Guest Blogger Vince Farrell marvelled at Goldman Sachs’ market-moving ability. Who did Farrell say Goldman “unloaded” on?

Yesterday they unloaded on Citi and GM and those stocks got hit. Goldman effect?

As I noted earlier, my strategy has so far been not to be long Citigroup. It gets low marks for earnings quality, price momentum and free cash flow in the models I follow. As for GM, it doesn’t even qualify to run through the models.

In the blog post, “Options Action: Make $$$ on Financials”, Stacey Gilbert talks up a strategy for

Gilbert says there is a strategy for investors who are long stock, naming Citigroup (C - Annual Report) specifically.

My strategy has so far been not to be long Citigroup. It gets low marks for earnings quality, price momentum and free cash flow in the models I follow.

CNBC Stock Blog: Bernie McGinn says forget subprime — buy bank stocks. Which one did he call a “tremendous franchise”?

He also likes Bank of America (BAC).

“Bank of America represents a pretty good buy right here,” he said.  “It’s a tremendous franchise; it’s the number one in deposits, it’s number one in credit-card balances, it will be number one in mortgages.”

Of course, it is that last part that makes me nervous. In the models I use, Bank of America is most notable for poor earnings momentum, poor earnings quality and poor price momentum.

In his Friday “Game Plan,” Cramer said banks may bottom soon. But he warned of possible “catches,” including:

The catch here, and there always is a catch, is that if HOV and TOL report poor numbers and the U.S. has lost more jobs, Cramer’s predicting next week would be horrible for the financials. American International Group (AIG - Annual Report), Washington Mutual (WM) Wachovia (WB - Annual Report) and Bank of America (BAC) could sink to multiyear lows.

None of the stocks fare especially well in the models I use. HOV doesn’t even make it past the screens, and Toll Brothers scores among the worst for earnings momentum and return potential.

Bank of America scores poorly for earnings quality, earnings momentum and price momentum. The same applies for Wachovia, which also ranks low for free cash flow. Washington Mutual, by contrast, has a high free cash flow ranking but is also among the worst ranked for return potential.

AIG is the only name on the list that is not a net negative in my models. Its poor scores for earnings momentum and price momentum are offset by high marks for earnings quality and free cash flow.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

Realty Check: Who sparked Countrywide CEO Mozilo’s “disgusting” e-mail reply?

“Disgusting,” Angelo Mozilo wrote in his inadvertent reply to an e-mail from Daniel Bailey Jr. who had asked the company to modify terms of his adjustable-rate mortgage.

My personal opinion is that Bank of America (BAC) is crazy to be buying Countrywide. I don’t know enough about the companies to say for sure, but I remember what happened to Conseco after they bought mobile home lender Greentree, which was that era’s equivalent of a subprime lender.

In the CNBC Stock Blog, “A Big Buy On Brazil,” what was Tom Del Zoppo’s advice?

Del Zoppo recommends that investors sell Citigroup (C - Annual Report) and buy Brazilian oil producer Petrobras (PBR).

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

On May 9’s “Stop Trading”, Jim Cramer warned NOT to buy certain stocks. Which one did he call a “travesty”?

Citigroup (C - Annual Report), AIG (AIG - Annual Report) and Circuit City (CC). Three of the worst companies America has to offer, at least that’s how Jim Cramer sees it.

But it’s AIG that takes the cake. The world’s biggest insurer has become a “travesty,” according to Cramer.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

Regular readers know I follow the spread between Baa-rated bonds and Treasuries to get a feel for how much they are willing to accept risk.

Last week, as the market rallied on the initial news of the JP Morgan (JPM - Annual Report) and Fed-led rescue of Bear Stearns (BSC) I said “The big questions are whether, how much, and how quickly the spreads will begin to narrow again. That will be the real signal from bondholders that the worst is behind us from the current crisis.”

Instead, credit spreads continued to widen. They averaged 343 basis points last week, up from 340 in the prior week.

It remains a double-edged sword. As long as the spread continues to widen, risky assets will perform poorly. However, the abnormally high risk premia we are currently seeing indicate that longer-term investors will be paid more handsomely for accepting such risks than they have been paid on average in the past.

By all accounts, JPMorgan (JPM - Annual Report) has all the leverage to complete its proposed acquisition of Bear Stearns (BSC) for $2.00 per share. Actually, since it is a stock deal and JPMorgan shares have risen since the announcement, the acquisition price is now $2.40 per share.

Still, for a deal likely to be made at $2.40 per share, why would anyone be willing to pay $5.00 per share for the stock today? One answer that keeps getting bandied about is that bondholders are buying the stock in order to vote for the deal, as it is worth losing some money on the stock to preserve the value of the bonds.

That argument makes some sense, but I believe it doesn’t tell the whole story. It is possible for the bondholders to not only preserve the value of their bonds, but to lose very little on the stock in the process.

While the stock has been getting all the news, options on Bear Stearns have seen enormous trading volume. I think the bondholders are buying the stock, but hedging their bets by creating synthetic short positions.

A synthetic short consists of writing a call option and buying a put. Here’s how I think a bondholder can be playing this:

Buy 100 shares for $5
Write an October $5 call option for 2.10 (bid price as I write this)

Buy an October $5 put for $2.45 (ask price as I write this)

Net cost for this transaction is $5.00 + 2.45 - 2.10 = $5.35. At expiration, it will be worth $5.00 no matter where the stock is trading. So, for $0.35 per share, or $35 for every $500 of exposure, the bondholders can buy the right to vote on the deal.

Given that the bonds were trading at $700 per $1,000 face value on Friday, and are worth $1,000 when backed by JPMorgan, it is pretty simple math. For every $1,000 of bond exposure, you can pay $70 to vote in favor of a deal that is worth $300 to you.

What’s more, since there was so much more debt than equity, only a small fraction of the bondholders need to make this bet to gain an overwhelming majority of the equity votes.  Or, each bondholder could insure a smaller portion of their value.

Taking that into consideration, paying $5.00 for the stock starts to make sense.

Provided, that is, you already own the bonds.

How quickly value can evaporate these days. Bear Stearns (BSC) closed on Friday at $30, down from $57 the night before. I spent the weekend working up an article on why investors should still avoid it despite an apparently low price relative to book value. Before I could publish it (not that it would have done any good), JPMorgan says it will buy Bear Stearns.

JPMorgan Chase & Co (JPM - Annual Report) said on Sunday it would buy stricken rival Bear Stearns for just $2 a share in an all-stock deal valuing the fifth largest investment bank at about $236 million.

How could a stock go from $57 to $2 in two trading days, all the while having a book value above $80? I can’t say, exactly. But here’s what I was planning to say on the assumption that the stock would still be $30:

Many value investors look for stocks trading at prices below the company’s book value per share. Such stocks are often undervalued.

After Bear Stearns’ shellacking on Friday, the stock closed at $30. Yet on the conference call, Bear Stearns CEO said its book value “fundamentally” is still in the mid-$80 range. Does that mean value investors should step in?

I don’t think so. Taking a look at the 10K the company filed in January, I found it quite easy to make most of that $11.8 billion book value disappear.

To start with, there is $950 million recorded as “goodwill & intangible assets.” Subtracting this out leaves a tangible book value of $10.8 billion, or $82 per share.

Next, Bear’s balance sheet includes, in “other assets,” $5.2 billion in “financial instruments that are valued using models or other valuation methodologies.” Most of the total is “comprised of financial instruments whose fair value is estimated based on internally developed models or methodologies utilizing significant inputs that are generally less readily observable.”

Given that the credit issues have really just started to flow through the system, I’d want to be conservative about the value of these instruments. For the sake of argument, I’m assuming they are really only worth half their book value. Admittedly, I’m just making a guess. But then again, so is Bear Stearns.

If I take $2.6 billion off the value of these instruments, the tangible book value is reduced to $8.2 billion, or $60.22 per share.

Bear also reported $33.5 billion in “assets of variable interest entities and mortgage loan special purpose entities.” These were the loans it was unable to move off of its balance sheet. Of this amount, Bear says its maximum loss is nearly $3 billion. For conservatism, I’ll assume that maximum loss gets realized. That cuts the tangible book value to $38.

Finally, As of November 30, 2007, the Company had notional/contract amounts of approximately $13.40 trillion of derivative financial instruments, of which $1.85 trillion and $1.25 trillion, respectively, were listed futures and option contracts. These amounts are not fully reflected on the balance sheet.

It’s likely that many of these derivative instruments offset each other, reducing the total exposure Bear faces. But without being able to see the underlying contracts, investors are unable to make that judgment. Since the tangible book value is less than a tenth of one percent of the notional value of these contracts, it isn’t hard to imagine the contracts changing in value sufficiently to wipe out the remaining tangible book value.

While there may be a buyout of Bear Stearns, it would be made by sophisticated investors with full access to the company’s financial information. These investors are in a position to determine a value for Bear Stearns.

I, on the other hand, am not. And if I can’t make a reasonable estimate of the company’s value, I’m going to stay away.

Disclosures: William Trent has no positions in the companies mentioned