Streetwise for Sunday Jan 25, 2009

Streetwise

Lauren Rudd

Sunday, January 25, 2009

Do Not Rely On Anyone To Part The Red Sea of Risk

“America’s Top Ranked Money Manager,” read the 2003 headline in The Wall Street Digest, an investment newsletter. Fast-forward six years: Sarasota, Florida money manager, Arthur Nadel, has vanished along with an estimated $350 million of his clients’ money.

According to the SEC, Nadel’s six funds appear to have total assets of less than $1 million, contradicting offering materials for three of the funds stating they had about $342 million in assets as of Nov. 30. The SEC has also said that Nadel recently transferred at least $1.25 million from two of the funds to secret bank accounts.

There are uncomfortable parallels between last month’s arrest of former Nasdaq Stock Market chairman Bernard Madoff and Nadel. Both were known for their social standing and philanthropic contributions. Nonetheless, they are charlatans of the investment world.

Madoff’s and Nadel’s promises of returns defied logic and are somewhat analogous to the Sirens in Greek mythology that lured sailors to their deaths with their irresistible songs. Like Madoff, Nadel’s investments generated returns regardless of market direction.

Here is a bit of advice. If you entrust money to a management firm, always make sure you have unrestricted account access. Philanthropic endeavors and social standing, while laudable, are not qualifications to manage money. Finally, accounts should always be independently audited by a recognized firm.

While those precautions will help prevent you from becoming entangled in a Ponzi scheme, they do not guarantee positive returns. Legitimate losses can and do occur. Stock prices fluctuate and at times those fluctuations can become nasty.

Unfortunately, rising volatility and falling share prices leads to a willingness to accept greater risk in an effort to capture additional returns. Add in a dollop of wishful thinking and some rose colored glasses and you have a deadly combination.

Do not rely on anyone to part the Red Sea and guide you to the Promised Land of high returns. It is your responsibility to separate the wheat from the chaff. Furthermore, with regard to stock prices, the past will not predict the future. Does that mean you ignore history? Absolutely not, in fact you should view historical financial data as a report card on management performance.

A good example is Cisco (CSCO), a company whose future appears bright despite the fact that it is about to undertake a new endeavor that could put it in competition with some of its key customers. However, it also has about $27 billion in cash.

For the its first fiscal quarter ended October 25, 2008, Cisco reported net sales of $10.3 billion, an 8.1 percent increase over a year ago, and earnings per share of $0.37, an increase of 5.7 percent. The company is expected to release second quarter numbers on February 4.

Of particular interest is Cisco’s entry into selling servers equipped with virtualization software as early as March. The company's move into the server market has long been a target of speculation, with technology websites over the past few months calling it by the code name "California." Targeting data centers, the new product line puts Cisco up against both Hewlett-Packard and IBM, companies it partners with in selling its network equipment.

The intrinsic value of the shares, using discounted earnings model with a discount rate of 10 percent and an earnings growth rate of 11.3 percent, produces a per share value of $38. A more conservative discounted free cash flow to the firm model produces a value of $41 per share. The shares recently closed at $15.70.