June 27, 2014
“And ye shall hear of wars and rumors of wars: see that ye be not troubled: for
all these things must come to pass, but the end is not yet.” – Matthew 24:6
Tomorrow is the 100th anniversary of the assassination of Archduke Franz Ferdinand in Sarajevo. The assassination sparked the July Crisis, which eventually led to the First World War. Once the war started, the New York Stock Exchange decided to close down. No one knew the war would last for so long. Soon traders were meeting outside the exchange to do their business (traders never change, do they?). After four months, the NYSE relented and reopened for business.
One hundred years ago today, the Dow Jones Industrial Average was around 80 (it’s not exactly comparable with today’s index, but close enough for our purposes). Since then, the index has doubled, doubled again, doubled again, and doubled four more times — and is close to doubling a fifth time. Last Friday, the Dow reached a new all-time high and came within 22 points of cracking 17,000.
It’s been a good century for investors. Of course, 100 years is, shall we say, a rather optimistic time horizon for an individual investor, but my point is to underscore the power of the long term. That’s what stock investing is all about. To quote the Rolling Stones, “time is on my side.” Time is on the side of all disciplined investors, and that was true even when the world was heading towards disaster.
Fortunately for us, we live in a far more peaceful world, but the lessons are the same. In this week’s CWS Market Review, I want discuss the latest mega-deal for one of our Buy List stocks. Oracle (ORCL) is on the merger warpath again, and this time, they’re buying Micros Systems (MCRS) for $5.3 billion.
I’ll also discuss the latest plunge in Bed Bath & Beyond (BBBY). The home furnishing store disappointed Wall Street yet again. The stock dropped more than 7% on Thursday. Here’s the thing: They actually reaffirmed their full-year earnings. I’ll have full details in a bit.
We’ll also look at the horrible GDP revision for Q1. It turns out the economy had its worst quarter in five years. Fortunately, the news looks much better for the rest of this year. I’ll tell you what it all means, but first, what the heck’s going wrong with Bed Bath & Beyond?
Bloodbath & Beyond
After the close on Wednesday, Bed Bath & Beyond (BBBY) reported Q1 earnings of 93 cents per share. This was one penny below Wall Street’s forecast, although it was within the company’s guidance of 92 to 97 cents per share. Quarterly sales rose 1.7% to $2.657 billion, and the all-important metric for retailers, comparable-store sales, was up 0.4%.
In my opinion, this was a mildly disappointing earnings report, but it’s far from a disaster. The market, however, was very displeased. Shares of BBBY dropped as much as 10% on Wednesday, and this came at the top of a very bad six months for them. The stock eventually closed the day at $56.70, for a loss of 7.2%. That’s its lowest close in 16 months. Yuck!
I realize I’m starting to sound like a broken record, but the problems Bed Bath & Beyond is having aren’t nearly as severe as the market’s behavior suggests. Yes, they’re in a rough spot, but they’re still very profitable. Unfortunately, this is how markets often behave — a stock can either do nothing right or do nothing wrong. Wall Street traders don’t exactly have a dimmer switch. The truth is that BBBY is a sound company that’s working through some issues. The company has been making investments to modernize its systems, and that’s cut into profit margins. They’ve also been hurt by a weak housing market. These are temporary factors.
Let’s look at its guidance. For Q2 (June, July, August), BBBY sees earnings ranging between $1.08 and $1.16 per share. Wall Street has been expecting $1.16 per share. That probably explains much of Wednesday’s sell-off. But here’s the important part. They kept their full-year guidance exactly the same, calling for a “mid-single digit” increase in earnings-per-share. BBBY made $4.79 per share last year. If we take “mid-single digits” to mean 4% to 6%, that works out to a range of $4.98 to $5.08 per share. In other words, the stock is now going for roughly 11 times forward earnings.
Here’s another important fact. Compared with last year’s first quarter, BBBY has 7.2% fewer weighted shares outstanding. In English, they’re gobbling up their own stock at a rapid clip. Unlike so many other companies, BBBY is truly reducing their share count. Plus, the company also has zero long-term debt. I apologize for the volatility, but I think this is one worth sticking with. This week, I’m lowering our Buy Below to $61 per share.
The Economy Dropped by 2.9% in Q1
Wall Street was stunned this week when the government dramatically lowered its report for Q1 GDP growth. The Commerce Department now says that the economy shrank by 2.9% in the first three months of this year (note that GDP figures are annualized and after inflation). That’s the worst quarter for the economy in five years.
Two months ago, the initial report for Q1 GDP showed growth of 0.1%. Last month, that was revised to a drop of 1%. Now it’s down to -2.9%. That’s the biggest downward revision between the second and third reports since records began nearly 40 years ago.
Although these numbers are shocking, I’m pretty skeptical. I’m not saying they’re wrong. I’m just saying…it’s complicated. First, let’s remember that this data is a bit old. It’s for Q1, which was January, February and March, and we’re nearly done with Q2. Also, a huge part of the downward revision had to do with healthcare, since Q1 was the quarter of the Obamacare rollout.
But my major concern is that the GDP numbers don’t line up with more recent data that hint at much stronger growth. Last week, I mentioned that some of the regional Fed surveys are quite optimistic. The trend in jobs is slowly improving. We’ll get the June jobs report next Thursday. Several other metrics like consumer confidence, the ISM reports and industrial production have also looked good. If the economy were truly deteriorating, we would see confirmation in other places. The key weak spot continues to be housing (and by extension, places like BBBY), but that should improve as well.
As investors, our concern isn’t the macro economy but corporate profits. Monday is the end of the second quarter, and soon Corporate America will report earnings results. What’s interesting is that this earnings season will be the first one in several quarters in which we haven’t seen forecasts lowered just before earnings came out. As we all know, Wall Street loves playing the game of guiding analysts lower, then beating those much-reduced expectations.
This time, earnings forecasts have come down some, but not much. The consensus on Wall Street is for the S&P 500 to report earnings of $29.40 for Q2 (that’s an index-adjusted figure). That’s down about 2.5% in the last year, which is very small compared with recent quarters. Typically, analysts overestimate early on, and the forecasts are gradually pared back as earnings season approaches. For now, Wall Street expects full-year earnings of $119.60 for the S&P 500, which means the index is going for about 16.4 times this year’s earnings. That’s slightly on the pricey side, but nowhere near bubble territory.
Next week we’ll get important economic reports that should shed some light on how well Q2 went. Next Tuesday, the June ISM report comes out. The ISM reports have improved for the last four months, and I expect another good number. Due to July 4th´s falling on a Friday, the jobs report for June will come out next Thursday. I think we’ll continue to see improvement of 200,000 to 250,000 jobs. The bottom line is that the Q1 GDP report is an outlier, and it’s old news. The recent data suggest that the economy is poised to grow at 3% annually for the next few quarters.
Oracle Buys Micros for $5.3 Billion
We’ve had a rash of deals on our Buy List. First, DirecTV (DTV) and AT&T (T) decided to hook up. Then Medtronic (MDT) did a big deal with Ireland’s Covidien (COV). Now Oracle (ORCL) announces it’s buying Micros Systems (MCRS) for $5.3 billion.
The deal is for $68 per share, which is a modest premium. However, shares of Micros jumped the Tuesday before last, when initial reports of a deal came out. In the last few years, Oracle has been a merger machine. Over the course of a decade, it has shelled out more than $50 billion to buy about 100 companies. Apparently, Larry Ellison isn’t done. This is Oracle’s biggest deal since they snatched up Sun Microsystems for $7.4 billion four years go. In the last 16 months, Oracle has announced 11 deals.
Micros, by the way, has been an amazing performer. In 1988, the shares were going for just 12.5 cents. The buyout price is 544 times that. Not bad for 26 years. The Micros deal is expected to close by the end of the year. Remember, of course, that any deal has the potential of falling through.
Last week, Oracle missed earnings by three cents per share, and the stock got punished. Fortunately, their guidance was a little better. I think this Micros deal is good for Oracle, and I’m pleased to see them on the offensive. Oracle remains a good buy up to $44 per share.
Buy List Update
This Monday is the final day of trading for the first half of the year. I’ll have a complete review of how the Buy List‘s performing. But before then, I can tell you that the Buy List is currently up 1.96% for the year — less than the S&P 500, which has gained 5.89%. Those numbers don’t include dividends. As I’ve mentioned many times, our Buy List has beaten the S&P 500 for the last seven years in a row, and it looks like our streak may be in jeopardy this year. I’m not ready to concede just yet, nor will I depart from our proven strategy, but I want my readers to know exactly where we stand.
Big losers like Bed Bath & Beyond have weighed heavily on our Buy List this year (BBBY is close to a 30% loser YTD). But we’ve also had some bright spots recently. Microsoft (MSFT), for example, just made another multi-year high on Wednesday. Wells Fargo (WFC) is also close to a new high. Ford Motor (F) has shown some strength lately. The automaker just hit an eight-month high on Thursday, and I think it has more room to run. Some of the top bargains on our Buy List include AFLAC (AFL), Ross Stores (ROST), eBay (EBAY) and Cognizant (CTSH).
That’s all for now. Next week will be an unusual week, since July 4th falls on a Friday. The stock market will be closed on Friday, and it closes at 1 p.m. on Thursday. Expect very light volume, however, since it’s the start of the month. We’ll also be getting the big June jobs report on Thursday morning. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!
Named by CNN/Money as the best buy-and-hold blogger, Eddy Elfenbein is the editor of Crossing Wall Street. His free Buy List has beaten the S&P 500 for the last seven years in a row. This email was sent by Eddy Elfenbein through Crossing Wall Street.
2223 Ontario Road NW, Washington, DC 20009, USA