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Sitting Around the Table July 20 2004

Dow Jones 10149
S&P 1102

July 20, 2004

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& tips on today's top undervalued stocks

You do not want to be on margin

Let us give this to you straight because you won't read about it in newspapers, or listening to the talking heads on television who espouse their nonsense through their prejudiced filters. We at believe you will make a fortune by looking at our ideas and making them your own, and if you give them sufficient time to work out. Harley Davidson and Black and Decker are two recent examples.

We believe that the market at these levels is reasonably priced. We also believe you have to be in the market to make money. No one will ever be able to time the market. Anybody, or any firm that tells you they can, is lying to you. Market timing does not exist. You have to make your decisions independent of market timing issues. We have never met a technical analyst who could MAKE YOU MONEY. They just don't exist. There is an entire industry built up around market timing and it is without merit. It is FUN though, and people want to believe in it, even though it is a fantasy.

Now for our straight talk. Our concern is a potential act of terror against the infrastructure of the United States, and what it would mean for the stock market temporarily. It seems to make sense that if we do get attacked, it will be before the November elections and not after. Think about it, whatever terrorists would do against us, would have a much broader impact before the election, not after. It could even TIP the election, one way or another. Such an act would have a negative impact on the market, perhaps shutting it down for a day or more, and opening decisively lower.

This is because the market is made up of basically two factors. One factor are the prices of individual stocks. The second factor is the overall level of the market. This means what people are willing to pay for the market generally. An attack would cause the overall market to trade lower period, at least temporarily.

The good news is that the United States itself could never, ever be knocked out decisively. A lot of pain is possible, but not a knockout blow. We have a $10 trillion dollar economy. Our infrastructure is worth something on the order of $25 trillion. Our national wealth is over $40 trillion. We are more powerful than any nation-state since the Roman Empire, and we probably eclipse ancient Rome as well.

With the collapse of the Soviet Union, a bi-polar world which was in effect for almost 50 years came to an end. This led to a general de-stabilization, and that's where we are today. Terrorism is the offshoot of this de-stabilizing process. Terrorism is the UNFINISHED BUSINESS that was not dealt with by both Republican and Democratic Presidents alike for 30 years, and now it must be dealt with. We are concerned with the financial impact on our stock markets and world markets only. That is why we are telling you this. You MUST NOT be caught on margin over the next few months. It is generally good not be on margin period, but it is especially true in this period.

We in America are a free society. That freedom makes us vulnerable to others, in ways we take for granted. The ability to move freely on subways, bridges, and highways, in theaters, the movies, all of this makes us vulnerable. Some crazed terrorist with a philosophy that falls off the edge of the table can easily take advantage of this freeness to hurt us. Whether it's our food supply or our electric grid system it doesn't matter. We can't PROTECT EVERYTHING, no matter what resources we put into the protection. As an example, Mexico is now part of the US electric grid system. An act of sabotage against Mexico's grid could easily knock out the system in the United States, and we don't mean for a day or two.

We are vulnerable overseas as well. The entire oil industry in Saudi Arabia is automated which means it can relatively easily be interdicted and disrupted. If you knock out some portion of Saudi's 20 million barrels per day, its puts us all back on gasoline lines for 3 or 4 hours per day, which we remember back in the 1970's. Just keep this in mind if you are thinking about using margin. We do not want you getting a margin call, it' s that simple.

We want to talk about two stocks today and a couple in the next day or two. The first one we want to deal with is Schwab (SCH). The Board of Directors of The Charles Schwab Company announced in the last hour that the CEO of the Company, David Pottruck has been fired. He's run the company for several years and since this stock is trading at a multi-year low and it shouldn't be, the Board got fed up, or did they? We think Charles Schwab himself stepped up to the plate, and fired Pottruck. Mr. Schwab is now personally taking over the company again, and why shouldn't he? Mr. Schwab built this company and we watched him build it. He is a revolutionary and an amazing innovator. He knows how to run a company.

Schwab the company has amazing resources and capabilities. This stock should have worked out by now. It is trading at a totally disproportionate level to the rest of the industry and that's going to change quickly. Schwab is not an individual to dilly dally around. We think we could see short-term positive movement the same way we did when Motorola announced a new CEO. In that case Motorola was up significantly in weeks. Schwab will make the company work regardless of short-term gyrations. He's just too smart to blow it, and he's turned this same baby around several times before when he has had to step in. Get involved with Schwab folks. We were early on this one, but in the end not wrong.

Black & Decker (BDK) $66.90

The stock exploded on the upside yesterday picking up over $6 in market value. Black & Decker announced the purchase of Pentair's Tools group. They will pay $775 million. This give BDK a much enhanced position in the professional tools segment of the industry they are in. Most do-it-yourselfers buy Black & Decker tools because they are trustworthy and relatively inexpensive compared to everybody else's products. This is because most people do not know the difference between professional tools, and the tools a hobbyist would use.

BDK was trying to fill a gap in their tool line. Pentair produces very famous professional lines of tools which include Delta, Porter Cable, DeVilbiss and Oldham brands. This is a big deal folks. If you remember we hit the ball out of the park with a company called Rayovac; they make batteries. When Rayovac acquired Remington Shaver, the stock exploded. We think the same thing is true here.

Think about it. BDK can deliver the new tool lines in the same trucks as they deliver their current line. They can eliminate one payroll department. A whole layer of executives can be released. The post-acquisition savings from the takeover will be huge. The stock market knows it and the stock market reacted.

By 2003 Black & Decker will add a dollar per share to their earnings from this acquisition. Part of this earnings gain will be from cost savings which we have spoken about. For the second quarter BDK put it all together and showed a 55% earnings growth. BDK is operating in a very favorable environment with a tailwind working on its behalf. This could be the best environment they have had in 20 plus years. They have also moved production to low-cost countries better than any of their competitors.

So what's it worth? Let's look at it this way. We can't give you consensus earnings because it will take at least 4 to 7 more days for Wall Street to re-compute their estimates for this company and develop a new consensus. We think we are looking at about $5.25 for this year and something approaching $6.20 next year. The stock is selling at 12 plus this year's earnings and less than 11 times next year's earnings. Look at the chart below:

  • Company 2004 PE ratio
    Black & Decker 12.7
    Masco 14.5
    Stanley Works 15.9
At $67 per share, the stock is still cheap. Would we initiate new positions in the stock? No, because that would make us momentum investors. We liked the stock as you know in November of last year at $47 and change per share. We could see the stock trade into the low $80's in the next couple of quarters. For the moment we hold and tell you to ENJOY THE RIDE, and good luck.
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