NVR

In my lexicon, NVR, a major homebuilder, stands for Not Very Risky. NVR was reborn in 1993 after declaring bankruptcy in 1992. The lessons learned then continue to pay off today. NVR does not tie up capital in lots, preferring instead to put options on them. The results have been excellent. The following chart describes the kind of steady stock results I prefer:

Orange You Sane?

In a post-Nardelli return to sanity, The Home Depot (HD) is focused on "three yards and a cloud of dust." The most recent quarterly discussion emphasizes that HD will slow down the rate of new store expansion, will not borrow money to repurchase stock and will improve the customer experience.

After years of "re-engineering" by Nardelli, these calls seem like a return to Home Planet Earth. CEO Frank Blake was astute in quickly selling HD Supply. This freed up capital and narrowed focus. Rather than engage Nardelliesque language, HD also depicted the new changes: lights that don't glare, bathrooms that are refurbished and clean, and floors that are polished.

When analysts focused on the macro environment, HD management brought them back to reality by simply asserting that cyclicality is a part of life. HD has presented the following graph showing "It's not different this time":


It stands to reason that a slow down in the economy would lead to greater "do-it-yourself" work, an interest in lower cost materials and repairing existing houses, rather than buying new ones. All of these trends are in HD's favor.

It's the Accounting, Stupid!

With all of the political claims of "transparency," the current challenges are actually accounting-based. A natural question for a business reader is "Why are the problems at the big banks and not the regional ones?" By reading the headlines, one might conceive that only big banks have gotten into trouble. Not so.

The larger banks have moved into more of a securitization-based method of business. This method, while superior, has a different set of accounting rules - those that "mark to market." Those of us in the securities business knew what a potential insanity would ensue - it's kind of like balancing my checkbook based on my wife's moods. Complete nonsense (well...mostly).

We have seen the results of this nonsensical accounting with regard to Fannie Mae and Freddie Mac. As these businesses delivered good results for the past few years, they were perenially under a black cloud for "accounting irregularities." The "mark to market" accounting, rather than actual cash flows, caused nightmarish financial restatements with billions suddenly disappearing and then reappearing. Analysts eventually just ignored all of the new accounting.

The regional banks are still, by virtue of antiquated methods of finance, allowed to use old-style accounting. When the cash flows start to decline, as they surely will, these banks will start to reveal lower earnings. The silver lining to the cloud of this "mark to market" nuttiness is that when the problems set in, the institutions are better prepared. For example, Fannie Mae and Freddie Mac have been much better prepared for the current crises as a result of years of haggling over their accounting. Ironically, then, a couple of years from now, larger banks (those that make it) may profit from this discrepancy.

The Law of Unintended Consequences lives on.

Harte-Hanks (HHS) Woes

Harte-Hanks (HHS) is an impressive niche player in the advertising industry with a dual focus on direct marketing and weekly shopper advertising publications. I have studied HHS closely since the sale of their newspapers to E.W. Scripps for nearly $800 million in 1997. It is difficult for a company to sell "on the sizzle," but HHS did. I wanted to see what their next act was.

Warren Buffett said that if you wanted to be considered a good businessman, get into a good business. The newspaper business has gone from an exalted franchise quality to a miserable business in a short period of time. (Mr. Buffett defines a franchise as having 1) needed products, 2) no close substitute, and 3) no price controls. ) Just how miserable HHS's weekly shopper business has become is depicted in the following graph created by Merrill Lynch:


Newspaper classifieds are experiencing a decline rate in excess of 20%. This decline is being blamed on the housing market and the economy. I don't buy it. In prior cycles, these revenues were considered countercyclical. Rather, I think this graph demonstrates the rapid deterioration of the economics in newsprint, pointing to the likelihood that these trends are long-term, not temporary.

Hope (for Oil) Springs Eternal

Oil Services companies are driven by the capital expenditure portion of the oil business, meaning that the revenues of these companies are received from the capital expenditures made by international and nationally-owned oil companies to discover and develop oil. Because I have an aversion to companies with high capital expenditures, lovingly termed "capital pigs," I have never been willing to invest in the Oil Services business. Yet, the cyclical financial strength (as measured by margin of profit and return on capital) of some of these companies has repeatedly peaked my interest. A graph from a Deutsche Bank publication shows that despite heavy participation in Oil Services by both U.S. and European companies, the U.S. market capitalization is four times as great: The publication states that the underlying factor is that U.S. Oil Services companies have margins of 30-50%, while European Oil Services companies have margins of 6%. This is surprising. The publication attributes this sizeable difference to U.S. Oil Services companies being focused "below the mudline (land or seabed)," while European Oil Services companies being focused "above the mudline." If so, there must be a principle operating here of something like "hope (or oil) springs eternal," meaning that the oil companies are willing to pay more for what is unseen and hoped, than for what is seen and known.

Why ConocoPhillips (COP)?

Ever since early 2006, when I learned about Berkshire Hathaway's (BRK) decision to purchase shares of ConocoPhillips (COP), I have wondered what caused BRK to choose COP over the other Big Oil companies. My analysis of an indepth study written by Deutsche Bank has yielded some results. These two graphs depict COP's conservative attitude towards geographic selection. While other companies drill with little regard for the political climate, COP appears to choose carefully based on honoring the "finders, keepers" principle.

History Of Oil

I have been studying a text about the oil & gas business written by the research team at Deutsche Bank. Since I grew up on a farm and experienced the volatility of commodity pricing, I have never been interested in oil & gas investing. However, watching the oil producing countries effectively "tax the world" has at least gotten my attention.

Since the beginning in 1859 when Colonel Edwin Drake struck oil, one clear pattern has emerged. Left to its own, capitalist enterprises will compete self-destructively to deliver oil at increasingly low prices. As a result, artificial constraints are necessary. The role of Standard Oil, the Texas Railroad Commission and OPEC has been the same - to impose these constraints.

I had formerly assumed that these "price-fixing" entities were not in the market's best interest. Actually, that is not true. Without their discipline, oil pricing would cause inappropriate pricing and utilization of a limited resource. OPEC is Big Oil's best friend. Current profits confirm this.

Also, there appears reflexivity between inflation and oil profits. With inflation, "stuff" is worth more. Gold reflects this. Yet oil not only reflects it, but is in a feedback loop pushing inflation up. Further, the best periods of investment performance for oil stocks have also been the best periods for small cap stocks. While I do not pretend to understand the connection here, it's worth thinking about.