ValuePlays

In a stunningly underreported event, Congress approved the blueprint for the 2008 budget and in it is the single largest personal tax increase in US history. Where is the media on this?

Passed essentially online party lines 52-40 in the Senate and 214-209 in the house, the budget blueprint plans to allow the personal income tax, capital gains and dividend tax rates to increase in 2008. Quoting House Budget Committee Chairman John Spratt (D. SC), “It’s not the perfect solution, but it is a long step in the right direction.”

How? Raising taxes has never been the answer to our “budget” problems. Cutting spending has. More money in the hands of Congress will only lead to more spending. If history has shown us anything, this is an undeniable fact. In the outline, it proposes $20 billion dollars MORE of discretionary spending than the President had proposed. How about we back out that “discretionary waste” and not pick my pocket?

Corporations have spent the last 4 years raising dividends at a 20 year record rate as a way to reward shareholders. The effect of these increases will now be negligible when the tax rate on them is allowed to almost double. Look at the chart below.

The S&P has enjoyed a smooth ride as investor have parked their money and enjoyed the steady stream of reduced tax rate dividend checks. An increase in these rates would cut the value of these dividends by almost 50% and surely lead to a huge increase in volatility. While professional traders love volatile markets, they are the enemy of the average investor who gets sideswiped by the big market swings and end up losing money.

I cannot figure out why no one is talking about this now. One thing for sure, if it passes, it will be all we talk about..

George Soros initiated holdings in Food Products company Archer-daniels-midland Co. (ADM). His purchase prices were between $30.76 and $36.72, with an estimated average price of $33.6. The impact to his portfolio due to this purchase was 1.27%. His holdings were 858,500 shares as of 03/31/2007. Shares of Archer-daniels-midland Co. were traded at around $36.69.

Soros, while I could not disagree with his politics more, I cannot argue with his track record in his investments. He is truly one of the all time greats in that department and anything he does is worth noting and following.

I have stumped for the value of ADM shares (and have held them for years) on this blog many times, the latest being here. It is always a confidence booster to know that one of the world greatest investors seems to be thinking along the same lines as you.

ADM shares, up 15% since I recommended them in Jan., are only in the infancy of recognizing their eventual value…

Could this be the beginning of the end of the lead paint public nuisance suits? At least in trials operated on a contingency basis between the government entity and a private law firm. Yesterday, President George W. Bush signed an Executive Order barring all contingency fees with private plaintiff law firms and expert witnesses in litigation involving the U.S. government. This is momentous for Sherwin-Williams (SHW), and NL Industries (NL).

From Law and More:

“This is a profound statement of policy that should influence state and local government to look at contingency fee proposals with a skeptical and critical eye. Given recent experiences and developments in California and Rhode Island, other public authorities should expect strict scrutiny of such arrangements from ethical, legal, financial and political perspectives.

“The magnifying glass is focusing on this issue – and the public will demand transparency and accountability. No one wants an encore of the tobacco litigation disaster which enriched the states and contingent-fee lawyers dramatically but provided minimal, if any, health benefits.”

“This Executive Order sets a proper framework for fairness and is consistent with the way the U.S. government should contract for services generally for appropriate transparency and accountability. While it may have precious little impact on the disposition of state leaders inclined to enjoy what they perceive as a Free Lunch, especially Democrats, it draws the right line in the sand for those officials of either party in the states who are concerned about abuse of the system they are supposed to uphold with integrity.

“A prime example is the just retired long-time esteemed Democratic Maryland Attorney General who had taken understandable umbrage at the temerity of noted trial attorney Peter Angelos who claimed that the had ‘contracted with the state’ to receive 25 percent of the $4 billion the Free State took as its share of the global tobacco settlement, or a cool billion dollar sure thing for what was over $200 million for his ‘effort.’ So – over time – principle shall triumph, as Americans loath those who rig the public system for gross financial gain without earning it.”

The U.S. Chamber of Commerce has issued a press release on this development.

Fully expect this to now follow to the state level….

This is great news for Sherwin-Williams and NL Industries as it is the beginning of the end for this litigation.

Read the Execuative Order here.

Corn prices have fallen 25% since their early March highs and the weather the past two weeks has lead to a surge in planting with up to 40% increases in some areas. The beneficiary? Ethanol producers. Versun (VSE), who recently experienced a 31% increase in revenue, reported a quarterly loss and said the culprit was increased corn prices that had them paying $4.05 a bushel in Q1 and a inexplicable $33 million “loss” contributed to hedging. How do you lose money hedging against higher corn prices when corn prices go higher??

When you consider Aventine (AVR) reported a profit and said they paid $3.58 a bushel in Q1, Verasun’s results seem to be an indication of poor management rather than rapidly deteriorating fundamentals in ethanol. Considering estimates have ethanol being profitable to produce at corn prices up to over $4.80 a bushel, ethanol will remain profitable for the foreseeable future. Archer Daniel’s Midland (ADM) reported Q1 results recently and while they do not release their price paid for corn (I presume this is due to it being dramatically lower than their rivals and would put pressure on suppliers to provide these prices to others), they reported an increase in Q1 corn processing results. Shares of Pacific Ethanol (PEIX) are traded up 12% after their earnings actually came in it a profit

Now that we have a record corn crop going into the ground at a rapidly increasing rate, corn prices look to plummet before the summer is finished. When you add the fact that new ethanol production capacity that was scheduled to come online has slowed due to the higher corn prices, anticipated demand will not materialize. For ethanol producers who managed their businesses well during the price spike, this will mean a series of earnings estimate beating results will come rushing in. Ethanol producers are in a unique position to be able to hedge their input prices against spikes. The rise in corn prices seems to have taken no one other than Verasun by surprise and producers actually benefited from it. Now that prices are falling and gas prices are going in the opposite direction, more good news is in store for investors.

With the current outlook poor for the sector, shares ought to spike on the unexpected good news.

World’s biggest retailer Wal-Mart (WMT) said Tuesday quarterly profits rose 8% to $2.83 billion ($0.68/share) and revenue rose 8.5% to $86.41 billion — hitting analyst estimates exactly. Wal-Mart said Sam’s Club and international operations were its strongest areas, while food and generic drug sales were large growth sections. It expects domestic comparable-store sales to rise 1-2% in the coming quarter after a 0.6% first-quarter rise. It forecasts Q2 earnings from continuing operations of $0.75-0.95; analysts had been calling for $0.79. In the company’s earnings press release, CEO Lee Scott shrewdly observed: “While these are record sales and earnings, we feel there was an opportunity to have done better,”

Thanks for the heads up Lee. Kind of like General Custard saying “we should have brought more guys”

It is time for Lee to go. It is not for the standard reason people give, the stagnant share price. Let’s be honest here. If you were dumb enough at the turn of the century to pay 60 times earnings for a massive retailer growing at less than 1/2 that, you deserve the predicament you are now in. Given Wal-Mart’s scale, it would have been impossible for ANY CEO to get performance out of the company to justify that high of a PE ratio and avoid the eventual share decline. The price of the stock had to fall.

Why should Scott go? I have been in 4 Wal-Mart the past 2 weeks and one thing sticks out. They have not changed at all the past 7 years. Everything feels the same, the look , the merchandise, the people, everything. The worst part is, there seems to be no plans to change anything. If you are struggling with earnings and growth because you have become stale, do something different. You just can’t sit there, no matter who you are. How about this? Let’s update the clothing. We have heard for years that Target has had great success with low cost brand name designer clothing. Wal-Mart’s is just low cost and in an increasingly brand conscious world, it just is not cutting it. Let spruce it up a bit. Maybe we could take some of the $7 plus billion you are sitting on and buyback a meaningful amount of shares? Wal-Mart is increasing cash at an over a billion dollar a year pace and last year spent just over that on share buybacks. Let’s take $3 billion and make a dent in the shares outstanding ( 1.5%) and give more back to shareholders if we are not going to put it work anywhere else.

Here is another issue. When I go into as Target, I can easily fins my way around because the layouts of the stores are very similar. It makes may shopping experience less frustrating. Are there any two Wal-Marts that are laid out the same? It makes it very difficult to “just run in” to a Wal-Mart to pick something up. Given the choice, I will choose a Target for thje convenience.

Wal-Mart’s image has taken a hit. When people want something “cheap” they think Wal-Mart, when the want a value, they think “Target”. Because Scott seems to have no desire to change that, it is time to go….

I hold no position in any company listed above.

Just when you thought consumer home equity induced spending was dead due to a slowing market and tightened credit standards, a new product promises to put some juice into it. REX & Co, backed by a subsidiary of AIG (AIG) has a new product that lets homeowners tap the value of their homes without taking out a loan.

The novel product gives homeowners cash for their equity in return for a portion of the proceeds from the eventual sale of the home. For instance, a homeowner who has a $500,000 home can extract $100,000 of that by giving REX 50% of the change in the home value. So, if the home is sold in 5 years for $750,000, REX receives half the increase, or, $125,000. If it sells for $600,000, they receive $50,000.

It is a break from the traditional debt based equity extraction option homeowners currently have and is available in California, New Jersey, Virginia, Florida, Washington, Colorado, New York and North Carolina. Founder Thomas Spoonholtz expects it to be available nationwide within a couple of years.

He aims to have it sold through mortgage brokers with up to a 2% of proceeds fee and homeowners will have to commit to hold the home for a set number of years or face “early exit” fees or 5% to 25%. This approach will appeal to retirees looking to maximize the extraction of equity from their homes without incurring interest payments. Younger borrowers will like the fact that their debt ratios will not increase and the effect on their credit scores will be non existent. It will also allow for higher borrowing limits since the home will be held for a minimum time frame, increasing the equity available.

What this product essentially does is allow current homeowners to borrow “future equity” in their homes and not pay interest charges.

Since “Woodstock For Capitalist’s” weekend in Omaha is now over, a bit about Berkshire and it’s leader. No one will will argue or dispute his past success and what he has done for shareholders. Nor will anyone attempt to belittle the atmosphere and honesty in which he runs the organization and the culture he created. That being said, being a former Berkshire (BRK) shareholder I would not consider purchasing shares until Buffet steps down. The reason? $40 billion in cash and no plans to spend it. Berkshire is, in essence an insurance company that pays no dividends. It’s results the past two years are due to one factor, no major catastrophes.

Buffet has the ability to “buffer” shareholders against the eventual catastrophe and it’s impact but refuses to part with his cash. Insurance industry profits have been at all time highs the past two years and even Buffet himself has acknowledged that this cannot continue. Berkshire earnings increases over that span have been due solely to insurance profits, not investing gains or increases in it’s other operating segments. Industry pricing has already come down and we are one active hurricane season away from watching those record profits evaporate. When they do, Berkshire shares will take a hit with them.

Here is my issue, Buffet has the power to insulate shareholders from this eventuality. His recent purchase of 10% of Burlington Northern and 15% stake in USG marked the first time this century he has taken a meaningful stake in any company. In the past 6 plus years he has dabbled in shares of Wal-Mart, Home Depot, Lowe’s and others without making any meaningful foray into them. When Berkshire was experiencing its meteoric rise, it was due to Buffet making huge investments in a handful of companies. Now, the definition of huge changes as your size does. $100 million to Berkshire in 1975 was significant, but today is 2% than of what Buffet has on hand to invest. That being said, Buffet still has the ability to make portfolio changing investments, he just chooses not to. Berkshire’s investment portfolio today resembles a mutual fund with small positions in over 30 companies that are bought and sold regularly. In the past Buffet has said “Wait for a fat pitch and then swing for the fences”. Why isn’t he doing that? Considering the investment possibilities Berkshire has, his recent investing record is one of bunts, not big swings. He has also said in the past “if you would not buy the whole company, why would you buy a single share”? Using his own logic, I have to ask “Warren, if you are going to invest $160 million in Home Depot, why not $1 billion” The theory still holds, if you would not buy 100 shares why buy one share and if you would buy one share, why not a hundred of them? An investment of 4% of his available cash is not “swinging for the fences”

25% of Berkshire’s current market cap is it’s cash. Shares trade at a PE of 15 times earnings and given it’s earnings ability and financial stability, that should be higher. The reason it isn’t? People recognize that the $40 billion will be sitting there next quarter and next year and in today’s low interest rate environment, money in the bank does not impress anyone. Put it to work and Berkshire’s multiple will expand.

Unfortunately, that will not happen until Buffet retires and someone else runs Berkshire’s investments.