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I promised last week that I would actually write a bull opinion on a stock rather than going around and ripping the social media space. So I’m gonna force my attention over to financial institutions and recommend a buy. Beware: most of my posts are written as a result of something I see in the market. This time, however, I’m writing because I want to be bullish on something.

I was tempted to do something in Europe but given the turmoil and uncertainty, I could not think of anything I’d actually recommend.

So how about Bank of New York Mellon? It’s great asset manager that has gone through a lot of M&A, acquiring asset managers around the world. This does two things: it diversifies their holdings and gives them increased economies of scale. Given that it is in an industry that is going through much consolidation, worldwide research and economies of scale is a good thing. Add to that a wide economic moat and its an attractive company.

So how are the stats? At 21.44 it’s trading at 3/4 book value of 28.51 (ttm). Compared to the S&P 500 it’s trading below PE, Price/Sales, and Price/CF ratio averages also. Therefore, it’s a pretty cheap stock with regard to those metrics.

As I mentioned before, the company has done a large number of acquisitions lately but is not planning any future acquisitions. I believe this will give the company some opportunities to grow organically as these acquisitions settle into place.

Overall, it looks to be a great stock. While it is an “asset manager”, it also is a custodian for a number of funds, giving it the ability to collect fees at low risk, unless something like financial crisis of 2008 happens again and banks start refusing trades from people. But I don’t see that happening any time soon.

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I mentioned I’d talk about another social media stock NOT to buy. Very simple, it’s Linked In.

Before people start going off on me, let me get something straight. I love LinkedIn’s business model. It provides a great service, possibly more useful than Facebook. Also unlike Facebook, they have premium accounts which people in business will pay for (I’m thinking recruiters and people in HR). While it is not as social or developed as Facebook, it does provide some services and fills a gap that FB lacks.

On the flip side, it is trading at 600x earnings. Yeah. I know with regards to technology companies a lot of people say you have to through out the P/E ratio but when something is trading that high compared to earnings, you have to wonder whether its worth it. While FB is somewhere around 65-70x earnings, LI is 9 to 10 times that. Yikes.

I have this shirt given to me from Pink Sheets from when I was a market maker and used their product. On the back of it in big letters it says “CAVEAT EMPTOR.” So just a quick Latin lesson, it means “Buyer beware.” Here’s a fun cartoon about it found:

Now LinkedIn is a great company, just not at the prices its trading at. When the Price Earnings, Price Book, Price to sales, and Price to Cash Flow ratios are all out of this solar system, I stay away until it comes back to Earth. Still, it’s a company to watch.

I promise to write some things that are uplifting, particularly about something to actually BUY.

Image comes from:
The Bunny System

Le Crackberry

Remember when you responded to 100 emails a day using this?

Remember when it seemed every banker, business person, politician, and anyone else that needed email on their cell phone all seemed to be on Blackberries? Those days are starting to go away. Research in Motion, the producers of said “Crackberries” posted earnings yesterday and they were dismal. So how did the great Crackberry go down?

First, RIM can blame Steve Jobs. Apple came out of nowhere and started the iPhone. A smartphone that was almost as good as Blackberry for the technical side but winning on the social side. I mean, the best Blackberry had for social was being able to connect for chatting and not to mention the Blackberry Messenger. BBM remains important, but it’s lost out to Apple’s iMessage in a way… though I think it would be better if iMessage was more separate than text messaging.

Second, and maybe part of number one, RIM can blame Google’s Android. Android came out as a respond to the iPhone, but with a lot more open programming. The tech geeks (whom I know plenty of) love Android because of the open source attitude they have. Don’t forget about the tech geeks. Maybe it’s the business users that drive the market in the short run, but its the geeks that drive innovation in the short and long run.

Third, they jumped into changing their game too late. Only now they are starting to dramatically change things. They acquired a company with a new OS, QMX, that has been going on since 2010. But Apple released the iPhone in 2007. That’s way too late, especially when things change all the time, especially in social media.

In the end, what does this mean? Right now, RIM’s book value is 19.00 per share or so and it’s trading at about 13. This is not a good thing. I’d be short RIM long term, which is sad in my opinion. I love the fact that their OS is very technical. The problem is there’s no market for it. MS-DOS got beat out by Windows. Windows is close to being beaten out by MacOS. It’s the circle of life. While I love the technical side of RIM and Blackberry OS, it just won’t stand. Phones are meant to be social and for business. Apple and Google got it. RIM only focused on the business, and that’s they’re downfall. While I still think they can compete, I mean I’d rather have a Blackberry for work than an iPhone (if only for the keyboard), Apple will win out. Or Google will, seeing as they have phones with keyboards.

If this were a chess game, I’d say, RIM, check (and your options are limited).

Fun links:
iPhone vs. Burrito – and the Burrito wins!

In the prior week, banks fortunes have changed plenty. Consider Bank of America. A stock once considered to be cheap ran up to $10 and then back down as a result of the news resulting in their stress tests.

While I know plenty of people who liked B of A at lower prices, at 10 is when people start to get nervous. I’m certainly not going to say it’s overvalued at 10 but it’s not a place I’d like to know it. Not while there are plenty of other worthwhile banks out there. At 10 it’s trading half it’s book value, which might be a good thing to some. But considering it’s trading at ridiculous price earnings ratios and it has enough risky debt to question its balance sheet, you might think of other reasons why its valued as such.

On the contrary, look at Wells Fargo. A company that during the 2008 financial crisis definitely took its lumps. Afterwards it acquired Wachovia, a company with a good amount of bad debt in its books and in serious need of cash.

Wells on the other hand trades at about one and a half times its book value currently. Many people question the Wachovia purchase, but in reality, Wells didn’t have that many bad assets during the 2008 crisis. Instead, it was guilty of being in a bad neighborhood. While every bank was either selling (Bear, LEH R.I.P.), or tanking because of what it had on its books, Wells went down just for being a bank.

They saw an opportunity to buy Wachovia because they could and why not to expand operations? If anything, downturns in the economy shouldn’t make us feel like the sky is falling, it should make us look for opportunities, just like Bank of America did with its Merrill purchase, JP Morgan did with its Bear purchase, and Barclay’s did with its Lehman purchase.

While maybe I should like BAC a little bit more given that it looked for opportunities, that bank makes me nervous and I think its relying on its brand name. I definitely like Wells Fargo more because its a more true retail bank trying to expand, where as Bank of America was primarily a retail bank, expanded into something else, and is now paying for the consequences. You could argue that Wells may go the way of B of A, but I think it will manage its safe business with its more lucrative ventures in the future.

I remember watching plenty of soccer (football/futbol) matches. More specifically the 2009 Champions League Final between Barcelona and Manchester United. At the time, Manchester United was sponsored by AIG, which had received a $85 billion (which got up to $182 billion) credit facility from the US government. I just loved the irony that the American public was sponsoring a football club in the UK. Honestly, I laughed then and the joke still isn’t old. I honestly thought they should replace the AIG logo with a picture of Uncle Sam or the American flag.

This week, AIG announced they would be looking to raise $6 billion in order to help pay back the credit facility. In order to do this, they plan on selling AIA Group, an Asia based insurance holding company. While AIG certainly is in desperate need of some cash to pay back the US Treasury, I worry about the long term prospects of AIG.

As a result of taking the bullish side of the first credit default swaps, AIG really hurt itself as a firm*. In order to meet short term liquidity issues, it had to complicate its long term solvency. Meaning, it had to forego its long term credit for short term credit. Now, the bills are coming due and AIG has to trim the fat. The main issue I have with them selling off assets is that it will reduce the diversification of the firm.

Not only that, I believe that AIG’s sell of AIA is just the beginning. I’m pretty sure more will be coming. After this, AIG will have raised $6 billion of the money they need to pay back. Afterwards, they will owe about $42 billion back.

* Credit default swaps – A credit default swap is best thought of as insurance on a bond. You can buy a credit default swap on Greek debt. If Greek fails to live up to its debt obligations and defaults, you get paid. Think like a put option. You pay a premium for downside risk. You don’t have to own the underlying asset.

CAPM:

Ke = Rf + B x MRP
where:
Ke = Cost of equity
Rf = Risk-free rate (Basically, a treasury bond [long term])
B = Beta
MRP = Market Risk Premium

An except from Warren Buffet’s annual letter to shareholders:

From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a non-fluctuating asset can be laden with risk.

I’ve talked to a number of people about how stocks are priced and how they’re priced wrong according to the Capital Asset Pricing Model (CAPM). This is because CAPM assumes that stocks are perfectly priced which is based on the efficient market theory. A quick note on efficient market theory, it basically says that all equities are perfectly priced all the time. Meaning, a stock will be perfectly priced compared to everything in the market.

I feel like when you learn about pricing things in finance, that the efficient market theory is like a fairy tale. You want to believe all of that is true. In reality, it’s just used as a process used to make you feel warm and bubbly until you get hit with the harshness of reality. The reality is that markets will always be inefficient (at least in my opinion).

This is not to say markets become more efficient, if that makes any sense. As more and more people enter the market, instruments should be priced better. This is not to say that because the NYSE has the largest amount of volume that it is the most perfectly priced market. But ideally it should be. People’s sentiments go into pricing stocks. People are not always rational.

This brings us back to this concept of CAPM and beta. I read an article in the Financial Times also articulating the same point Mr. Buffet brought up in his annual letter to shareholders. What both are saying is that beta doesn’t accurately represent risk, it just represents how much a stock moves in according to a major market index. In the US, most people think of this as the S&P 500 index.

Therefore, in the US, let’s say there’s a stock ABC. If it’s beta is 1, that means when the S&P goes up one point, ABC will go up one point (on average). If it’s beta is 2, ABC goes up two points (again on average) when the S&P goes up one point. In the same scenario that the S&P goes up a point and ABC’s beta is -1 (which can happen but rare), ABC goes down one point (on average).

Now, let’s say a ticker, we’ll use BSC as an example, has a beta of .7. This doesn’t reflect the fact that they own a bunch of worthless bonds and that they are highly dependent on that portfolio for liquidity and/or solvency.

Most people will know that BSC was the symbol for the now defunct Bear Stearns. I really don’t know what their beta was in 2007 before it tanked. But I know it didn’t reflect the price of the stock properly. And that’s because most reports base their prices on CAPM.

(This may have a continuation)