The Tycoon Report

So You Think You Can Pick a Stock?

Monday, April 23, 2007 | Jason Jovine

I have been fortunate in that every single stock that I have picked for you all since working with Tycoon has gone higher. 

As I have said 100 times, I will not be right 100% of the time, but my education and experience allow me to be right more than I am wrong.  And even if I am wrong, we will live to fight another day.  In other words, even if I am "wrong," I make sure that I buy companies that have a significant margin of safety which will prevent mistakes from turning into disasters, as I have often seen happen.  In order to decrease your chances of making mistakes, you have to study what you are thinking about investing in very carefully.

I know that there are a plethora of "experts" out there who give people financial advice, and it is really frightening to me.  Unlike many other professions (e.g. doctor or lawyer) for which a license and years of education and experience are required, anyone can claim to be a financial guru.  To me, it is hilarious to see.  Let me make something clear right now:  there are exceptions to every rule.  I am speaking in general terms here.

I thought that I would take this time to show you all a real financial checklist that a very well-known analyst on Wall Street uses before he even thinks about telling people to invest their money in one of his ideas, and then you could see how well your checklist compares to his.  In other words, do you really do your homework before you invest your money, or do you usually invest blindly?

The financial checklist BEFORE buying a stock ...

INDUSTRY KNOWLEDGE SHOULD COME FIRST!

Economic Sensitivity
1. Where in the cycle does the industry excel?
2. How has it performed in previous cycles?

Competitive Forces

1. Barriers to Entry
a) Capital Requirements
b) Switching Costs
c) Access to Distribution
d) Government Policies

2. Pressure from Substitutes
a) Ceiling on Prices
b) Elasticity of Demand
c) Head to Head v. Industry

3. Powerful Buyers/Suppliers
a) Threaten backward/forward integration

4. Competitive Strategies
a) Low Cost Producer
b) Segmentation/Differentiation
c) Niche Producer

Demand Environment
1. Elasticity of Demand
2. Speed of Product Innovation
3. Rate of growth

Markets Served

Growth
1. Cyclical, Continuous
2. Industry Maturity
3. Effects of recession/slow recovery

Industry P&L
1. Key Sensitivity Points to Profit Growth
2. Revenues- Price or Unit
3. Manufacturing Costs
a) Commodity exposure
4. Fixed costs
5. Variable costs

Valuation
1. Historical for group
2. Variation in different economic

COMPANY SPECIFIC RESEARCH QUESTIONS NEXT!

History: 5-yr numbers
1. 10K, Q and notes in detail
2. Mergers/Acquisitions - exact impacts
3. Off Balance sheet items - derivative use, retirement costs, employee options

Position in Industry
1. Biggest Competitor
2. Head to Head v Industry
3. Competitive Advantage

Markets Served

Growth
1. Cyclical, Continuous
2. Will it continue
3. Effects of recession/slow recovery

Supply/Demand

Outlook
1. 12 months/5 years
2. Why does the company want to be in this business?

Special situations/earnings interruptions
1. Mergers/Acq
2. Restructurings – effects/payback expectations
3. Discontinued operations

Where is the leverage
1. Operating: fixed v variable costs
2. Value Added
3. Costs
4. How to manage downturn

IRR

Pricing v Volume (elastic/inelastic)

Valuation

1. CF
2. P/E, P/E based on growth
3. Multiple of Book and/or ROE
4. Asset Value (potential break ups)

Price support/bottom level

What will make stock outperform (Catalyst)?

Why would someone short this stock?

What would make you change your outlook for this company?
1.What can the company do?



Take a deep breath ...

Don't worry.  You will not be tested on this stuff. 

I just want you to see how difficult it truly is, as well as how much homework you really need to do, to make Warren Buffet's money.  All of that being said, I hope that you all know by now that we here at Tycoon listen to you all.  In other words, whether it was the ETF product last week or our forthcoming products in the future, we listen to what the majority of you seem to want.  We try to produce a supply to meet whatever it is that you all are demanding.  Warren Buffet uses value investing to invest.  Does it interest you to learn this as well?  Out of that checklist above, ask yourself honestly on a scale of "0-10", "10" being that you get answers to all of those questions and "0" being that you do not get answers to any of them, where you fall on that scale.  PLEASE BE HONEST!!!

Do you take your money as seriously as you ought to?

Until the next time, folks, spend your hard-earned money wisely.





Jason Jovine
Contributing Editor
The Tycoon Report


Mark Your Economic Calendar: What's ahead for the week of April 23, 2007
Tuesday, April 24


10:00 - Consumer Confidence (for April): Consensus 105.0

Big Picture: The index reached a new five high in February.  Low long term yields and the tight labor market support a resilient economy, as volatile energy prices leave some bounce.  The index continues on an upward longer-term path.  Conference Board's survey is far larger and more business heavy than the household-heavy Michigan sentiment index.  The index is presumed to provide an early read on consumer spending, which is far better previewed through interest rates and income growth.

Implications: The Conference Board conducts a monthly survey of 5,000 households to ascertain the level of consumer confidence.  The report can occasionally be helpful in predicting sudden shifts in consumption patterns, though most small changes in the index are just noise.  Only index changes of at least five points should be considered significant.  The index consists of two subindexes -- consumers' appraisal of current conditions, and their expectations for the future.  Expectations make up 60% of the total index, with current conditions accounting for the other 40%.  The expectations index is typically seen as having better leading indicator qualities than the current conditions index.

10:00 - Existing Home Sales (for March): Consensus 6.50M

Big Picture: Home resales appear to be turning stronger, with gains in four of the last five months, as the level is now 7% above the September cyclical low.  Lower mortgage rates and prices help improve affordabiity, and thus demand.  Unsold inventory reached a 7.4 month high in October and is retreating.  The large stock of supply is leading the price decline.  Median prices have shown annual declines since August and stand -2.3% yoy lower in February.  Existing sales include condos/coops, which make up about 1/8 of the total.  The National Assoc of Realtors expects existing home sales to bottom in the second quarter.  The following rise should be very modest.

Implications: The name speaks for itself: this report provides a measure of the level of sales of existing homes.  The report is considered a decent indicator of activity in the housing sector.  Housing starts precede this report each month, but starts are a supply rather than demand-side indicator.  Existing home sales precede the other key demand-side indicator of housing -- new home sales -- thus boosting the visibility of this report.  Sales are highly dependent on mortgage rates, and will tend to react with a few month's lag to changes in rates.  Sales are also determined by the level of pent-up demand for housing -- immediately after a recession, sales are typically quite strong due to the demand which accumulated through the recession.


Wednesday, April 25

8:30 - Durable Orders (for Mar): Consensus 2.5%

Big Picture: Durable goods order growth has turned to an annual decline (-0.8% yoy) as business capital investment stalled since mid 2006.  Flush corporate balance sheets, high capacity use and rising exports remain strong underlying factors, as reduced demand tied to auto and housing add to weak capital investment.  Now business confidence plays a larger role in directing the pace of capital investment and the strength of the manufacturing sector.  A sustained downturn seems unlikely, but quite possible, given the roaring pace in early 2006 and record corporate profits.  Inventory downsizing adds to the weak demand to leave weak production growth.  Orders provide the outlook which has turned from stunning a year ago to declining currently.

Implications: The durable orders release measures the dollar volume of orders, shipments, and unfilled orders of durable goods (defined as goods whose intended lifespan is three years or more).  Orders are considered a leading indicator of manufacturing activity, and the market often moves on this report despite the volatility and large revisions that make it a less than perfect indicator.  These problems can be minimized by looking at the breakdown of orders.  The total number is often skewed by huge increases in aircraft and defense orders.  An increase based solely on strength in one sector tends to be discounted, while the market is more impressed with broadbased increases in orders.

10:00 - New Home Sales (for Mar): Consensus 885K

Big Picture: New home sales are down a large -38% from the peak in July 2005.  The year-end gains were more than doubled by the January/February plunge.  National Assoc of Realtors believe that new home sales bottomed in Q1 2007.  We expect a slightly stronger sales pace once the Spring season gets underway and weather is excluded as a dragging factor.  Lower fixed term mortgage rates, lower prices and the strong underpinnings of earnings growth and a low unemployment rate provide the underlying trend as the correction begins to fade.  Median prices are lower than a year ago, but prices will improve as unsold inventories are thinned.  Inventories reached a high of 8.1 months in February with the plunge in sales, and help direct the path for prices.  The high end of the market leaves average prices higher than a year ago -- 7.5% yoy in February.

Implications: The report indicates the level of new privately owned one-family houses sold and for sale.  New home sales usually have a lagged reaction to changing mortgage rates.  The home sales report is quite volatile and subject to huge revisions, making any one month's reading very unreliable.  The report rarely prompts a market reaction.  The market prefers the existing home sales report, which has a sample data pool four times as large and is released earlier in the month.


Thursday, April 26

8:30 - Initial Claims (for 4/21): Consensus NA

Big Picture: Initial claims follows a subtle upward trend as the aberrations are watched for clues on the labor market and economy.  The slow upward trends in both initial and continued claims reflect some slight loosening in the labor markets.  Claims provide a nearly real-time read on layoffs and the labor market, as the post-recession low 4.4% unemployment rate reflects the broader read of layoffs and hiring.

Implications: Initial jobless claims measure the number of filings for state jobless benefits.  This report provides a timely, but often misleading, indicator of the direction of the economy, with increases (decreases) in claims potential signalling slowing (accelerating) job growth.  On a week-to-week basis, claims are quite volatile, and many analysts therefore track a four week moving average to get a better sense of the underlying trend.  It typically takes a sustained move of at least 30K in claims to signal a meaningful change in job growth.


Friday, April 27

8:30 - GDP Adv. (for Q1): Consensus 2.0%, Chain Deflator Adv. (for Q1): Consensus 3.0%

Big Picture: Q4 leaves the last three quarters with average growth of just 2.4% as the Fed targets sub 'potential' growth (3%) to cool inflation pressures.  The forward risk is that sluggish manufacturing demand holds longer than expected, and on the upside that growth will outpace potential growth as the housing effect fades.  Lower energy prices aided Q4 growth by boosting consumer spending and slowing imports.  2006 growth was based on moderating consumer spending and the strong decline in housing as slowing business investment was bumpy.  2007 growth will be based on a more stable housing market as consumer spending remains stable and business investment provides the risk.  Inventories are currently overbuilt, but adjustments won't be severe after the firm Q4 slowing.  Stimulative fiscal policy contrasts with restrictive monetary policy as economic growth has softened but remains self-sustained.  Inflation risk is weakening as the slowed economy helps quell the pressures.  Little slack in the economy and  remaining inflation risks are the Fed's concerns.

Implications:  Gross Domestic Product (GDP) is the the broadest measure of economic activity.  Annualized quarterly percent changes in GDP reflect the growth rate of total economic output. The figures can be quite volatile from quarter to quarter.  Inventory and net export swings in particular can produce significant volatility in GDP.  The final sales figure, which excludes inventories, can sometimes be helpful in identifying underlying growth trends as inventories represent unsold goods, and a large inventory increase will boost GDP but might be indicative of weakness rather than strength.  The broad components of GDP are: consumption, investment, net exports, government purchases, and inventories.  Consumption is by far the largest component, totalling roughly 2/3rds of GDP.

In addition to the GDP figures, there are GDP deflators, which measure the change in prices in total GDP and for each component.  Though the consumer price index is a more closely watched inflation indicator, the GDP deflator is another key inflation measure.  Unlike CPI, it has the advantage of not being a fixed basket of goods and services, so that changes in consumption patterns or the introduction of new goods and services will be reflected in the deflator.

8:30 - Employment Cost Index (for Q1): Consensus 0.9%

Big Picture: Total compensation costs remain tame at 3.3% yoy given the low unemployment rate.  Wage growth is mildly accelerating but partly offset by the strong deceleration of benefit costs.  Wage growth of 3.2% yoy compares to 3.6% yoy for benefits which are half the growth pace of Q3 2004.  These figures contrast with the far more accelerated growth in the more inclusive productivity compensation costs and the wage/salary component in the personal income report.

Implications: The Employment Cost Index (ECI) is designed to measure the change in the cost of labor.  The ECI compensation series includes wages and salaries and employer costs for employee benefits.  The sum of the change in these two components equals the change in total compensation.  The Federal Reserve Bank of Cleveland aptly describes this aspect of the employment cost index thusly: "The ECI is the best measure of compensation (wages and benefits) growth available."  Briefing.com adds this extension: The usefulness of the ECI lies in its ability to tell us whether wage and/or benefit-cost growth appears excessive and whether compensation is growing faster than inflation.

10:00 - Michigan Sentiment (Rev. for April): Consensus 85.3

Big Picture: The push to a two-year high in January is largely tied to the drop in gasoline prices, as the recent equity drop and renewed fear about recession and sub prime mortgage lending leave the preliminary April index at an eight month low.  Fears are partly offset by the strong labor market.  The expectations component is up 9% since the August high in gasoline prices.  The University of Michigan survey is significantly smaller (500 phone calls) than the Conference Board's, includes a longer outlook (for expectations) as questions are focused on the household compared to the business heavy CB survey.  The index far better tracks the consumers' mood than spending habits better indicated through interest rates and income growth.

Implications: The Michigan index is almost identical to the Conference Board Consumer Confidence index, though there are two monthly releases, a preliminary and final reading.  Like the Conference Board index, it has two subindexes - expectations and current conditions.  The expectations index is a component of the Conference Board's Leading Indicators index.


Source:  www.briefing.com