Streetwise for Sunday Sept 14, 2008

Streetwise

Lauren Rudd

Sunday, September 14, 2008

You Cannot Forecast Short-term Trends

Market trends, like the trends of individual stocks, are impossible to forecast over the nebulously defined short-term, which we will take to be 18 months or less. To claim otherwise is, in my opinion, pure nonsense. Now before I hear from hundreds of chart readers, let me state that I unabashedly stand behind Benjamin Graham and Warren Buffett in believing that the short-term price trend of a stock is merely an indication of the market’s emotional mood at a particular point in time.

However, the performance of a company’s shares over a period of a year or two will be a mirror image of its financial accomplishments. Notice that I did not mention the market’s performance being reflected in the price of individual shares. While there is certainly some effect, it is relatively minor.

Unfortunately, too many investors, professional and amateur alike, are wedded to rear view mirror concept. That is wrong. While past financial fundamentals play an initial role in the evaluation process, prior stock prices are of minimal importance. It is a company’s projected course going forward that should drive the investment decision. And, it is the company’s adherence to that projection that will ultimately determine the success of your investment.

Heartening prose no doubt, but at the same time it is natural to find yourself losing faith because of the market’s judgmental outlook. Yes, volatility and uncertainty are frightening, even to seasoned investors. Nonetheless, you need to constantly remind yourself that investing is not about how your portfolio performed yesterday, or how it will perform tomorrow. Rather it is about your success a year or two down the road.

Therefore, you simply need to find those corporations with winning records of accomplishment that sell products you understand and whose share price you believe to be below current potential. For example, unless you are new to the planet, you have probably at least heard of Wal-Mart (WMT).

Each month Wal-Mart offers up an update on what sold and what didn’t, the reasons why and the net result on sales. At the end of each quarter, overall sales are either up or down, as are profits.

So now it is left up to you to judge whether Wal-Mart is well positioned to provide some price relief from the seemingly never-ending rise in the cost of living. If you believe the answer is yes, then go forward with your investment research.

On Aug. 14, Wal-Mart reported net sales for the second quarter were approximately $101.6 billion, up 10.4 percent from the $92.0 billion the company reported in the second quarter last year. Income from continuing operations for the second quarter was $3.385 billion, an increase of 9.3 percent.

Earnings from continuing operations for the second quarter increased to $0.86 per share from the previous year’s second quarter result of $0.75 per share. The prior year did include a net benefit of $0.04 per share from the net impact of a reduction of general liability and workers’ compensation claim accruals, gains from the sale of certain real estate properties and charges for legal and other contingencies.

Sales for last month increased 8.7 percent over the same period a year ago, while for the prior 30 weeks, sales were up 9.5 percent. It would appear that Wal-Mart is doing something right, despite the negative connotation the name has to many people.

The intrinsic value of the shares, using a discounted earnings model with a discount rate of 11 percent and an earnings growth rate of 11 percent, yields a value of $80 per share. The more conservative free cash flow to the firm model provides us with an intrinsic value of $73 per share, as compared to the recent price of $62 per share.