It didn't take long. An hour or two with the mouse and keyboard, tap tap tap, click click click, and I'm in cash. Up 17.5% for the year, time to take my ball and go home. The precipitating incident was trivial: I made what I considered a reasonable request, and my brokerage refused to grant it.

I told them it would cost them a customer, they very politely informed me they didn't care. So I closed my positions and moved the cash to an FDIC insured bank account. In point of fact, the service incident was the straw that broke the camel's back: I'm just plain sick and tired of the stock market. It's time to sit on the sidelines, step back and think - with my money in my pocket.

What's Different

In October 2011, I wrote an article entitled "Fixing Wall Street: Cutting the Gordian Knot."

Shares of Olin (OLN) bounced around before and after the Q4 2012 earnings report. The chemical company's Winchester segment makes ammunition, and speculators bid shares up while looking for a surprise based on hoarding in the wake of renewed interest in gun control. When announced, earnings were a beat, and featured record EBITDA. Shares sold off, then bounced as more long-term investors responded to the fine results.

EBITDA

CEO Joseph Rupp has been using adjusted EBITDA as the primary metric in evaluating company performance. Here's CFO John Fischer, from the Q2 2012 earning conference call transcript, discussing the acquisition of K.A. Steel:

The combination of the 2011 K.A. Steel adjusted EBITDA of $31 million and the $35 million of annualized synergies we expect to realize, when compared to the purchase price of $328 million, reduced by the $60 million present value of the incremental tax benefits made available to

Shares of Xerox (XRX) surged higher following Q4 2012 earnings, closing Monday at $8.23. Year to date the stock is up 20%. The company is a deep value play, driven to low multiples by concern that it may not be able to achieve growth going forward. Taking advantage of the low prices and strong cash flow, buybacks have been ongoing. This article updates on growth and buybacks, then digresses into a discussion of R&D.

Growth

Xerox operates in two segments - Technology (the copier business) and Services. Services encompasses the ACS (Affiliated Computer Services) acquisition, and includes ITO (information Technology Outsourcing), BPO (Business Process Outsourcing) and DO (Document Outsourcing). The question is, can growth in Services (52% of revenue) overcome declining sales in Technology (48%)?

Mathematically, if trends observed comparing 2011 to 2012 continue, the answer is yes. A simple projection using a 6% increase for Services and an 8%

Webster Financial (WBS) reported Q4 2012 EPS of 52 cents, beating estimates by 4 cents. The street responded with mild enthusiasm, bidding shares up 2.11% to close at $22.30. At a TTM P/E of 11.97, the regional bank continues undervalued. Today's share prices don't reflect the steady operational improvements that have been driving increased EPS.

Background

From the 10-K:

Webster Financial Corporation (collectively, with its consolidated subsidiaries, "Webster", the "Company", our company, we or us), is a bank holding company and financial holding company under the Bank Holding Company Act of 1956, as amended, which is headquartered in Waterbury, Connecticut and incorporated under the laws of Delaware since 1986. Webster Financial Corporation's principal asset at December 31, 2011 is all of the outstanding capital stock of Webster Bank, National Association ("Webster Bank"). Webster had assets of $18.7 billion and equity of $1.8 billion at December 31, 2011.

Webster, through Webster

Norfolk Southern Corp (NSC) has retreated from a 52 week high, based on weakness in coal shipments. Low cost natural gas is driving a reset in coal demand. However, capex directed at increasing intermodal shipments, and a generally pro-active approach by management make the railroad attractive as a long term investment at recent prices around $64.

Overview

The company describes itself as follows, in press releases:

Norfolk Southern Corporation is one of the nation's premier transportation companies. Its Norfolk Southern Railway subsidiary operates approximately 20,000 route miles in 22 states and the District of Columbia, serves every major container port in the eastern United States, and provides efficient connections to other rail carriers. Norfolk Southern operates the most extensive intermodal network in the East and is a major transporter of coal and industrial products.

Diminishing Coal Traffic

As a major transporter of coal, NSC can't escape the results of reduced

Performance for the year was nothing to be ashamed of: an IRR (internal rate of return) of 28% beat the S&P 500 index by 12.5%. However, concerns that the risk involved has been excessive compared to the actual returns, together with a reassessment of my discretionary portfolio objectives, leads me to undertake a shift in emphasis from a Deep (or high beta) Value investing approach toward a Dividend Growth strategy.

A Granular Analysis

Here's a spreadsheet, providing basic performance statistics and a listing of the larger winning and losing trades:

(Click to enlarge)

Starting with the winners, it should be noted that most of them had CCC credentials: they appear on the list of Dividend Champions, Contenders and Challengers as maintained by David Fish. The performance of the diagonal spread options positions is startling, relative to the underlying: I went back and rechecked my spreadsheet for all of them,

With U.S. corporate profits as a percentage of GDP at a record high, well-known bears Jeremy Grantham and John Hussman have issued dire predictions. This article applies factual analysis to margins and market level, finding little support for a strong bear case based on margin reversion.

From GMO's Grantham, as presented on the Morningstar website:

Another breakfast thought is that the earnings level is abnormally high. And GMO is pretty academic, sometimes to its cost, and so we ruthlessly normalize earnings to very long-term averages. And that's what separates us from most of the data. People think the American market is very cheap, in general. A great majority think it's reasonably cheap, and we don't, because we want it to be priced to the normal earnings. And the bulls say, well, of course, there's been a paradigm shift. Profit margins are higher and always will

Harmonic, Inc. (HLIT) has a sufficiently strong pattern of seasonal performance in Dec/Jan/Feb to suggest playing the stock for a pop on that basis. Since 1995, the share price has increased an average 18.5% in December, 13.5% in January, and 9.3% in February. Here's a chart:

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The average value of the stock was computed for each day of the year. That is, for January 1st the values from 1996 to 2012 were averaged, and so on throughout the year. Using the resulting averages, each day of the year was calculated relative to the first which was set to 100. The data was not trimmed. Prices were adjusted to reflect a 2 for 1 split Oct 15, 1999.

The January Effect

From Wikipedia:

The January Effect was first observed in, or before, 1942 by investment banker Sidney B. Wachtel. It is the observed phenomenon that since 1925,

Backtesting validates the effectiveness of DGI (Dividend Growth Investment) strategies. Over the past 10 years, an investor utilizing this approach enjoyed lower beta, higher Sharpe ratios, lower maximum drawdowns, and considerable Alpha. As a bonus, he beat the market.

However, DGI does not outperform other dividend strategies, as is demonstrated by comparing it with a strategy I have dubbed "Dividend Yield."

This article presents a series of backtests developed on StockScreen123, then proceeds to a discussion of the investment implications of the information developed.

A 10-Year Backtest

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The DGI Screen has the following parameters:

• Member of S&P 500 (SPY)

• Increased dividend each of the past 10 years

• Above 50th percentile on the site's "Basic: Quality" rating system

The Dividend Yield Screen eliminates the increase requirement, but is otherwise identical. Stocks that pass either screen are sorted by Yield, and the 40 highest selected. The portfolios are

MBIA (MBI) reported 3Q 2012 ABV (Adjusted Book Value) of $30.64, down from $31.23 the previous quarter and $40.06 as of 4Q 2008. While the continued erosion of this metric is disappointing, the most worrisome aspect of the earnings conference call was the discussion of the possibility of a liquidity shortfall. The issue is not new, but received increased emphasis in the presentation. Here's CEO Jay Brown on the topic:

Unfortunately, while loss payments by MBIA Insurance Corp uninsured securitization backed by ineligible residential mortgages continue to decline, the flow of new delinquencies is not abated as quickly as we had expected. We also have taken additional loss reserves against CMBS pools where the dominant counterparty is Bank of America's Merrill Lynch subsidiary.

Although these transactions were structured with deductibles, those deductibles are now likely to be eroded, resulting in claims being made to MBIA Insurance Corp. Depending on

Hurricane Sandy won't have any permanent effect on the P&C Insurance industry. Insurance stocks normally respond to catastrophes with a dip, followed by an increase as the implications of future higher rates are priced in by the market. For short-term traders, the usual strategy is to buy on the dip and sell as prices recover, while long-term investors look to accumulate additional shares at attractive prices.

Nevertheless, the event should be considered in the context of the industry cycle, as well as the overall market level. Also, it should be noted that an occurrence outside the usual probability parameters is a stress test for management competence in managing risk and reinsurance. Some players will be better prepared than others, as hindsight provides wisdom.

Context

The P&C insurance pricing cycle is on the upswing. Major players such as Chubb (CB), Travelers (TRV) and Hartford (HIG) are systematically raising rates, after multiple

Corporate profits as a percentage of GDP stand at near record levels. Bearish pundits point at this and assert that margins will revert to their historical average, leading to a plunge in profits and share prices. Working with data provided by the BEA (Bureau of Economic Analysis), this article explores that idea and arrives at a more moderate conclusion.

Sharing the Pie

click to enlarge images

Rather than use GDP, this analysis considers the shares of labor, capital, taxes and profits as part of value added. These shares sum to 100%. This walks around the issue of commodity cost: commodities aren't included. Logically, if commodities rise, commodity producers will show higher profits, offsetting lower profits for other businesses.

The trends are very clear, and consistent with anecdotal evidence and popular wisdom. Labor is getting a smaller share of the pie, and corporate profits are increasing accordingly. The correlation

"It can't really be that easy." Dividend or dividend growth investors sometimes sound too confident and assured: sooner or later those of us who follow other methods simply fall back on the easiest counter-argument. This article presents the results of backtesting a portfolio of low beta, high quality dividend payers. After poking and prodding the results, the answer is: "It would have been just that easy for the past decade or more." Very possibly it will be that easy going forward.

A Ten Year Backtest

Using StockScreen123, the following screen was backtested:

• S&P 500 (SPY) member
• Beta<0.80
• Yield>2%
• Equal investment in top 20 candidates, as determined by the site's Greenblatt ranking system, which focuses on quality
• Reconstituted every 3 months, 0.5% slippage

Here's a chart of the most recent ten year period:

(Click to enlarge)

The results are impressive: IRR for the 10 years is 13%, compared to 7%

Sporting P/Es of 5.6 and 7.9 respectively, MetLife (MET) and Prudential Financial (PRU) have become chronically undervalued. Ten years ago, both companies traded at multiples comparable with the S&P 500 average: today, they trade at half that. Here's a three-year chart for Prudential (green) with MET (gray) for comparison:

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Share prices have gone up and down: however, a linear regression shows PRU flat-lined, while MET is trending downward. During this same three-year period, PRU increased Book Value excluding Accumulated Other Comprehensive Income (BV ex AOCI) by 7.93% annualized. The dividend was increased from 70 cents to $1.45, and currently yields 2.5%. Combining growth in BV ex AOCI and the dividend, shareholder returns have been 10% annually, but Mr. Market will not pay up for this performance. On the same basis, MET has been earning 6%, eliciting a negative response.

Cost of Capital

Aswath Damodaran finds an

Hewlett-Packard (HPQ) is bumping along in the neighborhood of a 52 week low, with an Analyst Day scheduled for October 3rd. Ahead of this event, I conducted a review of valuation and strategy. HP is undervalued when compared to a realistic recovery scenario. If CEO Meg Whitman is able to present a convincing case for recovery over the next several years, shares may move from a recent price of $17.21 to $24, relatively rapidly. For those who use options, bullish strategies offer substantial opportunities.

Large Loss Lesson

I wrote a favorable HP write up in July last year, with the stock at $37, making a case for mean reversion. Investing on that basis proved unprofitable, leading to a review of the original decision.

The thinking was that Leo Apotheker, CEO at the time, had correctly identified the problems and developed a plan of corrective action. The company

Sometimes a bowler, after throwing a strike, will pause and reflectively repeat the delivery motion, as if trying to memorize how he did it, for future reference. As an investor, I typically review my trades after closing them, sometimes finding errors that can be discussed in a "lessons learned" type article. Every once in a while, I get the equivalent of a strike, and say to myself, "more like this."

Back in August, James Kostoherz did a fine job on the lessons learned genre, forthrightly going over a broken thesis and his discipline in closing the trade and moving on. I've done a few of them myself - most recently on Radian (RDN), previously on (LDK). Today I'm going to talk about getting it right.

The Wrap-Up

On 8/6/2012 I closed a diagonal spread on 3M (MMM), which had been running since 9/9/2009, with an internal rate

Property & Casualty Insurer Travelers (TRV) moved markedly higher early last week, driven by a strong presentation by CEO Jay Fishman at Barclays Financial Services Conference. I recommend it for anyone with an interest in the company. Mr. Fishman brings a calm and methodical approach to bear, and the material presented is factual and informative.

After reviewing the data provided, I suspect that intrinsic value is higher than the market recognizes, because the bulk of the company's profits come from a very high quality fixed income portfolio.

Fixed Income Portfolio

From the presentation:

(click to enlarge)

The largest and most stable contribution to ROE comes from the fixed income portfolio. ROE has averaged 12.9% over the past 7 years: 8.5% from long-term fixed income, 3.3% from underwriting profit, 1.1% from short-term and other. Underwriting results vary substantially year to year, driven by cyclical trends in pricing, unpredictable

Hartford Financial (HIG), prior to the financial crisis, had a history of reaching for yield. That played out poorly, and contributed to the company's current status as a speculative value play. New management doesn't seem to have changed the culture.

In line with my interest in word search as an analytical tool, I recently checked Hartford's 10-Q for occurrences of the words "synthetic" and "replicate." Here is what I found:

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According to the company, replication transactions are used as an economical means to synthetically replicate the characteristics and performance of assets that would otherwise be permissible investments under the Company's investment policies.

Hartford is writing credit default swap (CDS) protection. That's how AIG got in trouble.

CDS as Insurance

These transactions aren't being regulated as insurance. They're being passed off as investments. We have no way of ascertaining whether these CDS are naked or not. Naked

Cisco Systems (CSCO) finished fiscal 2012 (ending 7/31/2012) strongly, but gave muted guidance. The stock rallied nicely on earnings, and has held onto its gains, trading around the $19 area since. I wrote the company up favorably in December last year, advancing the hypothesis that it can compensate for slow or lack of growth in its primary product groups (switches and routers) with strong growth in its newer lines.

This article reviews the hypothesis, valuation, and strategy/tactics for the investment. The company is executing well, and transitioning toward a mature, dividend growth profile. The debt crisis in Europe, and slowdown in China, present challenges, and may keep a lid on the stock until visibility improves.

Product Groups

From the 4Q 2012 earnings presentation:

(click to enlarge)

Cisco met the high end of 5% to 7% revenue guidance, showing strong performance in Data Center, Service, Wireless, Security and Service

The verbal analysis of financial statements, specifically the use of word counts, can provide useful insights not available by more conventional means. This article examines the use of the word "believe" in the financial statements of banks. The findings: some banks have a far more extensive belief system than others. Bank of America (BAC) stands out like a sore thumb.

Statistical Analysis

The following table was developed by applying word counts to the most recent 10-Q for the big five Wall Street banks, as well as five large regional banks.

"Believe" includes all occurrences of the word, to include "believes". "Not" and "Continue to" reference belief phrases.

This metric allows us to assess the importance of management's belief system to the accuracy of the financial statements, and to investors' confidence in the numerical implications of the resulting product.

Notice the symmetry: Citigroup (C), Goldman Sachs (GS), JPMorgan