tough benchmark indeed in so short a period. Even so, the Bear Food portfolios as a whole were down only 12.9 percent, missing the S&P by more than 4 points.
However, I'm not ready to hand my portfolio picking skills over to a monkey with a dartboard quite yet. Over the full two-year period, a portfolio that was invested in the first Bear Food portfolio, and then split between subsequent portfolios as they were created would have been down 41.2 percent, compared with 34.1 percent for the S&P 500, so the overall performance remains good, better on the downside than almost all professional fund managers on the upside. There are, too, some extenuating factors, which I'll look at portfolio by portfolio.
The first portfolio, that of January 2001, contained three stocks: Cisco, Marriott and Goldman Sachs. Of the three, Cisco has provided most Bear excitement, dropping from $34 when it was picked to a low of $8.12, at which point it was just $1.32 from becoming the first official Bear Food. With more than a year to go until the end of this portfolio's life (January 2004) I remain confident that Cisco will make it -- the stock is still way overvalued at $13.40, while its reported sales and earnings remain strangely buoyant in an industry that is nothing short of a disaster.
The other two stocks in the first portfolio, Marriott and Goldman Sachs, are both down slightly less than the market (Marriott by 28.9 percent to $32.71 and Goldman Sachs by 30.4 percent, to $73.10, compared with a 34.2 percent drop for the market), but I continue to expect them to outperform the market on the downside going forward. Consumer spending has held up very well, and interest rates have dropped sharply; both have buoyed Marriott's share price, but may not continue to do so much longer. Goldman Sachs has benefited from a "flight to quality" from other investment banks. The investment banking business is however in a huge cyclical decline, and I expect both credit problems and sheer lack of revenues to affect Goldman Sachs further in 2003.
The second portfolio (December 2001) Wal-Mart, Home Depot and eBay has performed badly for a Bear, there is no two ways about it -- down only 18.3 percent over the year compared with a drop of 22.7 percent for the market as a whole. However there is a simple reason for this: all three companies are to some degree retailers, and U.S. retail sales have held up remarkably because of the continued decline in interest rates and the huge spike in home mortgage refinancing.
Of the three companies, eBay has performed in the most insulting fashion, to a Bear stock picker, by actually rising over the year, by 3.7 percent. Its business continues to perform well, and there continues to be a strongly favorable atmosphere in the market towards those Internet companies that can attain and keep profitability. Of all the nine companies on the three Bear Food portfolios, this is the one I am least happy to have selected as Bear Food, although I expect there to be a sharp sell-off and downward re-rating of the company at some stage in the next 12-18 months.
Home Depot, conversely, has performed very well from a Bear viewpoint, being down 47.2 percent over the 12 months, in spite of the huge volume of "money-back" home refinancing, much of the takeout allegedly to be spent on home improvements. The poor performance of the stock reflects two things. First, shopping at Home Depot is an unpleasant experience for all but the most dedicated DIY enthusiast; the stores are too big, poorly organized and inadequately re-stocked, and there is little if any skilled help available to the buyer in a product area in which skilled help is essential. Second, the tsunami of mortgage refinancing, whatever the borrowers told the lenders at the time, has mostly not been spent on home improvements, but instead frittered away in short-term consumption -- this bodes ill for both the U.S. economy and Home Depot going forward. I'm pretty confident that in the two years remaining for this portfolio, Home Depot will become true Bear Food by trading below $10 per share.
Wal-Mart has dropped only 11.33 percent in the year, and has undoubtedly benefited by the bankruptcy of Kmart, by continued strength in consumer spending, and by a move towards discount shopping during the recession. With the exception of the last factor, I expect these influences to disappear in 2003, and Wal-Mart to become more satisfactorily Bearish.
The third portfolio, DaimlerChrysler, Fannie Mae and Berkshire Hathaway has slightly outperformed the market downwards during its six months of life, dropping 19.9 percent compared to the S&P 500's drop of 17.3 percent.
This has been almost entirely due to a satisfactorily Bearish performance by DaimlerChrysler, down 36.7 percent in the six months from its original price of $50 per share. I expect this drop to continue, with even the company's flagship Mercedes franchise being adversely affected by weak economic conditions in its homeland of Germany and strength of the euro against the dollar, making U.S. sales from a European base unprofitable.
Fannie Mae has continued to benefit from the huge volume of mortgage refinancing, which of course provides the company with one-off fee income up front. At one stage, it appeared that long term interest rates had dropped too far too fast, leaving Fannie Mae vulnerable to refinancing of its existing mortgage portfolio, while its debt costs remained fixed. This danger appears now to have abated, but once the housing bubble bursts, which I fully expect it to do far before this portfolio's end-date of June 2005, I expect Fannie Mae to begin suffering a high level of credit losses -- at which point, being over-leveraged, it will be in trouble.
Berkshire Hathaway is down only 7.5 percent since June, compared with a market down 17.3 percent. Since the company is basically a leveraged investment portfolio, I expect its next annual valuation, due early in 2003, to be a highly unattractive one. At that point, the company may cease to sell at 200 percent of Net Asset Value, and the price drop could be severe.
Turning now to the future, my fourth Bear Food portfolio consists as usual of three companies, Capital One Financial Corporation ($30.20 Friday night), Amazon.com ($22.18) and Boeing (31.40).
Capital One is the leading credit card issuer to the sub-prime portion of the consumer market. Only 39 percent of its revenue is represented by interest; the remaining 61 percent is fee income, in which area Capital One is exceptionally aggressive. Of course, recent years have been very kind to Capital One, and this is reflected in its earnings, which have risen consistently. The company's P/E ratio is not inflated, only just over 8 times, reflecting the top-of-cycle nature of its current earnings, while its share price represents just under twice its net asset value. However, Capital One's allowance for loan losses increased from $840 million in December 2001 to $1,595 million in September 2002, with loan loss provisions in the latest quarter of $674 million, more than 10 percent per annum on the company's loan book of $26 billion. With consumers already over-borrowed, no amount of spurious late charges on its credit cards is going to cover this kind of default rate; the company is in deep trouble in the slightest economic downturn.
Amazon.com was the darling of the Internet bubble; its founder Jeff Bezos was Time magazine's Man of the Year in 1999. However, the company has yet to make a profit in a full year (it did so in the fourth quarter of 2001, and should again in this quarter) and its growth rate has now slowed to an uninteresting trot, with sales expected to be up about 10 percent to 15 percent in 2002 compared with 2001. The company is consistently cash flow negative, even in its annual profitable fourth quarters. While there is clearly a viable business model in retailing of books and CD/DVDs via the Internet, it is not at all clear that Amazon possesses any advantages apart from possibly temporary name recognition over established book and music retailers, who can compete with Amazon simply by setting up a Web site and a mail order operation. It is thus unclear whether Amazon.com will ever make a profit, but even if it hits its 2003 target of 24 cents a share on the nail, it is trading at over 80 times next year's earnings, for a company growing at 10 percent per annum. The company has net worth of minus $1.48 billion, and a market capitalization, even at one-tenth the peak stock price, of $8.6 billion. To put it mildly, it doesn't look like paying a dividend anytime soon.
Boeing's main business, commercial airplanes (55 percent of revenues) is one for which there is very little to be said, and the company is currently steadily working its way through an order backlog that is unlikely to be replaced. Its last revolutionary new product was the Boeing 747, introduced in 1970, and it has steadily been losing market share to the more innovative (albeit at the expense of European taxpayers) Airbus. It has a $4 billion exposure to the now-bankrupt United Airlines, and its most reliable customers, the U.S. airlines, appear very likely to follow each other one by one into Chapter 11, causing Boeing both credit losses and deepening gloom in its long-term outlook. Boeing is only in better financial shape than in 1970, when it almost went bankrupt, because it has very little in the pipeline in the way of new products -- its only semi-revolutionary development, the just-subsonic Sonic Cruiser, appears likely to die for lack of customer orders. Boeing's military business, 25 percent of revenues, is of course a growth area, but even here the Joint Strike Fighter contract, the largest for the next several decades, was lost to Lockheed. The company is trading at 14 times earnings, and 2.5 times Net Asset Value; even if it contrives to survive there is plenty of room for it to become Bear Food in the oncoming downturn.
As before, three well-respected companies, but all, for different reasons, likely to become Bear Food before December 2005.
(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
