Sunday, January 22, 2006

Of Prices and Values - Part I

Friday's 2% fall in the Dow Jones 30, obviously, got a lot of headlines over the weekend, but I think the reasons given for the fall are very short-sighted, and the markets will recover in the weeks ahead. It might be said that it does not matter what drove prices lower, the end result is several hundred billion dollars in losses. But this is a perfect case of the difference between prices and values. I do not believe the actual underlying values of US corporations fell by 2% on Friday, as did prices. The reasons given for the fall in prices were Citigroup's miss on earnings, GE's miss on revenue, and the rise in oil prices resulting from the showdown with Iran and a new tape from Osama bin Laden. The argument being made is that Citigroup and GE are such large companies that their "misses" cast a long shadow over the strength of the US economy and corporate profits in 2006. Citigroup's stock fell by almost 5% on Friday when they missed their earnings target by 2% -- for the quarter. Most of the analysts I follow have now reduced C's full-year 2006 earnings estimates by only about 1%. Having said this, I do not believe C is a good proxy for earnings for the average company or the US economy. They have missed earnings for three consecutive quarters, and in my judgment, have significant management problems, ethical issues, and a lack of a clear strategy. GE hit their earnings target, but traders sold off the stock because of a miss in the revenue forecast. GE's earnings news was solid: five of GE's six divisions had above 15% earnings growth. The explanation for the revenue slip made sense to me. GE's earnings release would likely have been a non-event had Citigroup's earnings miss not unleashed Wall Street's animal spirits. The showdown between the US and Iran resulting from the latter's nuclear ambitions has riled the oil markets, sending prices back near $70p/bl. I think it is unlikely that the US and other Western nations will embargo Iran's oil. These kinds of actions don't have a great history of success and would harm Western nations as much as Iran. I think it is also unlikely that Iran will withhold their oil from the market, either. Strategists I follow estimate that Iran substantially subsidizes the energy needs of almost 40% of its population. It is also well known that there is much political unrest in Iran, particularly among students and the young. The Ayatollahs cannot continue to subsidize their citizens' energy needs without the funds they derive from oil sales, and without the subsidies, they are likely to have millions of people in the streets. The bin Laden tape was just downright strange to me. As I listened to it, even before I heard any of the media give their interpretations, it sounded to me like someone giving a pep talk to his own minions more than an imminent threat to the United States. Politics is politics, so they say, and it is just possible that the number of young men and women willing to blow themselves up and kill their countrymen and women is dwindling in the face of the relentless pursuit by the US military . In the week ahead, literally hundreds of companies will be reporting their earnings. By this time next week, we will know a lot more about overall corporate earnings. I continue to be optimistic that earnings for the fourth quarter will be above estimates. Lost in the assault on prices is a bit of very good news: Citigroup raised their dividend by 11%. The way I score it that actually increases C's value. However, as I said earlier, I don't like the stock currently because of what I might call a weakness of their "heart." They need to clean up things at the company. They need one CEO to run the place, they need one CEO to clean up the place, and they need a culture where adding value to their customers and shareholders is their number 1 goal, instead of enriching themselves. Citigroup like several other companies has lost it way because it has heart trouble. These things can change quickly, however, with new blood (to coin a phrase) at the top. More later.