Tuesday, June 2, 2009

Here’s How You Can Figure It Out Yourself…

“Any suggestion that an American corporate icon like GM could file for bankruptcy would have been laughable a few years ago,” said Lynn Hiestand, a lawyer specializing in restructuring with Skadden, Arps, Slate, Meagher & Flom LLP.

That statement really seems to capture the moment of GM’s bankruptcy. I’d take the observation even further…noting that – in some of last year’s A-Letters – we were relatively certain Chrysler would fail.

But even as recently as six or eight months ago, GM’s bankruptcy didn’t seem like a sure thing…

Between tens of billions in bailout cash, Obama’s tight relationship with the UAW, and Waggoner’s insistence that a GM failure would bring about the end of the world…well let’s just say this one seemed a tad less likely, even to us.

It wasn’t a laughable idea…but it wasn’t as certain as it’s become over the last few weeks. Now, we observe the customized bankruptcy of an American legend with the same detached amusement as watching a waiter pour a glass of iced tea. My, how quickly the times can change…

But What if YOU Were A GM Shareholder?

What if – amongst such stalwarts as Kraft, JP Morgan and GE, your portfolio had a healthy allocation of GM in the mix? Venerable blue chips, your broker tells you, stocks for the long haul, as the book title goes.

But nothing lasts forever, as GM’s collapse reminds us. And while some of us can dismiss it with flair (Good riddance to bad autos!), others might be having a crisis of confidence when it comes to their stock holdings.

Is my money safe with GE? Should be the new hot-button question for you. As the weekend A-Letter always says; De Omnibus Dubitandum, or “all is to be doubted.” And that includes Jack Welch, CEO of GE.

Am I predicting GE to go in the hole next? No, not at all.

I just want you to consider it as a possibility. As Lynn’s comment above suggests, GM’s bankruptcy might’ve seemed impossible just a few years ago. But look at GM now: Proof positive that “Set it and forget it” is not a valid investment strategy.

You’ve got to keep the hawk-eye on your investments. And using some of the same metrics used by professionals and experts couldn’t hurt either. Here’s Andrew Packer with more…

“It’s all about their books,” Andrew says.

“And one of the major accounting trends to watch for is reported profits relative to free cash flow. There are two ways where rising profits and steady or declining cash flow can indicate a problem—and potential shorting opportunities.”

“First, inventories could be on the rise, even if higher profits are reported. That makes me worry about the quality of the reported earnings, as well as the likelihood of future earnings. A company may be taking advantage of bulk discounts from suppliers to obtain inventory at the best possible unit price, but if they can’t sell enough at retail and end up marking it down in a few months—a very real prospect with rising unemployment— then future profitability may be compromised. Earnings will take a hit when the write-offs are made.”

“Secondly, accounts receivable (AR) could also be on the rise. This is the last thing someone wants to see when going long on a stock. Rising AR can be an indication that companies are willing to do anything to show a rise in reported profits—including selling goods to customers who can’t repay on time… or at all. Credit markets remain tight and fickle, and companies have considerable leeway in reporting the amount of AR that could be a future write-off. Add in some credit-crunched customers, and all the profits being reported by a company with rising AR now spells major trouble ahead.”

“Just like earnings growth, cash flows matter. Monitor changes in cash flows in your long positions and watch out for the potential issues listed above. And above all, beware companies that report write-offs on a quarterly basis—such things are considered, in accounting parlance, non-recurring. Sorry, Beta: cash flow matters.”

Admittedly – as you can tell from his language – Andrew’s a short-side analyst. But in addition to spinning off some of the fastest profits stocks ever offer, shorting offers the kind of invaluable insight that tells you which stocks to steer clear of…which is crucial these days…

And What About the Broad Market View?

After all, a rising tide lifts all boats. A falling tide lowers all boats. And a tsunami wave…well, you get the picture…

“Am I the only cautious investor in this speculative frenzy?” asks Eric Roseman.

“I think you have to have your head examined to put new money to work at these levels. The entire gamut of risk-based assets has surged since March with barely any profit-taking or backing and filling. This is not a healthy market; what I also don’t like is the fact that trading volume on the New York Stock Exchange (NYSE) has been contracting, not expanding since the March 9 lows.”

“This whole rally smells bad and investors should pick their speculations carefully at these levels.”

“What’s truly amazing is that global markets have started to discount a typical v-shaped recovery whereby global economic growth will recover swiftly before the end of the year. Indeed, concerted global government fiscal spending is now finding its way into the real economy; but let’s not get too giddy.”

“We are still in the midst of a serious credit contraction and most companies and consumers can’t secure revolving credit or obtain financing. This will be a sluggish recovery at best and probably u-shaped like Japan since 1990.”

“Don’t be duped by the popular press and Wall Street pundits telling you it’s a new bull market. It is not!”

…New Tricks?

Let me be clear though; we’re not saying there should be a mass exodus from the world’s stock markets.

Just because I don’t like them right now doesn’t say diddly for your needs and expectations. And we’re not saying you absolutely have to get out there and start trading currencies or something (though you’d likely be amazed at the kind of profits you could find).

No, instead we’re just saying that you need to keep your eyes open. That there’s more to a company – and in turn, their stock – than the hype on CNBC or the editorials in the Wall Street Journal. No, there’s a real company behind those letters on the ticker. A real company, with a real balance sheet, real profits, and real obligations.

And – as any seasoned A-Letter reader knows – taking such complicated things and cramming them down into a “fire & forget” or “stocks for the long run” portfolio simply invites disaster.

You’ve got to keep your eyes open, especially when it comes to your investments, to make sure you don’t lose big on the next GM, Lehman, Bear, or WorldCom.

Stick around for today’s Editor’s Corner, and our commodities expert Eric Roseman will let you in on a unique new Gold ETF that offers even more protection from the sinking dollar.

And Eric will be back tomorrow to tell you all about how he and his Commodity Trend Alert subscribers pulled in a 20% gain in May, using proven value investing strategies and companies with rock-solid balance sheets.

Yours in Personal Sovereignty,

MATTHEW COLLINS, A-Letter Editor

(For more information on Eric’s Commodity Trend Alert, just click here)