Revenue up 2.2%! Hype up 500%!
By: Bill Fleckenstein (via the The Damon Vickers Web Site)
The mania has come and gone, but Wall Street acts as if the old bull-market "rules" still work. Spurious notions abound, like stocks being cheap based on where they once traded or on
"relative valuations." Companies continue to promote their stocks, hoping that investors won't see through the hype. The times are tough, but facing the facts is the best medicine.
After the market close last Tuesday, Dell Computer (DELL, news, msgs) decided that a rounding error the length and breadth of 2.2% was the stuff of which news is made. Its
announcement engendered hallucinations of sugarplums in the Philadelphia Semiconductor Index ($SOX.X), as that index promptly took the lead to the upside the next morning.
As I watched the early action, it was just this kind of thinking that left me stunned by how few lessons have been learned thus far from our bear market, now 2½ years in the running. The
reasons cited for buying stocks are, in general, their supposed cheapness, based on some theoretical model based on assumptions. You rarely see bulls talk about how a specific
business is valued cheaply, given the dynamics of that business. This certainly can't be done for a multitude of companies.
Goring bull arguments
Owning corporate America en masse does not compensate you for taking risks, even if it's "at fair value" to some model based on Treasury yields. Just because 10-year Treasurys yield
3.70% doesn't mean that paying a big price-to-earnings ratio is a good risk-return proposition. In fact, it could be argued that the fact that yields are low indicates the economy is very
dicey and corporate earnings are less predictable, and that therefore we should pay a lower multiple. In fact, it could be further argued that stocks ought to produce a decent dividend
yield, as has often been the case in the past, to compensate one for the risk of owning shares. The market will determine over time what dividend yield is required, but the historical mean
is approximately 3%, and that's a long ways from here on the downside.
The other favored bull argument is psychology. So the line of thinking goes, everyone is bearish, just look at the CBOE Volatility Index ($VIX.X), put/call ratios, or some other variation
on that theme. And yet, more investment advisors are bullish than bearish. The speculation that surrounds the stock market is still all about guessing what the other crapshooters are
going to guess first.
Gravitational bull
The only real ally the bulls have is momentum. When the tape's on the move to the upside, everything is OK. But as soon as that stops happening, the fundamentals take over and stocks
start going down. I will just repeat this again: In my opinion, stocks are still too expensive, psychology is all wrong, the economy is getting worse, not better, and earnings are going to
get worse, not better.
Yes, it is true that stocks are down a long way from where they started 2½ years ago. But that doesn't make stocks cheap. It just goes to show you how totally ridiculous they were. After
all, at one point, the U.S. stock market became the global economy, having a valuation of almost 50% of the entire world's GDP.
I just don't see how this bear market can end without stocks being cheap, or at least close to cheap. This smug attitude about people being able to catch "the bottom," and that let's be
bullish because everybody else is bearish, or some variation on that theme, has to be eradicated. It seems to me that a bear market of this magnitude, following a mania the size of which
we had, ought to end in people being terrified and wondering if stocks will ever go up again. Perhaps I am being too extreme in my views, but it appears that what carries the day
continues to be hype.
Act III: The fat lady sings
Returning to Dell, it was with great fanfare that the company announced it would be beating the revenue estimate. The hoopla surrounding the headline surprised me, because after
running through the numbers, I saw that Dell was beating its current revenue estimate by a whopping 2.2%. But before talking about its need to sanctify what amounts to a rather
pedestrian rounding error, let me give credit where credit is due.
The company has executed brilliantly in the PC business over the last few years. Operating in a difficult environment, it has successfully competed against Gateway (GTW, news, msgs)
and Hewlett-Packard/Compaq (HPQ, news, msgs), which have not been able to execute well at all. So, I will grant Dell its superb execution and survivor skills. Instead, my rant has to do
with the promotional tactics that I believe the company uses to try to hype its stock. (For a somewhat more evenhanded, though negative analysis, please see "Too Easy for Dell," by the
ever-thoughtful Jesse Eisinger, in the October 2 issue of the Wall Street Journal..)
To appreciate the depths of the hype, let's begin by looking at the much-heralded number itself. Dell tried to frame the fact that its $0.21 earnings-estimate guidance was big news. But in
fact, that has been the same consensus estimate for some time, and that's what the company indicated it might make at its last earnings release. Now, I will admit that I myself was
skeptical that Dell could make the $0.21, and I can't wait to do the forensics on the income statement and balance sheet when they are reported. But that is a separate topic.
Returning to its projected 2.2% revenue increase for the quarter, my question is, what makes that so special? As any person who is close to any company in corporate America knows,
2.2% does not meet the test of materiality. (Remember, now, this is a projection, and we don't know exactly what's going to happen.) I happen to find it extremely promotional that a
rounding error up or down is deemed to be news. Can you imagine someone that you respect coming out and crowing that they might beat revenue estimates by 2.2%, but earnings
estimates are the same? I mean, ask yourself, what's the purpose of that? There's only one purpose -- to try to goose the stock.
Post-bubble lather
What has got me all lathered up is that this is precisely what went on all day long, every day during the mania, when companies shamelessly put a positive spin on everything that they
did, in order to talk up their stocks, so the executives could make money. Do you really want to own shares in a company where management is so focused on gunning its own stock? If
you're a speculator, you might love it. But if you're an investor, you should be worried, because what does it say about a management that diverts its attention from running the business
to managing its share price? Here, I would also just add, what does it say about a management whose stock focus entails put-selling and losing all the money it ever made from selling
PCs (retained earnings), plus a billion dollars and counting?
Of course, all Dell's cheerleading to a standing-room-only crowd of "investors" has now led to a multiple out of whack with the prospects for the PC business. Perhaps it's worth 15 or 20
times earnings, but do you want to pay 35 times trailing estimates for a company that two years ago was earning the same amount of money that it's earning now? Remember, this is an
industry that we know has little growth, limited barriers to entry, and competes on price. After all, if Carly Fiorina wasn't running Hewlett-Packard, Dell might not be doing so well. That,
too, is another topic.
Skull-to-crossbones ratio
Well, that is the problem: Too many in corporate America still think that they are in the business of marketing their own stock -- though thankfully, this has started to become less
fashionable. Visible companies like Dell in particular should be castigated for the practice, because it sets a terrible example for the rest of corporate America. Every promotional company
I have ever seen during my 22 years in this business has ended on the trash heap. No exceptions.
In any case, I believe that the model corporate citizen is a company that strives for credibility and understatement -- and Dell's immersion in hype constitutes neither an attempt at
credibility or understatement. Let's stop rewarding corporate chieftains for playing the game of stock promotion, and maybe they will get back to the business of acting like responsible
leaders. Meanwhile, if we as investors fall for this, we haven't learned anything from the fallout of the mania.
The Uncle-Sam scam
Finally, in the Yankee-ingenuity department, I'd just like to point out a recent story in The Wall Street Journal called "How to Juice the Return on a Savings Bond." Here we read about
how people have been using their credit card to buy bonds, cash them out, pay the penalty for early cash-out, and still come out ahead, via the credit card companies' frequent flier miles
or cash-back perks. It's just too bad that they can't redirect the energy expended in all this to learning how to be better investors – for instance, how to recognize the sham in corporate
American hype -- than milking a couple of pennies off of the U.S. Treasury. |
