ASK THE ANALYST: Q & A WITH DOUG ROGERS

Doug is back!!!!

After a longer-than-we’d-like hiatus from the newsletter, we’ve pried our favorite analyst from his diligent research efforts in the interests of giving you, our dear reader, answers to some of the more pressing questions of the day. 

We ourselves wonder if this recent rally is for real, if it is time to once again look in earnest at the market as an investment vehicle.  Undoubtedly, money has been made in the gains of late and we believe that the sidelines are now teeming with dollars waiting to dive in.

Along those lines, one of our long-time favorite companies, Smith & Wesson Holding Corp. (OTCBB: SMWS), has attracted quite a bit of investor attention with its front-page feature story in the Wall Street Journal last week (click here for the article).  Last time we presented good old S&W (click here for our S&W news piece on 9/27) the stock was showing signs of improvement, closing at $1.27.  Today, on the heels of the WSJ story, the stock traded as high as $1.65, closing at $1.58.  That’s a 25% appreciation since our last S&W update.  Congratulations to those (like us) who own it!

S&W is always an interesting story and so is today’s Reader Q & A with Doug Rogers.  Remember, we’re always eager to take your questions for Ask the Analyst at ask@stockupticks.com.  Additionally, if you’re a CEO or financial professional who wants to see their company’s story featured in our pages, email us at that same address and we’ll look into it.

And now ... 

Question: The market turning upward like it has over the past couple of weeks has me looking at small cap investments once again, wondering if recent gains aren’t signaling the end of the bear market.  Does this move up combined with strong earnings by big companies like Microsoft indicate we’re on our way back to a bull?

Doug Rogers: Seasonal adjustments to inventory in preparation for the holiday buying season have certainly helped corporate profits as manufacturers and raw materials providers fill the increased orders.  However, an increase in net income is always a positive sign as it demonstrates cash flow through the economy.  Corporate spending eventually trickles its way down to become employee wages that will be used to purchase products and complete the economic circle.  Obviously, it’s difficult to say that any particular current report indicates the end to any market, bull or bear.  We still see conflicting valuation data on many companies, indicating a lack of investor direction as they struggle with the readjustment of their portfolios against current fiscal needs.  The upshot is that indicators suggest that we’re coming to an equilibrium point, but we haven’t found direction.  Investors can now, however, begin to see which companies are most likely to rebound faster than others, thus presenting better opportunity to investors, but investment horizons should remain at least 12 – 24 months out. 

Question: As the Christmas season looms, what are your thoughts on retail stocks that benefit greatly from holiday spending?  How will consumer spending eventually affect these companies? Any optimism?

Doug Rogers:  Typically, retail stocks do a tremendous job during the holiday buying season.  These, however, are not typical times!  The performance of retail stocks is driven by consumer spending as you correctly suggested.  Jobless claims are expected to climb slightly for this month and consensus estimates in personal spending is expected to contract while personal income reports are expected to remain flat.  That combination of flat earnings, further lay-offs and decreasing consumer spending has cautioned retail analysts for months now.  I recommend seeking value in solid market performers that are reporting improving results, rather than seeking short-term gains through seasonal sector rotation.  The indicators that we’ve seen recently could catch investors out if they’re hoping for a surge in retail stocks from the holiday season alone.  A good combination might be to determine what you feel is the strongest retail player right now and invest with a 6-12 month horizon.  But, keep an eye on those consumer spending reports, many analysts are very concerned about retail sales this year.

Question: My buddy keeps pushing me to buy oil barrels before what he anticipates will be an inevitable conflict with Iraq, saying that the barrels will just go up and up in value. Another more cautious friend says that the general public has a misunderstanding as to how much U.S. consumed oil even comes from the Middle East and that it’s no big deal (to us). Who’s right?

Doug Rogers:  Oil production and prices are set by OPEC, which has historically demonstrated that its members’ enormous financial stake tends to transcend politics and religion.  Crude oil futures contracts, through March 2003 have recently dropped, indicating a lack of acute concern over the potential conflict with Iraq.  If Saddam Hussein, however, behaves like he did in Desert Storm and torches refiners, we could see a slight depression in short-term supply that temporarily drives prices up, but we cannot foresee that.  Oil prices have remained relatively stable since the late ‘70s and I don’t anticipate any significant material changes to that, despite potential military action in Iraq.  If you would still like to track it, watch the Crude Oil Futures contracts for dramatic changes.  If the pros are concerned, maybe you should be too!  Current available symbols for Crude contracts with expiration dates are CLZ2 – December ’02, CLF3 – January ’03, CLG3 – February ’03, and CLH3 – March ’03.

You’re other friend has a good point too, but needs to extrapolate to the next level.  It is true that only approximately 12 – 13% of U.S. crude oil imports in FY2000 came from the Persian Gulf, so much of the general public does have a misunderstanding about how much oil from the gulf is consumed by the U.S.  But, you’re friend hasn’t acknowledged why it is so critical for us to protect those flows of crude.  The Persian Gulf supplies the majority of consumed oil to our European and Asian constituents.  Price hikes and shortages in our largest consumer export markets would have a tremendous negative impact on the U.S. economy by the way of higher costs on imported goods, lower supplies and drastic cuts in foreign demand for U.S. products. 

Question: In the end, what will happen to shareholders of Enron or Worldcom? To put it plainly, are they all just completely screwed? Will shareholder lawsuits help? Will their shares be worth anything? 

Doug Rogers:  Holders of Enron stock will most likely not regain any significant value in their holdings, if any at all.  The Company is engaging incorporate garage sales and there’s no indication that it will emerge from bankruptcy in a form anywhere resembling its prior stature, if it emerges at all.  Right now, that’s not likely.  The primary problem with Enron is that most of the fraud was perpetrated with non-existent entities and assets, which means that a large portion of the Company never really existed.  I anticipate that other energy providers will bid for, and purchase, the remaining Enron assets like pipelines and power lines and Enron will cease to exist.  Stockholders will take their IRS taxable loss and move on.

Worldcom is slightly different.  Worldcom executives were intentionally hiding losses, but the Company’s significant assets and millions of monthly-paying customers still exist.  The assets and cash flow give the Company options to reorganize and eventually move towards stronger financial ground.  Kmart is another example of this and their recently announced contraction in losses is testament to the fact that companies can, and do, emerge from bankruptcy and rebuild shareholder value over time – sometimes a long time.

Question: Doug, if you were looking back at the rise and fall of dot-coms, what companies would you say have navigated the turbulence most successfully? eBay? Yahoo? Amazon? Do you give more credit to a company that had to really shake up its business plan on the fly (like Yahoo) versus one like eBay that pretty much stayed the course?

Doug Rogers:  eBay and Amazon, if those are my choices.  Both have demonstrated a tremendous amount of grit, determination and corporate focus.  Anyone who doesn’t at least respect Jeff Bezos for his commitment and strength of character is misguided.  The plan should never have worked, especially when compared to his peers and the overall market.  Heck, he had to turn to the European debt market at one point to raise the capital he needed to continue.  The results have been astonishing, frankly, because no one thought that one company could achieve economies of scale in so many markets, so quickly, utilizing a single medium that had demonstrated the futility in attempting to do what he did.  If that weren’t enough, Amazon relentlessly added products and services while cutting prices during some of the most pessimistic moments.  They lost $121 MM in FY2001, but compare that to their loss of $570MM in FY 2000!  Obviously, I am very impressed with Amazon the company and its management.  They have done a wonderful job of becoming to the 21st century, what Sears Roebuck was to the 20th and have remained agile and dynamic during the process while staying focused on the core business plan. 

Ebay also demonstrated their commitment to their core, but grew more organically through encouraging and supporting users while adding corporate clients that are almost transparent to users.  They had a good model based on low operating costs (ever tried contacting them?) and revenue-generating cash flow.  They’ve added services as demand dictated and acquired service providers when it was fiscally worthwhile to do so.  EBay’s Net Sales nearly doubled from FY 200 to FY2001 and EBITDA (operating profit) more than doubled.  eBay took a text-book route of achieving their goals by starting small and growing consistently with relatively conservative strategy.

Yahoo only survived the dot-bomb fall-out by virtue of its shear size alone.  Radical changes to a business plan and corporate strategy glaringly demonstrate the ineffectiveness of that plan to create long-term growth.  Yahoo remains a living example of how not to generate revenue, which is probably its greatest legacy.  It will (may) remain a testament to the misguided, poorly executed and gross extravagance of the dot-com era.  Yes, they have survived, but in outward appearance only.  Their size and the stature of those institutions and individuals with vested interests in their success enabled them to make core changes to their structure without significantly deteriorating brand equity and market clout, which is itself a tremendous achievement.

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