I have not written in some time about a theme that I think is an important one. Skeptics could probably argue that the reason I haven’t written about it was that the recent facts have contradicted my belief, though the fact is just that I haven’t gotten around to it. So, to put the cards back on the table, it is time to talk about valuation cycles.

Many people can tell you that the average market P/E over the long term is something like 15 times. Of course, “average” doesn’t imply that the P/E is always 15. About half the time it is higher, and about half the time it is lower. The trick is figuring out in advance which half is which.

In behavioral finance, some would argue that the market follows long-term trends in valuation. Rising valuations spark investor interest, and additional investors adding money to the market causes further increases in valuation.  Once all investors are in the market, though, valuations peak. As they begin to decline, investors gradually lose interest and start pulling money out of the market, further causing valuations to decline.

The theory would explain why, despite profits following a fairly regular 7% annual growth rate, the market tends to have large advances followed by long periods of sideways movement.

Source: Barron’s, via The Big Picture.

Extending that to the current period, a 15-20 year period of sideways prices and/or declining valuations would have started sometime between 1998 and 2000.

Econoday recently updated the S&P 500 quarterly data for both profits and stock prices, saying:

Stock prices have lagged profits throughout the expansion, showing declines early on for five straight quarters in 2002 and 2003 even while profits were moving ahead and then exceeding profits for another five straight quarters in 2006 and 2007 even while profits began to contract. As of this writing, the S&P for April is down 6 percent year-on-year, indicated by the last red bar on the right of the graph. Profits have not been supporting share prices for more than a year, an unsustainable disconnect between profits and shares that hints at big losses in the stock market should the big expectations for future profits fizzle out. Even if companies do meet the expectations, stock prices are not necessarily going to follow higher right away.

Five straight quarters of increasing valuations (if prices are rising faster than earnings, valuations must be getting higher) is enough to pose a serious challenge to the notion of a long-term cyclical trend, but it also isn’t quite enough to make me abandon the belief. That said, if valuations don’t resume a downward trend sometime this year, continuing to believe in a downward cycle would start to look more like stubbornness than reason.

I originally posted this on April 30, but had to rebuild the site after encountering some problems. Reprinted here.

Readers who have been trying to access the site over the last couple of days, I apologize. There’s no telling what you might have been able to access, if you were able to access anything at all. Blame it on a flubbed software “upgrade.”

It’s a shame, too, because it had to happen just when there was an exciting announcement to make that is probably driving more visitors to the site.

You may recall that when I reviewed the Newsflashr service I said the feeds available are currently limited to a selection (admittedly a large one) of the top sources. While these are indeed the sources I most frequently consider, there are other sources I would like to be able to add as part of a personalized newsflashr.

I also said that based on what I have seen, I would bet adding those features is simply a matter of time.

Little did I know. As Gal explained in a news release:

We’re introducing two new sections for “Stock Market Beat” & “Techmeme Leaderboard” for new selections of the top business and technology news sources. Thanks to Bill Trent at Stock Market Beat for submitting his list of favorite financial news sources. Bill recently wrote a thorough review of newsflashr where he mentioned that he would like to see an option to get a personalized page and, by coincidence, we had just completed our work on this feature. So here’s our new way of viewing Bill’s OPML reading list:

Feeds view: http://www.newsflashr.com/feeds/stockmarketbeat.html
Topics view: http://www.newsflashr.com/topics/stockmarketbeat.html

Now you can sift through my news sources to see where I’m coming up with some of my crazy ideas.

In the meantime, I’ll be trying to restore my site to its previous condition.

Bankrate has asked a group of investment professionals and investment journalists to weigh in on how an investor should prepare for or invest in hard times. I was one of those who weighed in, and my frequent readers probably can figure out much of what I had to say.

What makes the article interesting is that the eight respondents really brought different perspectives to the topic. While some of the advice may contradict other parts, taken as a whole I think it really provides a balanced outlook. Any investor should be able to come away with some tips that will work for his or her own circumstances - and that’s what really counts in the end.

photo credit: qnr

This article is a reprint of my February 21, 2008 RealMoney column

The last year hasn’t been a good time to own a newspaper. The best performing stock was Washington Post (WPO), which managed not to decline significantly. New York Times (NYT) and Gannett (GCI - Annual Report) are down as much as half, while smaller firms like Lee Enterprises (LEE), Belo Corp. (BLC - Annual Report), McClatchy (MNI) and Journal Register (JRC) have registered declines ranging from 60-80%.

Always on the eye for a contrarian opportunity, I wondered if the time might be right to take a stake in one of the papers. The one that most attracts my eye is Lee. Lee provides of local news, information and advertising in primarily midsize markets, with 50 daily newspapers and a joint interest in five others, rapidly growing online sites and more than 300 weekly newspapers and specialty publications in 23 states. In 2005, the Company acquired Pulitzer and has since trimmed the combined operations by selling certain local papers and printing operations.

Although its valuation multiples and price performance resemble those of the other small firms, Lee is less heavily leveraged (a mere 3:1 debt/market cap ratio compared to 4:1 at McClatchy and 12:1 at Journal Register) and generates a significantly higher free cash flow yield than those firms. Compared to Belo, its Zacks rank of 2 indicates favorable earnings revisions, while Belo is in the worst category.

However, it will take more than being the best in a rotten bunch to make me take the plunge. Lee has to offer some real value, and pay me for the risk I would be taking by owning the name. At first glance, the 10% free cash flow yield (operating cash flow plus after-tax interest expense minus capital expenditures, divided by enterprise value) and 6.4% dividend yield would appear to do the trick. But are they sustainable?

There doesn’t appear to be much near-term risk to the dividend due to its relatively small share of annual cash flows. Pension plan is under-funded by $75 million, but the annual required contributions are just a few million.

The biggest concern relates to $306 million in notes issued in conjunction with the Pulitzer acquisition, which are due in April 2009. It would be tough to come up with that money in the current credit environment, but at some point over the next year I expect the credit markets to return to normal. Under its credit agreements, Lee can also increase its line of credit by up to $500 million as long as it meets certain financial criteria.

The Best Laid Plans

Over the longer term, Lee will have to generate at least modest revenue growth (the consensus five-year estimate is 5%) and execute according to its plan. Unfortunately, the plan is running into some road blocks.

Lee Enterprises’ Stated Corporate Plan

Source: Company filings

Earnings Quality

Until the management can effectively put their plan into action, revenues and earnings look set for continued declines. In 2007 operating income decreased $5,157,000, or 2.5%.

Tax settlements reduced income tax expense by $6,880,000 in 2007. On an apples to apples basis, earnings per share declined from $1.82 to $1.66.

While the earnings are declining, they do appear trustworthy. The accrual ratio measures the difference between cash-based earnings and accounting (accrual) based earnings. The closer to zero, the better. With the exception of a spike in 2005 related to the Pulitzer acquisition, Lee’s earnings quality has been high.

Source: Zacks Research Wizard, compiled by William A. Trent

I Would Look to Enhance Yield With Options

Although a put-write may offer another alternative play on the name, the options are thinly traded. The March 12.50 puts are available for approximately $1.45 at the time of writing, while the March 10’s are trading at about $0.30. The choice would depend upon the investor’s objective: someone wanting to own the shares at a lower price could use the $12.50’s to get an effective purchase price of just over $11.00, while an investor who doesn’t really want the shares could get a 3% one-month yield on money at risk using the 10’s.

I also think if I wrote put options and ended up with the shares, I would turn around and write covered calls to continue enhancing the yield and offsetting some of the risk.

Disclosures: None

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

This article is a guest post by Heather Johnson.

The stock market can be thoroughly intimidating, especially to those who have little experience buying and selling stocks. Investing is an even more daunting enterprise to those who have had a small taste of beginner’s experience, which more often than not ends badly. But never fear, there are plenty of people out there who have faced similar obstacles and have overcome them. Better yet, some of these every day fiscal heroes are looking to share their stories and have the minimum technical aptitude required to put their tales on the web. Although many of these bloggers haven’t yet achieved their ultimate goals, they are all successful in that they’ve taken that vital first step: they have changed the way that they think about money. Learn from these brave souls, take heart in their success, follow their lead by conquering the market in a unique way, and write your own story—maybe you’ll make a future edition of this list.

As everyone knows, those who play the stock market have their highs and their lows. Many of these who are presented below used to reside very near the bottom. No one can tell you how to get out of a hole like someone who has spent some time in one. So without further ado, here are ten stories of unlikely turnarounds and hard-earned prosperity.

1. The Dough Roller: The Dough Roller graduated college over $55,000 in debt because he had no control over his spending habits. Since that time, he has devoted himself to learning about investing in residential real estate and the stock market. He has done the research, made some sound fiscal choices, and is well on his way to being financially solvent.

2. Trader’s Narrative: Babak can help you learn about the financial markets because he was once as ignorant as anyone about such matters. He knows his stuff at this point and is generous with the expertise that he has painstakingly gained.

3. Index Fund Fan: Index Fund Fan learned a great deal (and learned it the hard way) when he got badly burned when the tech bubble burst around the turn of the millennium. He’s learned his lesson and is happy to teach you how to avoid similar suffering.

4. Mac’s Money Blog: Robert McIntosh is an investor in individual stocks, commodities and mutual funds. He has lived at both ends of the financial spectrum and wants to share how he arrived at each extreme.

5. Trader-X: Trader-X has developed an unbelievable 80% win rate with his market strategy, but this success is hard earned. He is more than willing to admit that he was nearly wiped out a couple of times on bad option and penny stock trades in his early days and he wants you to learn from these experiences.

6. Changing My Direction: Formerly an engineer by training and trade, the writer behind Changing My Direction is turning his life around by making smart investments. His success has allowed him to write full time, travel the world, eat fine food, and generally enjoy his life.

7. The Deprived Investor: The Deprived Investor and his wife started out their marriage on the wrong foot, putting their honeymoon on the credit card and quickly piling up some serious debt. They were able to pay it off in equity and have forever changed the way that they think about money and investing.

8. The Microcap Speculator: Early on in his investing career, a crooked broker played The Microcap Speculator for a fool and pushed some stock on him. He took the bait, invested a bundle, and lost almost all of it. He has learned how to control his risk, has made a comeback, and is happy to tell you how he did it.

9. Money Smart Life: The dot com bubble burst for Ben from Money Smart Life, just as it did for many others, and he lost his shirt on tech stocks. He has learned the value of diversification and proudly preaches its merits.

10. Growth in Value: The voice behind Growth in Value has been in the stock trading game for some time, getting his start at the age of 14. He was a bit of a savant and had early success, but suffered through some lean times caused by poor investments in tech stocks and Asian markets. Now he’s a solid value investor who has learned from this wealth of early experience.

By-line:

Heather Johnson is a freelance business, finance and credit writer, as well as a regular contributor for BusinessCreditCards.com site for comparing small business credit cards. She welcomes questions, comments, and freelancing job inquiries at her email address heatherjohnson2323@gmail.com

The following is a reprint of my January 16, 2007 RealMoney column

In a volatile market, investors tend to gravitate toward companies and investments that provide stability. As crazy as this may sound, I think that stability can be found in a semiconductor company – namely, Taiwan Semiconductor (TSM). I think the table below shows just how stable.

Taiwan Semiconductor Cash Flow Generation ($U.S. Billions)

Sources: Taiwan Semiconductor, Yahoo! Finance, William A. Trent estimates

Taiwan Semi operates in an unsexy part of the semiconductor industry known as “foundries.” It sounds as exciting as a blacksmith shop, and that isn’t far from the truth. Foundries don’t design any of the products they manufacture. Instead, they make the chips that other companies design. Their expertise isn’t in technology so much as process and efficiency.

Because they don’t design the chips themselves, Taiwan Semiconductor and other foundries such as United Microelectronics (UMC) typically get lower gross margins. The design profits fall to their customers. TSM’s expertise in manufacturing and economies, however, are much needed by customers who are often too small to absorb the enormous costs of building a chip fabrication plant.

Such customers include many fabless semiconductor companies and systems companies such as Altera (ALTR), Broadcom (BRCM - Annual Report), Marvell (MRVL - Annual Report), nVidia (NVDA), Qualcomm (QCOM) and VIA Technology, as well as integrated device manufacturing companies such as Advanced Micro Devices (AMD - Annual Report), Analog Devices (ADI), Freescale, and Philips (PHG).

Many small customers have given the company a balanced sales base. By end market, 40-45% of sales are communications-related, about 30% are to the computer market, 15-20% go to consumer electronics and the rest serve the memory and industrial markets. In 2006, the largest customer represented 10% of company sales, and the top ten amounted to just over half of sales. The lack of concentrated exposure to any customer or end market is one of the reasons TSM can generate stable cash flows.

The largest customer related risk factor may be that three quarters of sales are to customers in North America, and thus may impact the company if there is a U.S. recession. However, the global end markets for technology suggest that the true end customer is more widely dispersed geographically.

As the cash flow table shows, it seems fairly safe to say TSM will generate about $2.5 billion in cash flow. In some years, such as 2006, the cash flow may be unusually high. But even the industry downturns in 2004 and 2007 did relatively little harm. Given that the current enterprise value for Taiwan Semi is about $42 billion, it is offering a free cash flow yield of just under 6%.

If I had $42 billion that I wanted to invest safely, I might choose between buying TSM outright or investing it all in 5-year U.S. Treasuries. The Treasuries are currently yielding about 3.0%, so I would get $1.25 billion in interest each year from my investment. If that were my choice, I think I would go with the $2.5 billion in cash flow offered by Taiwan Semi.

It’s true that as a small investor owning a portion of TSM I would not be able to access all of the free cash flow. There is some risk to the comparison, since I am hoping the company invests any cash they hold onto wisely. But the company does pay two thirds of the cash flow as a dividend. Unless things change, that is still a 4.0% yield taxed at 15% compared to a 3.0% yield taxed at my marginal income tax rate.

How Bad Can it Get?

As stable as it may appear, I also have to acknowledge that TSM’s cash flow is not guaranteed. However, I think 2007 probably marked a fundamental bottom for the semiconductor industry – or at any rate that things won’t get much worse.

Consider, for example, the pricing environment. The Bureau of Labor Statistics reported that semiconductor prices declined 16.9% in December compared to the year earlier. That number was a modest improvement over November’s decline, which was the worst on record. Even the depths of the Internet bust were better times for semiconductor pricing. The fact that the pricing environment is so extraordinarily bad suggests to me that it probably won’t get too much worse.

Year/Year Change in Semiconductor Prices (PPI Data)

Source: Bureau of Labor Statistics

Furthermore, as I have written in other columns, I think the turnaround in semiconductor fundamentals is within sight. Pricing is a function of supply and demand, and since March of 2007 demand (semiconductor revenues as reported by the Semiconductor Industry Association) has been growing at a faster rate than supply (bookings for new semiconductor equipment as reported by Semiconductor Equipment and Materials International).

I think the industry’s recent restraint in adding new capacity will soon become evident in stronger pricing even if there is an economic slowdown. If I am right, what already looks like a solid and stable cash flow level could soon look even better.

Disclosure: William Trent has a long position in SMH.

My long-term orientation doesn’t typically fare so well in short term stock picking contests. Nonetheless, I have decided to enter the blogger face-off over at SINLetter. You can check in to see which of us are making the best picks between now and the end of March.

My picks were long SMH, short Diebold (DBD) and long CSG Systems (CSGS).

A couple of weeks ago I was afforded a rare opportunity to buy one of my favorite stocks, Landstar (LSTR - Annual Report), at what I considered to be a bargain basement price. As I said at the time:

Over the last 12 months, Landstar generated $167 million in free cash flow. Nearly all of its operating cash goes to share repurchases and dividends since the company isn’t buying trucks. On a $2.1 billion enterprise value, that amounts to an 8% free cash flow yield – more than twice the yield on Treasury bonds and a healthy risk premium in today’s market.

What’s more, Landstar’s 5% apples-to-apples growth in a bad year suggests the longer-term growth rate could be significantly higher. With today’s price justified even without any growth, the prospect of an eventual return to double-digit growth rates gets my mouth watering.

I was prepared to wait a while before earning significant returns, but Landstar got me a good way along during its mid-quarter conference call yesterday.

Landstar affirms 4th-quarter profit view (Reuters):

Chief Executive Henry Gerkens said on a conference call he was “very comfortable” with the company’s October forecast, which calls for earnings-per-share in a range of 47 cents to 52 cents.Analysts, on average, were looking for Landstar to earn 49 cents per share on sales of $624 million, according to Reuters Estimates.

The shares were up more than 5% after the call, but it will be a while before I am ready to sell. Even after yesterday’s rally the shares are yielding 7.1% free cash flow-to-enterprise value. With the 5-year Treasury at 3.4%, that still amounts to more than a 100% premium, and Landstar should still provide growth.

In fact, I would be willing to own Landstar up to a parity yield with Treasuries, because I think the growth alone is sufficient premium for the risk. On that basis, and with today’s Treasury yield and trailing Landstar FCF, I get an implied value of nearly $90 per share. Obviously both variables could change over time, and a fall in Landstar’s free cash flow or a rise in interest rates would indicate a lower possible value. But at any rate, I feel like I have quite a margin of safety.

Well, after a couple of false starts, I finally have a refreshed look for Stock Market Beat. To give appropriate credit:

The theme was designed by Matt at Dagon Design.

Header Photo credits (left to right):

• Silver and Gold Still Life by Adrian Bartel
• Wall Street Bull by Shawn Grenninger
• New York Stock Exchange by Alexander Marc Eckert
• Silver and Gold Still Life by Adrian Bartel
• Nasdaq Ticker - Times Square by Rooty.

I hope to make other improvements in the weeks to come, but fortunately have been too busy to focus much on the blog.

I was sent a pre-publication copy of Timothy Sykes’ book An American Hedge Fund and found it to be a quick and fairly enjoyable read.

The book recounts the improbable tale of how Sykes turned his Bar Mitzvah money into a multi-million dollar hedge fund, and reads as much like a trading diary as it does either a novel or a personal finance book. As to what it actually is, if you were one of those people offended by the “truthiness” of A Million Little Pieces you may want to steer clear. The book is billed as a memoir, categorized under Business/Personal Finance and described in the cover letter I received as a novel. Not to mention it was published under Sykes’ own “Bullship Press” label, so consider yourself warned if not every fact in the book is verified.

Personally, though, I could care less about whether a story is truth or fiction as long as it reads well. And here the book turns out to be quick and, assuming you are into the stock market, enjoyable. The biggest turnoff was that hardly a page goes by without a clinical description of the gain/loss on some trade that was made. I would have preferred a more general discussion of how Sykes learned from his successes and mistakes, with the trades serving as illustrations rather than the other way around.

Sykes is able to tell the story with the right mix of chutzpah and humility, fessing up to his mistakes - some of which he continued to make even after professing to learn from them. I find it particularly ironic that late in the book Sykes says:

Looking back, I had foolishly gotten into this industry thinking I could easily grow my operation to the $20 to $50 million asset range based on my performance alone. I would’ve saved a great deal of time, energy and money if somebody had written a book like this to warn me about the true nature of the industry.

Four pages later, he says:

I’d read up on the self-publishing industry and thought I’d found another niche market ripe with opportunity. If I went this route, I’d have total control over my book, quadruple profit margins, and I could distribute the truth to the general public within a few months.

Something tells me his next book will be an expose of the publishing industry.