Streetwise

Lauren Rudd

Sunday, September 5, 2010

Wall Street and the Football Season

Before we delve into this week’s topic, I would like to take a moment to extend a sincere heartfelt note of thanks to everyone who sent emails, letters and cards wishing me a speedy recovery from my recent knee replacement surgery. The surgery was successful and the road to recovery, while painful, should be uneventful.

Meanwhile, this is Labor Day weekend and of course that means the start of football season. In football, the offense usually huddles before each play by forming a circle around the quarterback, their bodies leaning forward, their heads bent inward and their butts pointing towards the rest of us.

On Wall Street, as Alan Abelson once pointed out, a huddle consists of an analyst calling out stock plays to an assembled group of wealthy clients, their bodies leaning forward, their heads bent toward him and their butts pointed at the rest of us. But wait, the opposition has a defensive play designed to increase to a more equitable level the taxes paid on the Street’s stratospheric levels of income.

Running interference for the Street’s offense, Steve Schwartzman, the billionaire chairman of the Blackstone Group, the private equity giant, compared proposals to end tax loopholes for hedge fund managers with the Nazi invasion of Poland. It seems that the avarice on Wall Street is as limitless as the pain and suffering it has wrought upon Main Street.

However, to atone for its sins, the Street limits many of its investment ideas to a specific client base, meaning those that generate the largest fees and commissions. In doing so, they prevent those less generously endowed, financially speaking, from the duress of information overload. One cannot help but admire such altruistic ideals.

Nonetheless, you are not excluded from the world of potential investment profits, albeit on a smaller scale. To that end, one of the most often asked questions is how I go about selecting the companies that appear in this column. The hoped for answer is that I have an algorithm that spits out “guaranteed to win” investment prospects. Unfortunately, I do not.

While selecting investment candidates does entail the analysis of large quantities of data, subjective human judgment has been and always will be the deciding factor that carries the ball to the goal line. Although computers can run complex algorithms and analyze reams of data in the blink of an eye, compared to the human mind the most advanced computer is no more powerful than a dim flashlight. There simply is no substitute for human judgment.

Unfortunately, the human intellect is also not immune to embellishing those expectations by including a large dollop of hope, some dreaming and maybe a prayer or two. The reason is that we try to mold reality to meet our expectations, rather than the other way around. Only an unemotional analysis will enable you to peer through the hysteria that so often envelops Wall Street. A good example is Novo-Nordisk (NVO), a Danish healthcare company with an 87-year history of innovation and achievement. The company has developed an extensive array of medical products and is a leader in its field.

When I last talked about the company a year ago, my earnings estimate for 2009 was $3.37 per share with a 12-month price target for the shares of $68. The company earned $3.32, which was a bit lighter than my estimate. However, the shares recently closed at $87.85. In analyzing the company, keep in mind that much of the financial data is released in Danish Kroner, so the exchange rate with the dollar is going to have an effect.

The intrinsic value of the shares, using a discounted earnings model with a growth rate of 21 percent and a discount rate of 15 percent is $154. The more conservative free cash flow the firm approach yields an intrinsic value of $115 per share.