Streetwise for Sunday June 21, 2009

Streetwise

Lauren Rudd

Sunday, June 21, 2009

Some Clarity on Investing

If concerns over possible tax increases, health care reform, the deficit, inflation and potentially higher interest rates are clouding your investment outlook, you are not alone. Therefore, let me see if I can add a bit of clarity, while at the same time stripping away the emotional aspects of these issues.

There is no question that Medicare is the linchpin of deficit reduction. If, or more likely when, Congress does finally pass a health care reform bill, it is unlikely to include the necessary measures for reducing payments to doctors, drug manufacturers and insurers. Congress does not have the fortitude for a fight of that magnitude, given the special interests involved. Furthermore, even a serious health care package is not an overall panacea.

Therefore, the Administration is committed to a deficit equal to no more than 3 percent of GDP within five to 10 years. The Congressional Budget Office is projecting a deficit of at least 4 percent for most of the next decade, assuming some combination of tax increases and spending cuts.

Meanwhile, the current deficit is not leading to higher inflation, despite what supply side economist Arthur Laffer says. A recent study by University of Chicago professor Casey Mulligan concluded that inflation rates and government spending are only weakly correlated. Moreover, without the current deficit, as Nobel laureate Paul Krugman has said repeatedly, we would be facing a full-fledged depression.

And the statistics continue to show that the inflation remains under control. The Producer Price Index for May rose 0.2 percent. If you exclude the volatile food and energy sectors, the core PPI fell 0.1 percent. Consumer prices increased a minuscule 0.1 percent in May. The CPI’s core rate, excluding the food and energy, rose 0.1 percent. Consumer prices were flat in April and declined 0.1 percent in March.

This brings us to interest rates. Simply put, the Fed will likely reaffirm its position of continuing to keep rates at their current low levels at the close of its next FOMC meeting on June 23-24. However, long-term rates are market driven and subject to the vagaries of supply and demand.

Despite what some politicians would have you believe, the world is not coming to an end. So, while others are bemoaning their supposed fate, you should be adding quality stocks to your portfolio. A good place to start is the Street’s latest casualty, Best Buy (BBY).

Best Buy recently posted lower first-quarter earnings, and the outlook for the rest of the year appeared mediocre, compared to past performances. Nonetheless, its domestic market share grew by almost 2 percent from a year ago.

Earnings came in at $153 million, or 36 cents per share, for fiscal first quarter ended on May 30, down from $179 million, or 43 cents per share, a year earlier. If you exclude restructuring charges, earnings were 42 cents per share.

Revenues increased 12 percent to $10.1 billion. Gross profit for the first quarter increased to 25.3 percent of revenue from 23.7 percent, while sales at stores open at least 14 months declined 6.2 percent. However, a year ago consumers were spending government stimulus checks.

Best Buy reaffirmed it guidance of $2.50 to $2.90 per share in earnings, with revenues of between $46.5 and $48.5 billion. Same-store sales will likely be flat to down 5 percent.

Nonetheless, the shares appear undervalued. The intrinsic value, using a discounted earnings approach with an earnings growth rate of 12.2 percent and a 12 percent discount rate, is $65 per share. The more conservative free cash flow to the firm model produces an intrinsic value of $54 per share.