Letter - August 2002





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Ready, Set .... ?

There was a comedian on the Fred Allen radio show called the Mad Russian, whose entering line (in a heavy Russian accent) was “How do you do?” Do what? Stand on your head and read Ilda Grosswax’s 17,000 word essay on the importance of breathing? Confused? If you have been in the stock market lately you certainly are, and if you’re not, toss this letter in the wastebasket and return to GO.

From April 2000 to this past April the stock market was in a slow decline, a steady erosion of prices; nothing dramatic, but cumulatively devastating. But in the past 90 days the bear has bared his teeth, taking a wallet-pinching bite out of equity portfolios. Hopefully, it will turn out to be his last gasp. Selling has been frenetic and irrational, interpreted by some as heralding the market bottom. A couple of record “up” days has convinced many investors that, indeed, the worst is over. Although there are still plenty of land mines out there, investors are beginning to bargain hunt. This week President Bush signed a bill that would further regulate Wall Street and hold the feet of CEOs to the fire. However, we do not expect investors to be overly forgiving. The shadow of ENRON will be with us for a long time and companies whose results do not meet expectations can expect the “deep six”. Successful companies such as CITIGROUP, the banking conglomerate; DUANE-READE, a highly successful drug store chain; and VERIZON, a leading telephone company, all have seen their stock prices sharply cut when expectations were not met.

Whose expectations?...... probably the group of analysts who follow the stocks. While their record of forecasting leaves much to be desired, brokerage analysts still have great influence over prices of stocks they follow. Let’s face it: what does the average investor know about individual stocks he owns? The problem is that in a few cases, stock analysts and corporate officers have had higher priorities than protecting stockholder interests. Hopefully that will change. It looks like Merrill Lynch has been chosen to be the whipping boy. But don’t put all the blame on the brokerage fraternity. The bond rating agencies such as Standard and Poors, Fitch and Moody’s are now trying to make up for past oversights by showing no quarter when analyzing balance sheets. A bond rating change can literally destroy a company overnight and has done so in too many cases. Also not helping the market is the Fourth Estate, which seems to take great pleasure in reporting the dark side of the financial world. The public has loved (stocks) and lost, something the media will not let them forget. Nor can CEO’s now forget or claim ignorance of the numbers: certify financial reports, signed and sealed, or go to jail! New found caution on the part of top officers will undoubtedly put pressure on the income statement. Soon we might be asking, “Where have all the profits gone?”

Despite market anxieties, stocks have not gone out of style. It has just become more difficult to find good ones. Looks to us (and just about everybody else) that the stock market has pretty well exhausted itself but lacks incentive to rally. The overall economy has been good for the past nine months. Yet, while it was heading north, the stock market was heading south. The stock market and the economy are out of sync, a not unprecedented phenomenon. If the economy slows down in the second half of the year, it should not necessarily deter investors who are looking forward to better times in 2003/2004. Sustaining the stock market should be a weak dollar, continued very low interest rates, and the prospect of increased government spending.

Having hedged our bets every which way, we still believe this is the time for investors to reconsider both additions to their portfolios and a general house cleaning. The new buzz word on Wall Street is “total return.” Shocking as it may seem, that figure is between seven and ten percent, which includes dividend support. More than ever, stock selection will be the key to successful investing. Stocks at the moment which we feel are favorably priced are…..

Citigroup (NYSE C, $33) eps $3.20, 10 times earnings… quality at an attractive price for this international financial giant.

IBM (NYSE IBM, $71.50) eps $4.00, 18 times earnings… technology and market exposure. Company has rising earnings outlook which does not appear to be acknowledged by the market.

CIT Group (NYSE CIT, $21) eps $3.25, 6.5 times earnings… IPO during bear market at depressed price makes this leading financial lender look cheap. San Juan Royalty Trust (NYSE SJT, $10.15) dividend yield 10%... in natural gas we trust. Long reserve life, high yield and no balance sheet risk. Natural gas, currently depressed, has bullish long term outlook.

Cendent (NYSE CD, $13.80) eps $1.40, 10 times earnings… travel and real estate services including Avis, Howard Johnson, Ramada Inns, Century 21, Coldwell Banker … well run with steady earnings growth… management has consistently beat earnings estimates.

Echostar (OTC DISH, $16.25) growth in revenue and profitability… excellent management team and strong growth in cash flows makes this satellite broadcaster a great long-term holding.

Philip Herzig

We urge you to read our important notice about these letters and the securities they mention.