Sad Sight

It's truly a sad sight seeing how people will loot damaged stores. I remember being in New York after the 9-11 attack... people came together and supported one another. That was completely different from what seems to be going on in Louisiana right now. Man, that is one disappointing and pathetic sight as cameras catch these looters who show no simpathy for their fellow citizens.

Security can't even do anything despite being heavily armed. In my opinion, some of those nonlethal apparatuses would be perfect for dealing with such looters that give no respect for authority.

Fed Unlikely to be Aggressive

In hindsight of Katrina, the September fed fund futures rose slightly to 96.40. It still suggests that the Fed will likely raise rates to 3.75% in September 20th meeting, however the likelyhood of 50 bps has fallen. I doubt an aggressive move is necessary. However, those disturbing gas prices will likely impact inflation and thus, our economy.

Fighting Terrorism with Cool 007 Toys

Here’s an interesting story from the Washington Post titled Xtreme Defense for both venture capitalists and the kid in all of us who wanted cool James Bond gadgets. Just imagine how these tools would be able to get us out of sticky situations. There have been much talk and issues about the use of “nonlethal” weapons. This particular article follows around this entrepreneur with some interesting nonlethal apparatuses; but he learns that the venture capital game remains a tough game to play.

This article points out some of the new technologies surrounding nonlethal weaponry and their possible applications. Some of these uses range from counterterrorism to controlling public disorders. The report mentions some other defense and protective related products. I particularly like the mini-fortress shelter that could double as a sauna. This product may have come in handy for this hurricane season.

The Build Up Phase

I don't like to think about capitalizing off disasters, but you know there are people out there who will take advantage of any situation. I say it's better to acknowledge the truth instead of either ignoring or condemning it.

With that said, here’s a thought for the day. Money managers and analysts have a certain preferred method of building a portfolio. Generally speaking, most apply the top – down or bottom – up approach. Top – down basically means that you analyze the macroeconomic conditions and work yourself down to the company specifics. Bottom – up approach is the opposite, where you would screen for good companies and add them when conditions look favorable.

Well, here’s a bit of a top – down thought for the day. Hurricane Katrina devastated the southern part of the U.S. And many victims currently suffer a nightmare-like pain that will not be easy to relieve. From an investment perspective, think about what companies will benefit from the rebuilding phase. People will pick up the pieces and move on with their lives.

Nature Taking Its Course

I guess God will have his say in influencing our economy. Hurricane Katrina is expected to cause a record high cost of impact. I don't know how the insurance companies have been able to survive this hurricane season... Let me rephrase that, I don't know how home insurance buyers can afford high premiums, especially with mortgage payments and these oil prices. Oil rigs will also be damaged due to such devastating phenominon. These overwhelming storms may be the catalyst that slows our economy. Oil prices will likely spike AGAIN as supply is decreased. Help! President Bush, I think we will need to see some of those strategic oil reserves. I'm afraid to drive anymore, because going to the gas station is like a glutton for punishment... but I don't know how much more I can take.

You kinda have to ask yourself what's causing these storm attacks. I'm no scientist, but I'm thinking the reversal of the magnetic poles may have something to do with all of this.

Looking In the Footnotes

It's important to look through the past SEC filings to comprehend a company's outlook. You should also look at the economic factors that impact the company's revenues and profits. Another thing to do is to compare findings and valuations to its competitors. These tasks can be daunting, however looking through the 10 Q's and K's can lead to some warning signs that may prohibit further investigation and analysis. For instance, the Management Discussion and Analysis (MD&A) section explains the board's views of its company. You can also find off-balance sheet items that isn't reflected on its financials. I know my previous "blog" analysis on overstock.com is rather elementary, but a simple 30 minutes of analysis can reveal alot about a company.

I have nothing personal against OSTK's CEO, and putting aside the noise surrounding the company... you must ask questions when you see the following warning signs in its recent 10 Q:

We believe that the cash and marketable securities currently on hand, amounts available under our credit facility and expected cash flows from operations will be sufficient to continue operations for at least the next twelve months. While we anticipate that, beyond the next twelve months, our expected cash flows from operations will be sufficient to fund our operational requirements, we may require additional financing. However, there can be no assurance that if additional financing is necessary it will be available, or, if available, that such financing can be obtained on satisfactory terms. Failure to generate sufficient revenues, generate profitability or raise additional capital could have a material adverse effect on our ability to continue as a going concern and to achieve our intended business objectives. Any projections of future cash needs and cash flows are subject to substantial uncertainty. See “Factors that May Affect Future Results.”

What happens after the 12th month? This statement is too vague. Maybe they're basing this number on the working cap burn rate, in which case... what happens after the 15th month? Just a thought.

Or

We may be unable to generate sufficient cash flow to satisfy our debt service obligations.

Our ability to generate cash flow from operations to make interest payments on our debt obligations will depend on our future performance, which will be affected by a range of economic, competitive and business factors. We cannot control many of these factors, including general economic conditions and the health of the internet retail industry. If our operations do not generate sufficient cash flow from operations to satisfy our debt service obligations, we may need to borrow additional funds to make these payments or undertake alternative financing plans, such as refinancing or restructuring our debt, or reducing or delaying capital investments and acquisitions. Additional funds or alternative financing may not be available to us on favorable terms, or at all. Our inability to generate sufficient cash flow from operations or obtain additional funds or alternative financing on acceptable terms could have a material adverse effect on our business, prospects, financial condition and results of operations.

Or what about the part about how they completely depend on the 4th quarter and the holiday sales? One out of four... I don't like those odds.

All this should take you about 15 minutes to find when considering your investments (Hint: know what you're looking for and use the "find" function tool). Some may be willing to take the risk for the potential reward... what I to refer to as risk/reward (punishment) potential, but only you really know your risk tolerance level. At any rate, you should know the facts and use available information to distinguish investing from gambling.

How Long Can OSTK Last?

Going strictly on OSTK’s recent quarterly figures, the company’s burn rate (excluding capex) is approximately $3.4 mil. At this rate, its cash reserves and recent quarterly numbers imply that OSTK will run out of cash in about 9 months. Working cap burn rate gives a slight glimmer of hope for OSTK, suggesting that it has almost 15 months.

What are they going to do about cash if they don’t drastically improve operating and net margins? I can understand that Pat Byrne uses his company to favor consumers, but this comes at the cost to its bottom line figures. He doesn’t want to “play the Wall St. game” and gives little importance to EBITDA. Growing top line is easy when you’re practically giving things away, but what does that mean for its shareholders?

Pat Byrne seems like he’s reluctant to issue more shares to float. Its cost of cap is most likely to go up as banks would most likely second guess before lending to OSTK (who knows how it would be spent). I’m not sure funding his crusade would reflect a wise investment.

Was all of this commotion a bad and costly publicity stunt to get people to visit overstock.com? Pat Byrne takes the insults and then passes the company off to his father, as he stated this plan in the recent Q&A with Motley Fool. Whatever the case, its business model makes little investment sense. They need to seriously improve operations. Its future simply remains too uncertain, especially with all of its hoopla going on now.

Fed Fund Futures Probability

As of today, the Fed Fund Futures is pricing that at least 25 basis point hike is pretty much definite. The September price also implies about 50% probabiliy that the Fed will move more aggressively and raise 50 basis points in their upcoming meeting on September 20th.

You can refer to the resources mentioned at the end of my RWW article to see how fed fund futures probability works.

Fed Fund Futures probability simply calculates what these futures prices imply and indicates what market participants expect from the Fed. This is just one of many tools to forecast the Fed's moves.

Epinion Review Numbers

Numbers can often be deceiving, and accounting shenanigans are something analysts must be aware of when researching companies. We must be thorough, especially when investments are at stake. Aside from financial figures, analysts look at other numbers to help diagnose companies. These numbers include survey data.

Some people have expressed concerns about the review survey figures of Epinion, particularly that of Overstock.com. The number of reviews for Overstock.com on Epinion seem questionable. Amazon's 2004 annual revenue was $6.9 billion and received 1,060 Epinion reviews. Whereas, Overstock's trailing 12-month revenue adds to $641 million... yet it somehow managed to generate 35,286 Epinion reviews.

Let me see if I'm getting this right. Overstock generates less than 1/10th the sales Amazon realizes, yet OSTK somehow managed to obtain 33 times the Epinion reviews than those for Amazon! Overstock must be really (and I mean REALLY) good at convincing their customers to take review surveys. Maybe it’s me, but I don’t remember being so enthused about taking customer surveys.

To be fair, it is possible that Overstock is much more aggressive than Amazon when it comes to having its customers take reviews on Epinion. However, other reviews and surveys (particularly from Resellerrating.com) contradict that of Epinion. My point is this... only the survey takers really know how they rated a company. Survey numbers can be deceiving, so investors should be careful and not put too much faith in one survey. Overstock has been gaining alot of negative attention, and purely from an investment perspective, it's probably best to move on and consider better companies to add to the portfolio.

If Oil Goes Any Higher... Something is Gonna Pop!

I used to envy those who drove Hummers, Lincoln Navigators and the likes. Not anymore… like Mr. T used to say, “I pity the fool!” I pity the fools who drive those gas guzzling machines in highly gas priced environments. I remember when I could fill up my car for around 20 bucks; but now, I give a sigh of relief if I am able to fill it for under $40. That’s not nearly as bad as the poor fella that had to fork up 80 US dollars to feed his big badass Escalade.

Ladies and Gentlemen, these ridiculous gas prices ARE a problem. I like to think that there is some glimmer of hope that we could avoid a dismal economic outlook… but if these gas prices continue, then that may be the negative catalyst that forces our US economy to come to a halt. If I have to consistently second guess or question whether I really need to take my car or not, then I’m thinking everyone is thinking something along the same line.

There’s this term economists use, which is “purchasing power”… and well, I’m pretty sure I don’t have much of that given these conditions.

Overstock.com is Such a Blah Stock

Overstock.com has been gaining some headlines lately, so I figured I should take a quick look at its financials. Their recent quarter gross margin is 14% compared to Amazon's 23% annual gross margin. OSTK's admin costs are outpacing its gross profits... not good. It needs to seriously increase its gross profit per employee if it wants to generate any operating profits, and I don't know how they will do that with its CEO focused on his crusade to bring down the evil empire led by the Sith Lord.

Onto its balance sheet... OSTK's inventory as a percentage of its total assets is approximately 26% compared to AMZN's 14%, which implies that OSTK is having a relatively tougher time getting rid of its inventory. OSTK has also been building up their PP&E, and such investments may be of some help to the company as its recent quarter gross margin has improved from a little over 10% in the same quarter in the previous year to its recent 14%. However, this figure isn't even close to that of AMZN, most likely due to company size and some product differences. There are really too many factors to consider, which I'm not going to get into in this 15 minute analysis.

It has negative cash from operations, and its figures don't seem kosher... particularly the change in inventory. All in fairness, perhaps I've missed something; plus, this particular blog isn't a formal analysis. Beware of the free cash flow shown in Yahoo, because it is posting the recent quarter and general figures. It appears that the Yahoo figure is including sales and purchases of marketable shares (from the cash from investments). From what I understand, fixed capital investments should be factored in calculating free cash flow... not including marketable securities. With that said, OSTK sold over $100 million worth of marketable securities which would increase Yahoo's version of OSTK's free cash flow. I'm not certain exactly how Yahoo is calculating free cash flow, but I tend to notice they seem off at times... So I would recommend doing due dilligence before taking my word for it... especially from this blog analysis.

It doesn't seem wildly overvalued at 1.38 price/sales. However, P/S shouldn't be the only valuation ratio in determining a company's value. I wouldn't recommend buying nor shorting (even if it was possible) OSTK. I will say that Byrne's recent actions can't be good for OSTK.

With this said, I do not have any long or short positions of the companies mentioned in this blog.

Chaos in Markets

Traders, analysts, fund managers, and average day people all play the market. And tons of information and quantitative data flow continuously. Man, all this info gives me a headache. However, this concept known as chaos theory says there is order to this disorder. Do things really have a higher order of explaining these highly volatile fluctuations in various data? That's kinda like saying things are all predetermined... except it's too complex for a person to fully comprehend.
Sure, people have utilized fractal patterns, fibonacci sequence, calculus, and everything math and life has to offer to better explain chaotic behavior... and I guess that's why we should be thankful for the mathmaticians and scientist that study and explain these things to the laymen like us.
I'm the type of person that likes to understand concepts that's been thoroughly studied by some dedicated individuals and then apply the knowledge to however I see fit. Take for instance, people have analyzed music to where each note frequency can be seen as wave fluctuations like those in stock markets. They conclude certain frequencies allow scales to made simply because it sounds pleasing to the ear. I don't need to know every exact details to play what I am able to play.
My question is who is playing the music, and can anyone hear what's being played? And what kinda music is being played by the markets?

Neural Networks

You have to love technology. You can actually teach your computer to make predictions. This process is known as Neural Network, which utilizes artificial intelligence to recognize patterns.

Remember that it learns only what you teach it, so picking the right variables is extremely important in making correct predictions... garbage in, garbage out. I guess that's where the human touch is critical.

Statistics Is Only A Tool... But A Good Weapon

Stats and math is a good tool to have around. And no matter what, we will never have a perfect model that explains everything... particularly the stock market. Einstein once said something like that you shouldn't put too much faith in a beautiful (mathematical) model, because there's alway room for error.

That's funny because building models have become so easy with the development of statistical software packages. However, relying on what they spit out as results is like going on blind faith. For instance, say that you have built a nice model to predict the GDP. However, if the independant variable(s) you've chosen result in a regression error that is serially correlated, then you should know what that means and what those numbers say.

It's probably true that nobody can beat the market if they solely rely on couple of factors. It is necessary that many tools be used to manage your money. I like to think of investing as going into battle... the more intelligent weapons (tools) you have, the better likelihood of your success.

How High Will Oil Prices Go?

I suppose this is the question on everyone's minds. I think the following link will give readers a good overview of how gas prices work. This should give a good starting point to understanding where oil prices may head.

Are Markets Random or Not?

I've read many text on how people think market prices move randomly. This means that past price movements have no predictive value... So does this mean most of the financial professionals have no value in doing their jobs? Indeed this is something that academics would like to believe, thinking a simple buy and hold strategy is the best method to profit from markets. They also believe that there is no benefit of utilizing fundamental and technical analysis.

I'm sorry... I don't think markets are that simple. Their theories about how nobody can beat the market is ridiculous. People need to start thinking "outside the box" and realize that markets are not so random. Value can be found, especially when all the analytical tools are simultaneously applied.

Hedging It

John W. Snow appeared on CNBC and finanlly admitted that Chinese authorities have engaged in the derivatives market to exploit hedging techniques. I wrote about this in my July newsletter for R.W. Wentworth.

Here's a section from that newletter:

The more that people have attempted to explain Greenspan’s conundrum, the more confused everyone seems to be. Well, let’s break the situation down. We know that entities have been purchasing long-term Treasuries, pushing down the yields on these securities. Many believe the Chinese have contributed to this phenomenon.

Here is a possible explanation to why entities have bought Treasuries. Before the Asian crisis came to fruition, Asian institutions have been engaged in the “carry-trade.” Many hedging institutions use carry-trade strategies to profit handsomely from discrepancies in interest rates between economies. To briefly explain this hedging method, one would borrows (short) from the economy with the relatively lower interest rate and lends (long) to that with the higher interest rate.

Under some crucial assumptions, this strategy virtually allows one to make what I like to call free money. However, conventional wisdom tells us that there is no such thing as free lunch. For instance, a cross-border carry-trade method works only under a fixed exchange rate system with interest rate differentials, because exchange risk must be eliminated. Under a floating rate system, participants are vulnerable to foreign exchange risk. If China is abusing the carry-trade strategy, then that may explain their true reluctance to float the Yuan. China has been able to borrow on international capital markets at a lower rate than the World Bank charges.[1] According to Nouriel Roubini, Associate Professor of Economics and International Business at Stern School of Business (NYU), credit in China is reported to be unusually low, both in nominal and real terms.[2]

Certain requirements may provide some light to China’s situation. Some participants use derivatives like swap contracts to set their positions and profit from carry-trade. Typically, the only capital involved in swap agreements is the posting of collateral, which is usually in the form of G-5 currencies or government securities (excluding Japanese government securities).[3] Perhaps China has been using swap agreements and has bought U.S. Treasuries for collateral.

As mentioned, this is only a possible explanation because this cannot be confirmed by public data. Entities that use derivatives keep their positions off-balance sheet, allowing users to elude accounting rules or government regulations.

[1] http://www.dawn.com/2005/07/03/ebr12.htm
[2] http://pages.stern.nyu.edu/~nroubini/ChinaTripReport-Roubini-Setser.pdf
[3] http://www.financialpolicy.org/dscrole.htm