Cheap Stocks…And Expensive Ones

Last week, we noticed an obscure little feature of today’s economy. Productivity – as currently measured – depends to a large extent on computers and information technology. The more computing power the economy is able to put at your fingertips per dollar spent, the more ‘productive’ the economy is deemed to be.

The late ’90s were famous for reducing the price of computing power. That was the source of the ‘productivity miracle’ that the Fed chairman likes to talk about.

But who actually turns the little screws and snaps together the plastic components to make laptops, routers, keyboards and switches? At first, they were assembled in garages by American entrepreneurs. But it didn’t take long before high tech industry discovered outsourcing – just as almost every other industry in America has.

Today, much of the work of building IT devices is done by Hindus, Moslems, Buddhists or barely reconstructed Communists. What does it mean, then, when the computers are made overseas? Yes, a U.S. consumer gets more for his money. But he is still a consumer…not a producer. How has the U.S. economy become more productive as a result?

We don’t know. But we’re suspicious. High productivity is supposed to justify high stocks prices; productivity growth is meant to increase corporate profits by allowing a company to boost output without hiring more people.

IBM reported earnings recently. Sales were about where they were in 1997. Earnings were a little bit higher than they were 5 years ago. Instead of $1.06 per share, Big Blue earned $1.33 a share. But a close look at the report shows that it was not operation that made the difference – but various financial manuvers.

So, an investor today gets about what he got in ’97. The trouble is, he has to pay a lot more for it. A share of IBM went for $53 at the end of ’97. At the end of 2001, the same share was priced at $120.

Or, take Intel. Like IBM, the company’s sales in the last quarter of 2001 were about where they were in 1997. Five years ago, the company earned about $1 per share and the stock sold for $17. Today, you have to pay twice as much to buy a share…while earnings have been cut in half.

So, where are the earnings that productivity growth was supposed to bring?

Perhaps they are overseas, too…in the companies that actually produce the Information Technology components? We don’t know. But we never met a really cheap stock we didn’t like. And Marc Faber, in last week’s Barron’s suggested a few.

“Everything is a commodity,” says Faber. “A TV, A DVD player, even a strategist on Wall Street! In the long run when you have technological innovation a product becomes a commodity.”

Once it becomes a commodity, competition lowers prices…and forces production to the low-cost producers. Currently, many of these companies’ stocks are also at very low prices. Unlike the U.S., many foreign markets are cheap.

For example, Faber recommends a company called Bimantara Citra in Indonesia. “It is basically a media conglomerate,” he told Barron’s readers, “with interests in telecommunications, infrastructure, transportation, hotels and chemicals. The stock is now around 1,300 rupiah, and the net asset value is probably more than twice as much. Earnings this year will be about 200 rupiah, and the P/E is about 6. Bimantara is basically an asset play. And some people are circling for a takeover.”

Another Faber suggestion: Mayora Indah, “the largest manufacturer of candies and cookies in Indonesia. It has a market cap of $20 million and sells for 6 times earnings.”

“Kalbe Farma, a distributor and manufacturer of pharmaceutical products is also cheap,” says Faber. It, too, sells for just 6 times earnings and has a market cap – $50 million – barely higher than what Enron’s CFO earned for helping to hide the facts from investors.

Or how about Chareon Pokphand Foods in Thailand? There must be something important about the 6 times earnings price level in the Far East, because this company, too, is at that level.

“I am very bullish on Shanghai property prices in the long run,” says Faber. “I think Shanghai eventually will be a more important city than New York. China’s market capitalization was essentially zero in 1989. Combining the Shenzen and Shanghai markets, it is now close to $600 billion. So no market has grown faster. One way to play China is to buy a conglomerate called Shanghai Industrial Holding, listed in Hong Kong. It sells for about 11 times earnings.”

Also in Hong Kong is the Hang Seng Bank with a yield of 5% – twice what you can get from a CD.

Of course, you could buy IBM or Intel instead. That’s the discreet charm of the capitalist system. You can buy cheap stocks or expensive ones. Either way, you get what you deserve.

Your correspondent…

Bill Bonner
January 28, 2002 — Paris, France

If the recession is over – as many claim – it will be the shortest, mildest recession since WWII. The storm passed over so quickly, hardly anyone noticed it. Few picnics were postponed; few softball games were rained out.

“The report by the National Assn. of Realtors,” says an LA TIMES article, “attested to the amazing resilience of U.S. consumers, who have kept snapping up homes in the face of rising unemployment and weakening business conditions.

“Although home sales dipped in December, buyers purchased 5.25 million homes last year, 2.7% more than the previous year. Median prices of previously owned homes rose an impressive 6.1% to $147,500.”

And even in the shallow depths of the recession stocks remained at festive prices. The Dow rose last week, up less than 1% but already so high that the S&P 500 sells for 39 times trailing earnings. For the last half a century, the median P/E for the S&P is not even half that level – 15.6.

And from Reno, Nevada, comes news that International Gaming Technology, the company that makes slot machines, just had its best quarter ever – with profits up 9% from a year earlier. Gaming, in casinos or on Wall Street, is still a good business…as people seem to love to lose their own money in an attempt to get someone else’s.

So, Eric….what happened in the world’s greatest casino on Friday?


Eric Fry in New York…

– After two losing weeks in a row, the stock market finally notched a small gain. The Dow, NASDAQ and S&P 500 each advanced more than half a percent last week. But all three indices remain in negative territory for the year.

– Things haven’t been easy for the stock market lately. Along with all of the ordinary burdens – like collapsing corporate profits – that are weighing on its shoulders, the market must also fight for breath as it trudges through the toxic fallout from Enron.

– On the plus side, these noxious, corrosive vapors will likely strip away some of the market’s dishonest veneer. And the post-Enron market might become a better place to buy and sell stocks than it is today. Candor, for example, might become a little more fashionable among corporate management. Conflicts of interest might become a little less prevalent within Wall Street brokerage operations.

– In short, the U.S. financial markets might become the “level playing field” that Arthur Levitt tirelessly advocated throughout his tenure as head of the SEC.

– But there was little appetite for reform during the rip-snorting bull market of the late 1990s. Obviously, Levitt’s timing was off. Amidst the euphoria of the stock market’s bubble years, most investors would have preferred listening to a Beowulf reading than to Levitt’s voice of reason.

– But times have changed. Now that thousands have lost billions, some folks are seeking the former SEC chief’s counsel.

– “Enron’s collapse did not occur in vacuum,” Mr. Levitt informed the Senate Governmental Affairs Committee last Friday. Rather, it resulted from what he termed a “culture of gamesmanship.”

– It is a corrupt culture “that says it’s O.K. to bend the rules, tweak the numbers and let obvious and important discrepancies slide. A gamesmanship where companies bend to the desires and pressures of Wall Street analysts rather then to the reality of numbers.”

– This financial “anti-Eden” that Levitt described is a place “where analysts more often overlook dubious accounting practices and too often are selling potential investment banking deals. Where auditors are more occupied with selling other services and making clients happy then detecting potential problems, and where directors are more concerned about notoffending management and with protecting shareholders.”

– The cure that Levitt prescribes begins with “[exposing] Wall Street analysts’ conflicts of interest.”

– Meanwhile, over in the gold market there is neither conflict nor interest of any kind. The yellow metal has become a kind of financial “shut-in” – no one seems to care about it whatsoever.

– Instead, the long list of contrary indicators that seemed certain to presage a major rally in the gold market keeps growing longer and longer. It’s been more than a couple years since the Financial Times boldly declared the “Death of Gold.” And still, #79 on the Periodic Table of Elements has not stirred from its lengthy slumber.

– Two weeks ago, Alan Greenspan seemed to go out of his way to deny gold its historic role as the currency of last resort. The central-banker-turned-standup-comedian quipped, “If the evident recent success of fiat money regimes falters, we may have to go back to seashells or oxen as our medium of exchange. In that unlikely event, I trust, the discount window of the Federal Reserve Bank of New York will have an adequate inventory of oxen.”

– Then last week, adding insult to insult, long-time gold analyst Andy Smith from Mitsui Global Precious Metals informed the New York Times that gold is “yesterday’s money.” He punctuated his declaration by saying, “I doubt whether we’ll have three digits in this price in 5 or 10 years.” Presumably, the perennially bearish Smith was not predicting $1,000 gold, but $99 gold…best case!

– Could the sentiment in the gold market be any more bearish? Or, to put it another way, are there any contrary indicators left?

– The gold market is a Bermuda Triangle for contrary indicators. Eventually – you would think – there will be a point at which the sentiment simply cannot become any worse. We must be getting close when the chairman of the Federal Reserve implies that seashells are more valuable than gold.

– I own neither gold nor tech stocks. But if I were forced to choose between buying bullion or buying Cisco, I’d favor the reviled monetary relic over the revered tech icon.


Back in Paris…

*** Washington Post columnist, David Ignatius, finds evidence of American greatness even in the Enron debacle. “In a perverse way,” he writes in today’s International Herald Tribune, “Enron actually illustrates what makes American capitalism work so well: the possibility that even the mightiest company can suffer a total, devastating flameout.”

*** Compare this to the “frozen wasteland that is the Japanese banking system,” he invites.

*** Okay, we will. The Japanese think they have too much at stake to let the whole banking sector go down. The Bush administration did not think that of Enron. Here at the Daily Reckoning, we can’t help but wonder. What if J.P. Morgan…Fannie Mae…or the entire U.S. economy suffered a ‘total, devastating flameout?’ How superior would we be then?

*** Today marks the date on which Holy Roman Emperor Henry 4th ‘went to Canossa.’ He had been excommunicated by pope Gregory 7th, in a dispute over who got to choose bishops.

*** On that day, it was the Emperor who was Japanese. In an act of penance, he stood barefoot in the snow for three days at the Castle of Canossa, until Gregory pardoned him. But not long after, Henry 4th was back on top of the world…and forced Gregory to flee Rome.

*** Note to Ignatius: what goes around, comes around.

The Daily Reckoning