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The Death of the iPad?

Apple (AAPL) knocked the ball out of the park in this week’s earnings release, boosting quarterly revenues by 12% and earnings per share by 20%.  And these numbers included less than three weeks’ worth of iPhone 6 sales. (The iPhone 6 and iPhone 6 Plus were only released on September 9.)  Gross margins actually expanded a little, from 37% to 38%, proving that Apple remains—at least thus far—immune from price competition.  With the momentum from the phone launch still building, I expect Apple to finish calendar year 2014 with a bang.

Investors in Apple stock have a lot to celebrate right now.  But iPad sales are distinctly not one of them.  iPad sales actually fell during the quarter from 13.1 million to 12.3% million.

Of course, some of this weakness is due to would-be tablet buyers sitting on their wallets until the latest-generation models came available early this quarter, and were this an isolated incident I would be tempted to leave it at that.  Unfortunately, it’s not.  iPad sales have been consistently weaker than expected for most of 2014.

What gives?  Are we witnessing the death of the iPad?

Yes.  Or more accurately, “sort of.”

I’ll start with the most obvious point.  Apple made a strategic decision to cannibalize its own business with the IPhone 6 Plus.  The larger-screen phone makes a tablet redundant;  an iPad becomes a larger version of your phone except without the ability to make regular voice calls.  I consider this the right decision, as it makes the iPhone—Apple’s biggest moneymaker— more competitive with larger-screen Android devices.  Forgone iPad sales are acceptable collateral damage in the far more important smartphone war.

But iPad sales had started to decelerate long before the iPhone 6 Plus was released, and the story is a little more complex than that.  What I see happening to iPads—and to tablets in general—is what happened to PCs starting around 2012.

Two years after the 2010 launch of the Apple iPad, PCs sales actually went into year-over-year decline, and have continued their decline until now.  The most recent sales data shows PC sales as flat this year rather than down, but the fact remains that the tablet radically changed the PC market.  The upgrade cycle got stretched, as consumers made do with their older desktops and laptops a little longer and diverted the funds they would have used to upgrade to a tablet instead.  And in some cases—particularly in the lower-end consumer market—buyers ditched their PCs altogether, as a tablet was more than sufficient for their modest computing needs at home, such as reading books and emails and checking Facebook.

Moving forward to 2014, we see similar dynamics at play.  Consumer Intelligence Research Partners finds that American iPad buyers tend to hold on to their tablets for 2-4 years between upgrades.  The lifespan of an iPhone is shorter, at 2 years or less.  (On a side note, my smartphones tend to have a life of about 12-15 months; I’m a heavy user, and I have two rambunctious young boys in the house that have a talent for finding new and exciting ways to break them.)

Frankly, iPads don’t change that much from generation to generation, or at least in ways that would persuade a user to upgrade.  Processing power and networking speed is fast enough at this point to last you a few years.

What does this mean for the Apple iPad and for tablets in general?

Let’s look at the PC market for clues.  The PC is not “dead” by any stretch.  I sit in front of one for at least nine hours per day, as do most professionals, and that won’t be changing any time soon.  But I’m not buying a new one any time soon; I might use a given PC for 4-5 years between upgrades.   That’s where most iPad users are today.  They use their iPad regularly but there is no compelling reason to upgrade, particularly if you already have a new phone.  That’s a recipe for slow growth.

The good news for Apple stock is that it really doesn’t matter.  I have argued for years that Microsoft (MSFT) was an attractive stock even in the face of declining PC sales because of its cheap price, its strength in its other business lines, its solid balance sheet and its ability (and willingness) to aggressively raise its dividend.

Today, Apple is in the same position.  As I reasoned in “Why Carl Icahn is (Kinda) right about Apple Stock,” Apple stock is being priced by Wall Street as a no-growth company.  But its balance sheet is a fortress, it is aggressively raising its dividend and repurchasing its stock, and its other product lines outside of the iPad are stronger than ever.

Disclosures: Long AAPL in Dividend Growth Portfolio

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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What Does Larry Ellison’s Departure Mean for Oracle?

Larry Ellison, founder and long-time chief executive of Oracle (ORCL), took the financial media by surprise yesterday by stepping down as CEO.  He will be replaced by current co-presidents Mark Hurd and Safra Catz, who will serve as co-CEOs.

I had always expected Ellison to be the kind of CEO that would die in the saddle with his boots on.  He has a well-deserved reputation as a control freak, and his stewardship of Oracle has made him the world’s fifth wealthiest person.  He also has one of those larger-than-life personalities that could have been the inspiration for a James Bond movie villain.  He owns the Hawaiian island of Lanai, for crying out loud, and owns a yacht nearly the length of a football field.  And though it has never been confirmed, I fully believe that somewhere, on one of his properties scattered across the globe, he has a tank full of sharks with frickin’ lazer beams attached to their heads.

A man like that doesn’t’ quietly go into retirement, and indeed Ellison has indicated that he plans to retain the title of Chief Technology Officer in additional to serving as executive chairman.  But at age 70, he is finally willing to share some of the day-to-day management.

What does any of this mean for Oracle stock?

It means more of the status quo.  Hurd and Catz are very capable executives, but neither are transformational figures.  And both will be operating with Ellison’s rather long shadow over them for the foreseeable future.

Oracle also faces competitors on all fronts in its database and cloud businesses, from established heavyweights like IBM (IBM), SAP (SAP) and Microsoft (MSFT) to relative upstarts like Salesforce.com (CRM).  It’s a brutally competitive market, and with corporate spending in deep freeze for most of the past five years, growth has been hard to come by.

That said, slow revenue growth has been an issue for the S&P 500 as a whole, so Oracle’s problems are hardly unique.  And Oracle stock is reasonably attractive at current prices.  Oracle trades for 17 times trailing earnings and just 11 times expected forward earnings.

Oracle-shares-outstanding

Oracle has also been a heavy buyer of its own stock (see chart), and like the rest of Big Tech has become a reliable dividend payer.  Since initiating a quarterly dividend of 5 cents a shares in 2009, Oracle has more than doubled the payout to 12 cents.

Wall Street did not react well to yesterday’s announcement—or to Oracle’s uninspiring earnings release—and Oracle’s stock price is down about 5% today.  But at current prices, there is a lot of pessimism built into to the stock price.  At these prices, Oracle can deliver lukewarm results for the next several quarters running and still likely match the S&P 500’s returns.  And if maybe—just maybe—Oracle’s cloud initiatives finally start to gain steam, the Oracle stock could enjoy a nice 20%-25% rally.

Disclosures: Long MSFT

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Scottish Secession and Opportunities in…Spain?

We are officially in uncharted waters.  The biggest macro risk right now for the markets is not the Fed or European Central Bank…or ISIS or even Vladimir Putin.  No, the biggest macro risk is the mood of Scottish voters.

Scotland’s referendum on independence from the UK will be held on September 18.  Up until very recently, the polls of prospective voters consistently predicting that the “no” camp—i.e. Scots that prefer to remain in the UK—would win by a fairly substantial margin.  But a poll released on September 7 showed the “yes” camp in the lead for the first time.

The latest compilation poll by ScotCen shows the “no” camp still in the lead, but with a week to go, it is far too close to call.

Scotland is a soggy, wind-swept country of less than six million people on an island an ocean away.  Why would Scottish independence matter to the capital markets…or to our portfolios?

Because it brings uncertainty.  No one really knows how the capital markets will react to the disintegration of one of the oldest and most sophisticated financial powers in world history…or how it might spread.

The closer Scotland comes to independence from the UK, the more Catalonia will agitate for independence from Spain…which brings back all of the uncertainties of the past four years of on-again, off-again sovereign debt crisis.

Is there a trade here?

There might be.  If a Scottish secession vote spills over into a sharp selloff in the Spanish capital markets, I would suggest using it as a buying opportunity.  Put the iShares MSCI Spain ETF (EWP) on your watch list.  I don’t necessarily expect a swoon, but I want to keep a little powder dry…just in case.

Alternatively, if you prefer to buy individual securities, I like Spain’s banking juggernauts Banco Santander (SAN) and BBVA (BBVA).  Both have a global footprint and are in position to take advantage of the ECB’s coming flood of monetary stimulus.

Again, I don’t necessarily expect to see a major correction.  But if Scottish jitters send Spanish equity prices down a quick 10%, I recommend snapping up a few shares.  Plan to hold for 6-12 months and use a relatively tight 10%-15% stop loss.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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How Does Discover Stack Up Against Other Credit Card Stocks?

Apple (AAPL) made news this week with a leaked rumor of a deal with credit card giants Visa (V)MasterCard (MA) and American Express (AXP) that would transform the new iPhone 6 into a viable mobile wallet.

Conspicuously absent was any mention of the third-largest American credit card brand by cards in circulation, Discover Financial Services (DFS), operator of the Discover and Pulse networks.

And yes, I said “third.”  Despite its lower profile, Discover has more cards in force than the much older and more prestigious American Express: 61 million vs. 52 million, respectively, based on latest head-to-head comparisons. Though based on purchase volume, Discover remains a distant fourth.

Investors in DFS stock shouldn’t fret about the Apple snub; as I explained in my last article, I expect the iPhone mobile wallet to have a negligible effect on credit card transactions volumes. Far more significant is the fact that Discover has almost entirely closed the acceptance gap between itself and Visa and MasterCard, at least in the United States.  The number of merchants accepting Discover had grown by 24% since 2009 to 9.2 million at the end of last year.  Visa and MasterCard are accepted by about 9.4 million merchants. At least within the United States, it is now rare to find a card-swiping merchant that does not accept Discover.

Furthermore, Discover recently tied with American Express as card with the highest customer satisfaction, according to J.D. Power’s rankings.  The survey measured factors such as card terms, rewards programs and customer service. Discover’s leap to the top is significant when you consider that American Express sells itself as a prestige card for business and high-net-worth consumers.

So, who are all of these Discover cardholders?

Using data from ESRI, Pam Allison did an interesting study of the demographics of Discover cardholders.  True to its origins as a Sears (SHLD) product, Discover tends to be most popular in the prairie and rustbelt states of the Midwest and tends to be popular with an older, more conservative segment of the population—the segment of the population you would most expect to see shopping at a local Sears store.  From a risk management perspective, that’s not a bad thing; consumers in this profile are less likely to get overextended and become delinquent in their payments.  Of course, this conservatism also makes them less likely to do a lot of transaction volume.

Writing for MarketWatch, InvestorPlace.com editor Jeff Reeves recently called Discover stock “the best financial stock to buy today” based on its strong earnings growth, loyal customer base, shareholder-friendly dividend boosts and share buybacks, and its recent diversification into non-credit-card businesses such as student loans and mortgages.

I would add that Discover is also quite cheap, trading for 13 times trailing earnings and 11 times forward earnings—or about half the valuation of rivals Visa and MasterCard.

Granted, Discover—like American Express—is an actual bank with all of the risks associated with it.  Visa and MasterCard are essentially tollbooth operators; they are payment systems rather than lenders, and as such have higher margins and no credit risk.

So, all else equal, Visa and MasterCard should trade at a premium to Discover and American Express.  Though a gap as large as today’s would seem a little extreme.  Furthermore, Discover is significantly cheaper than American Express, which trades for 18 times trailing earnings and 15 times forward, and this despite American Express having significantly lower margins.

Discover cannot match MasterCard or Visa internationally, and both have made expansion in emerging markets a major strategic focus. But of the four major credit card stocks, Discover would seem to be the best overall bargain by a wide margin.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Apple’s New Mobile Wallet: Who Wins, Who Loses?

Apple (AAPL) is expected to make waves this month with the launching of the iPhone 6—and a version of the phone comparable in screen size to Samsung’s (SSNLF) popular Galaxy line running Google’s (GOOG) Android operating system.  Given the similarity of app selection and performance between high-end iPhone and Android models, screen size has long been a major differentiator; it will be interesting to see how Samsung responds in its next release.

But Samsung and Google are not the companies looking at stepped-up competition from Apple when the iPhone 6 is launched.  Apple has reportedly inked a deal with Visa (V), MasterCard (MA) and American Express (AXP) that will potentially make the iPhone far more viable as a mobile wallet. That’s bad news for EBay’s (EBAY) PayPal and for newer upstarts like Square, both of which had started to make inroads of late.

How will the new wallet work? You would essentially store your credit card details in your iPhone, allowing you to leave the plastic cards at home.  Your phone would communicate with the merchant’s cash register via a near-field communication (“NFC”) chip, and you would use your fingerprint to verify your identity.

Apple’s new mobile wallet is really nothing new. Already, various credit card issuers use NFC chips that allow you to “tap” your card rather than swipe it.  And Google has had a similar NFC-based mobile wallet product for years, though merchants have been slow to adopt it due to the cost of upgrading their systems and limited demand from consumers.

Let’s dig a little deeper into the details to see who stands to gain or lose the most.

Credit Card Issuers

One seemingly obvious beneficiary would be the credit card companies, though we need to see more details about the deal to draw any real conclusions.  Already, middle and upper-income Americans use their credit and debit cards for substantially all of their day-to-day spending, and anyone using Apple’s mobile wallet is already using a credit card.  It’s hard to imagine legions of cash-only Americans suddenly making the jump to electronic payments because their iPhone offers a snazzy new app.

Nationwide 66% of all point-of-sale transactions are made with plastic.  Small businesses have historically been less likely to accept plastic due to high costs and the need for expensive and cumbersome card readers.  But with Square and PayPal Here and their competitors now able to turn any smartphone or tablet into a payment terminal, it’s now not uncommon to pay your babysitter or the neighborhood ice cream man with a credit card.

Furthermore, we can assume that Apple will take some share of the swipe fees.  We have no information on what sort of fees would apply to merchants, but unless the fees are higher on the mobile wallet—which would discourage retailers from accepting it—it’s hard to see Visa, MasterCard or Amex really benefitting from this.  The only real positive I see would be the security benefits.  Apple’s fingerprint technology would make it harder for an unsophisticated thief to steal your card and go on a shopping spree.

Merchants and Consumers

For consumers, the benefits will be negligible at first. It will be years before mobile wallets become accepted broadly enough for you to leave your plastic at home. So even if you plan to use your mobile wallet everywhere you can, you’re still going to have to lug around a physical card.  Longer term—if it catches on—you might enjoy as slightly thinner wallet and have less risk of having your card stolen.    But for the foreseeable future the benefits are marginal at best.

As for merchants, unless the fees are drastically lower—and we’ve seen no indication that this will be the case—there is very little upside.  Upgrading payment systems will be an immediate expense with very little obvious benefit.  It’s hard to see a would-be customer going to one of your competitors because they allow payment with an iPhone whereas you require a plastic card.

5-10 years from now, the story could be different.  I rarely have cash in my wallet, and as a result I often avoid restaurants and parking garages that do not accept credit cards.  We could eventually have a similar situation with mobile wallets, but that might be a decade from now.

Mobile Payments Competitors

I would saw that the parties with the most to lose would be newer non-bank payment systems, such as Paypal or Square.  Some retailers—including giants like Home Depot (HD)—allow you to pay with PayPal.  Likewise, Square scored a major coup two years ago when it partnered with Starbucks (SBUX), though that deal ran out of steam once the new wore off.

A successful mobile wallet that used existing credit and debit accounts would make it harder for an upstart like Paypal or Square to emerge as a new standard.  Even in the absence of a successful mobile wallet scheme, I wouldn’t be surprised to see Square out of business and PayPal relegated to a niche market within five years.

What about Google or Amazon (AMZN), both of which offer rival mobile wallet platforms?

Counterintuitively, Apple might actually help them by pushing broader acceptance.  iPhone users can be a demanding lot, and if their enthusiasm for mobile wallets spurs merchants to accept them, this would potentially help all other NFC-based mobile wallet providers.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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