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As a contributor to the New Low Observer (http://www.newlowobserver.com/about-this-site), we intend to give new insights on a low risk approach to trading in dividend paying stocks for tax deferred accounts. The New Low Observer (http://www.newlowobserver.com/about-this-site) is not intended for... More
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  • Review: California Water Service Group

    Contributor C. Cheng asks:

    "Interesting that you should mention scarcity of water creating an upside cap on the company's profitability. Now that California is dealing with drought conditions, how do you think this will factor into CWT's performance?"

    Our response:

    On January 3, 2010 (found here), we posted an Investment Observation on California Water Service (NYSE:CWT). At that time we said that CWT has a 6-year pattern of trading in a range before breaking out to the upside, price is driven by the dividend with an upside target of $24.145 ($48.29).

    Regarding the 6-year cycle, we said the following:

    "CWT has had a pattern of trading in a range for approximately 6 years at a time before breaking out to a new and higher trading level. The following are the range in years that CWT traded before obtaining a new high:

    • 1976 to 1982
    • 1985 to 1993
    • 1993 to 1997
    • 1997 to 2004
    • 2005 to 2011 ???"

    Our expectation was that at some point in 2011, CWT would ideally be bought for the pending breakout of the stock price.

    (click to enlarge)

    The reality of the situation with CWT is that the stock finally broke out of the trading range in January 2013. Again, the 6-year trading range was only the average. However, while investors waited for the stock price to increase there was a sizable dividend being offered at the time. Coincidentally, the price of CWT has peaked at $48.28 on a closing basis as recently as March 25, 2014. This closing price is within $0.01 of our projected high set in 2010.

    Our view is that only in hindsight will we know for sure the impact of water scarcity on CWT. However, below is the trend of quarterly earnings since our 2010 posting and it seems to reflect the fact that instead of being able to see higher earnings in the face of scarcity (the rational economic view) we're seeing pre-drought earnings.

    (click to enlarge)

    What we do know is that the price performance of the CWT has a lot to do with the price paid. Given that CWT currently trades at 25.8x earnings and yields "only" 2.8% (low for a utility), the odds of the stock outperforming in the long-run are slim.

    In addition, utility companies generally issue bonds to fund their operations. With interest rates on the rise, their cost of funding will put more pressure on the future earnings. As such, our view on the risk/reward isn't as rosy for CWT.

    Tags: CWT
    Jun 16 1:30 PM | Link | Comment!
  • Dow Doesn't Deserve 17K?

    In an article titled "3 reason the Dow doesn't deserve to be at 17,000" (found here), author David Weidner outlines why "…the bull market in stocks is running for all the wrong reasons." The three reason that Mr. Weidner gives are lack of public participation, corporate earnings are flat and few alternatives investments for savers.

    We actually believe the opposite is true, the Dow (NYSEARCA:DIA) is short of the mark in terms of where it could or should be based on historical precedence. On the topic of public participation, although Mr. Weidner is correct that the public isn't as active in direct ownership of stocks, an alternative view could be that when and if the public does get involved, usually the late stage in a bull market, the Dow could easily over-shoot on the upside by a wide margin.

    In our March 13, 2013 article (found here), we pointed out that the average trading volume has been in a declining trend since June 2, 2009. Our concern was that with the decline in trading volume, indicating a lack of participation by the public, there may be a point at which stocks could not sustain their climb higher. We said the following:

    "When the increase in volume arrives, the question then becomes, will there be a dramatic increase or decrease in stock market price? Will the general public's lack of participation be the catalyst that charges the market to move higher? This situation has to be resolved at some point."

    As time has passed, we're starting to believe that if the public finally does begin to participate, even on a marginal scale, the stock market could effectively skyrocket.

    Mr. Weidner's second point is that with corporate earnings being flat, there seems to be less of a justification for the stock market to move up as much as it has. However, the stock market usually works in mysterious ways when it comes to the impact of corporate earnings. As an example, the some of the biggest stock market gains are accompanied by lower than expected or declining corporate earnings and bear markets often coincide with exceptional corporate earnings. As an example:

    "Right now, corporate earnings in the U.S. are very good. actually much better than analysts expected as recently as six months ago. But look at my Primary Trend Index (page 2 chart); it hit a new bear market low on November 4. Study the advance-decline ratio (which is a proxy for the action of all the stocks on the NYSE). The A-D ratio hit a new bear market low on the same day, November 2. Now check the daily new highs and lows. New lows have been coming in heavily, with day after day of more new lows than new highs (Russell, Richard. Dow Theory Letters. November 9, 1994. page 1.)"

    The above commentary was during a period when the stock market traded in a range from August 1993 to February 1995.

    "The word is out - corporate earnings in the period ahead will be leveling off or declining. Investors are switching to defensive shares (Russell, Richard. Dow Theory Letters. October 11, 1995. page 6.)"

    The above commentary was during a bull market in stocks that saw the Dow Jones Industrial Average rise +144% from October 11, 1995 to January 10, 2000.

    "The market is saying that corporate earnings are fated to decline, that price/earnings ratios are due to shrink and that business will be facing much tougher times (Russell, Richard. Dow Theory Letters. August 12, 1998. page 3)"

    The above commentary was near the 1998 low and the Dow achieved a +24% gain by January 10, 2000 (excluding dividend reinvestment). Additionally, a new investment at the 1998 date would have gained +67% by October 2007 with only a -11.77% loss at the 2003 stock market low after the crash of 2000.

    "The stock market, since August 1982 has presented us with four major lessons. Lesson I: The market has its own wisdom and it can move completely opposite to the obvious fundamentals. In August 1982, the fundamentals for the economy, the international picture and for corporate earnings looked terrible. And I'm not sure things have changed that much since late-1982 (except in the interest rate sector). But the market, despite this, surged to record highs (Russell, Richard. Dow Theory Letters. February 9, 1983. page 1)"

    Since the above statement regarding the market from August 1982, the Dow has gained +1,209%. It is necessary to note the fact that Russell said "…The market has its own wisdom and it can move completely opposite to the obvious fundamentals…" This is huge and explains why we're choosing to adopt the view that maybe the opposite of what is expected will prevail.

    Mr. Weidner's third point is that, "…there are no alternative investments…" and that the Federal Reserve's "…easy credit seems to be inflation in the stock market." The widely held view that the stock market has moved up due to Fed policy seems to miss the mark by a wide margin. As outlined in our article titled "Is the Fed Responsible for the Stock Market Rise Since 2009?" (found here), in the period when there was no central bank from 1836 to 1914, the stock market averaged a gain of +167% after large declines. If the Dow Jones Industrial Average were to rebound +167% from the March 2009 low, then the index would sit at 17,500.

    Aside from the incorrect claim that the Fed is the reason for the stock market, Weidner goes through the list of "lacking" alternative investments. The first "investment" that is mentioned is fixed-income products like the 10-year Treasury (NYSEARCA:DTYL). Yet, short-term treasuries aren't investments per se, they are savings instruments that carry the lowest risk available (aside from cash). Yes, short-term treasuries should have some role in your financial plan and can be beneficial in declining interest rate environments and market panics. Also, treasuries are a great place to park your money before the next big investment.

    Weidner isn't interested in high yield junk bonds (NYSEARCA:JNK) because the issuance level exceeds what it was at the peak of the 2008 market. This assessment doesn't tell the full story since the junk debt market will continually increase in size. Simply stating that the market is two times higher than a select point in the past doesn't put the information into its proper perspective.

    Weidner doesn't like housing because it seems to be a game for only the cash rich investors, however, this would fit the billing as an investment alternative to the stock market. After all, committed investors are putting real money on the line in order to secure real estate.

    On gold (NYSEARCA:GLD), Weidner says that it is down -30% from the peak. That's it!!! Weidner has nothing else to say about a metal that is revered by many and is held in central banks around the world for some strange reason. Sounds like an opportunity to investigate the pros and cons of gold. Weidner doesn't go there and therefore confirms his view that there are no investment alternatives.

    You'd think that Weidner would like oil (NYSEARCA:OIL), after all, it is only up by +20% in the last year. However, Weidner says, "…Nice, but it's still trailing the stock market." So, it would seem that if the asset is truly an investment, you should not have to compete with cash in the real estate market, gold is down so no interest there, oil is up so no interest there and junk bonds are being issued too much. All this leave a saver with no investment alternatives.

    It is important to put the facts in a comprehensible order before making any claim. First and foremost, savers should only become investors when they are willing to accept the risk of loss. Once the acceptance of the risk of loss is established the many investment alternatives need to be examined in their proper context. Keep in mind that the stock market is adept at doing the opposite of what investors expect. Finally, from a historical standpoint, wider public participation in any investment always takes place in the latter stages of a rising trend.

    Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: DTYL, DIA, GLD, JNK, OIL
    Jun 14 11:32 PM | Link | Comment!
  • Target: The Analysts And Risks

    Contributor C.Cheng says:

    "According to Morningstar, 'increased competition from rivals such as Wal-Mart (NYSE:WMT), Costco (NASDAQ:COST), and Amazon (NASDAQ:AMZN) is an ongoing threat to Target's (NYSE:TGT) share of domestic retail sales.' Furthermore, Target's expansion into Canada proved to be bumpier than predicted and they will probably not meet their projected targets. What are your concerns regarding these developments?

    "Over the course of the past year, Target has reached its 52-week low and is currently hovering near it. Do you think this is a temporary development or an indication of a fundamental issue with the company? (found here)"

    Our Response:

    The primary concern seems to be how long Target can suffer from bad execution or will the company continue to spiral down. The mention of Wal-Mart (WMT) reminds us of a previous review we did of the stock. On June 8, 2009 (found here), we had the following to say of Wal-Mart:

    "The price pattern [not increasing in value] on Wal-Mart reflects a concern by investors, starting in 2000, that the consumer economy was going to be in trouble. If the price goes above $70 or goes below $45 then we'll have some advanced warning about what may be around the corner for the U.S. and Chinese economy. Seems that this company is a leading or more reliable indicator (for the time being).

    "In general, Wal-Mart's stock is not being recognized for the simple fact that the company can generate positive earnings. Although WMT's debt really bothers me, company management may be clever like a fox by amassing huge amounts of debt now to be paid off later with inflated dollars."

    Many investors were disappointed about the fact that for nearly 10 years, from 1999 to 2009, Wal-Mart's stock price traded in a range from $40 to $65. This is an example of the risk that a retailer like Target (TGT) might face, trading in a range for an extended period of time.

    However, the premise of the 2009 Wal-Mart article was that if, over an extended period of time, the company can continue to maintain earnings, increase or retain margins, borrow prudently and decrease shares outstanding there is a good chance that value of the company will increase. Not long after the 2009 Wal-Mart article, with the stock trading at $49.84, the shares of WMT broke out of the $65 resistance level and increased to the most recent high of $81.37, an increase of +63%.

    Our purpose of tracking stocks that have a history of dividend increases, like Wal-Mart and Target, is to determine values and the competency of management. The decision to increase dividends cannot be sustained over an extended period of time if management is incompetent, perpetuating fraud or willful negligence. When we acquire a stock like Target at depressed levels, we're indicating that the problems faced by the company, although a current drag on the stock price, will be resolved in due time. Keep in mind that downside risks should always be a consideration.

    A secondary concern that is worth addressing is the source of analyst reviews and the quality of such reviews. For example, Deutsche Bank Markets Research provided this analysis of an investment downgrade of Target on July 12, 2013, within 2 weeks of the top ($73.50) in the stock price on July 24, 2013.

    (click to enlarge)

    Although DB was not in the position to offer a pure sell recommendation, a failing of most research shops, the downgrade with an upside target that was spot-on indicates the high quality of the research that was done. We recommend you get a copy of this report to see what the risks were, according to DB, in advance of the subsequent decline that had ensued.

    Contrast the Deutsche Bank downgrade on July 12, 2013 with the Piper Jaffray review on July 9, 2013 which gave Target the highest rating possible of Overweight, essentially a buy recommendation two weeks before the peak.

    (click to enlarge)

    Piper Jaffray essentially gave a buy recommendation of the Target within 4% of the high. Additionally, the stock was expected to increase to $80. This is a report that is worth contrasting to the DB report. We'd eliminate the points that are similar and focus on the differences as the defining piece to the quality of the analysis, in favor of DB.

    A challenge with Morningstar reports is that they have a cookie cutter approach that is easy to identify the weaknesses. Below is an excerpt from the Morningstar Report dated July 8, 2011 when Target was trading at what was later to be revealed the low in the stock price from the January 3, 2011 peak.

    (click to enlarge)

    Just to highlight what was said by Morningstar, at the time:

    "Increased competition from rivals such as Wal-Mart, Costco, and Amazon are ongoing threats to Target's share of domestic retail sales."

    It appears that Morningstar's overall risk analysis does not change whether at a low in the price or at a high. Because this was a general risk assessment we wouldn't put much emphasis on this particular warning on the stock. However, the most informative assessment of risk within a Morningstar report is usually the section titled "Bulls Say" and "Bears Say".

    Although normally a good summary of both sides of the matter, the case for and against Target, as made in the Morningstar report dated May 27, 2014 are essentially offsetting points as the "Bull Says" section indicates, "PFresh and REDcard should help to drive store traffic, delivering enough expense leverage to offset the negative impact on gross margins from those initiatives." While the "Bear Says" section suggests, "Target's ROICs have declined since the PFresh initiative transitioned a larger portion of assets to lower-return food business." Usually, this section is better at outlining the risks and potential benefits of ownership of the stock. For Target it wasn't particularly enlightening.

    Our own recommendation of Target on June 24, 2011 (found here), at the low, was as follows:

    "Target (TGT) landed in the third spot after Fitch cut its debt rating. They've taken the rating down from A to A- on claims that Target is aggressively buying back its own shares and remodeling stores in Canada. We've said it before that shares of Target look attractive at a 2% yield but it's even more attractive at a 2.59% yield. This yield boost was because the companyraised its dividend by 20%, from $0.25 to $0.30 per share. Once again, IQTrend has estimated that Target is a good buy when it reaches a 1% yield."

    We believe that understanding the downside risks are vital to the success of any investment that is ever made. Additionally, the quality and consistency of such assessments should line up a majority of the time. In the particular case of Target, the risks are still out there, however, we believe that the history of the company's management team ensures that the problems are being addressed which may include taking the losses by closing the Canadian stores and cutting or leaving the dividend unchanged.

    Disclosure: The author is long TGT.

    Tags: TGT, WMT, COST, AMZN, Target
    Jun 11 9:09 PM | Link | Comment!
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