Analyzing The Kroger Company

Selecting stocks from the myriad of choices is more of a craft than a recipe.  It takes time to learn the ability to look through the profile of a company and determine that it is worth making an investment, let along timing when to make that investment.  Even when you’ve gotten enough experience to choose stocks, not every pick will work out immediately, and some will never work out.  That’s the reason to bet on more than one horse.

Many people look for hot stock tips.  They just want someone to tell them what to buy and when.  If you look to CNBC or another news outlet to do this, there are a lot of other people out there who hear the same report; therefore, it is unlikely you’ll get anything like a good price for the stock.  If you get a tip from a friend, the advice may be questionable.  It is therefore best to learn how to pick your own stocks.

A good thing to do if you’re just getting started in stock investing is to try things out on paper first. Pick several stocks, pretend that you bought some shares, and just watch what happens to your account balances over a period of a few months to a year. There are even stock picking contests in which you can participate. Note though that real investing is long-term – several years – so unless you are willing to try things out on paper until you are forty (which is not recommended) you’ll get more of a feel of what the day-to-day movements of your holdings than really be able to see if your picks pan out. Another idea is to look at past successful stocks (Home Depot, Apple, Microsoft, Wal-Mart, Clorox, McDonald’s) and see what their balance sheets looked like early in their development.

Today I’m going to discuss the process I go through in selecting a stock, using The Kroger Company as an example.  Note that I am not recommending this as a pick for anyone – every individual has his/her own special situation and everything must be taken into account before buying a stock.  The point is simply to describe the process.

The source of data I normally use is The Value Line Investment Survey.  They have an online edition, but I normally just use the print edition (I like being able to flip through the pages quickly).  There is some merit to using an online tool and various screening parameters to narrow down the search, but I find a strong factor I use is the shape of the price history of the stock, so I like to be able to flip thorugh pages.

This week I noticed that the Kroger Company had a 1 for Timeliness (a Value Line proprietary measure which shows which stocks have good momentum – i.e. are likely to do well in the next year).  Looking at the full-page company analysis, the first thing I notice is the price chart, which shows that the company has been fairly flat for the last several years.  Normally I would turn the page at this point since I’m looking for companies that are growing over the long-term.  Ideally there would be a long, slow increase in price with the price doubling or tripling over the ten-year period shown.

In this case, however, the long-term appreciation potential, as shown by the 3-5 year range on the chart, and the Annual Total Return projections in the upper left, show a return of between 18 and 24% per year.  Given that the average stock market return has averaged somewhere between 10 and 15%, this is a good return and makes the stock worth a second look.

The next thing I notice is the yield, which is currently about 2.4%.  Given that bank accounts are currently paying nothing, this is a nice yield.  It means that even if the stock sits there and the price doesn’t move, I’ll still be doing better than I would be parking the money in the bank.  Of course a small decline in share price could quickly eliminate the gains from those dividends, so holding a stock for dividend yield is a long-term strategy.

Next I look at the earnings per share history.  I see that the company has had increases in earnings since 2003, and they mainly had increasing earnings in the years before that, albiet with a couple of bad years.  This shows that the company is growing in either market share or the number of stores open.  Looking at the number of stores, I see that it has held steady somewhere between 3500 and 3700 for the history given.  This means that the company is not growing but perhaps they’re becoming more profitable – or they are buying back shares and increasing the per share earnings that way.  Looking at common shares outstanding I see that this is the case.  They have decreased from 758 million shares in the early 2000’s to 561 million shares today.  So, they have been buying back shares with excess profits rather than expanding dramatically, which makes sense since this is a well established business.

Looking at earnings growth rate, I see that a rate of 10% growth in earnings but 12.5% growth in dividends is expected over the next five years.  Since share price grows at about the rate of dividends for well established companies, I can expect the share price to also grow at about 12% per year, give or take.  I look at PE ratio history and see that it is trading at a PE of 9.3, versus a historic average of around 14, saying that the stock is undervalued (hence the large potential return over the next 3-5 years).  I look at debt, which is substantial (no debt is good).  Finally, I look at the financial strength, which is B++ (A+ would be better).

This stock appears to be at a good entry point since there is a large possible return over the next five years.  It looks like they are buying back shares and increasing their dividends with the excess cash they are generating, but they are not opening more stores.  It therefore won’t be a dramatic growth stock, but it might be a good income stock.  I would think about adding this stock to a tax advantaged account such as an IRA (since the dividend rate is fairly high, I don’t want to pay taxes on the dividend each year, particularly with talk about raising the dividend rate back up to ordinary income levels).  I would hope to get a fairly good return over the next few years as the share price catches up with earnings, and then it will hopefully continue to pay a good yield as earnings grow and these earnings are primarily paid out as dividends.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

What Happened when the Housing Bubble Burst

A few posts back I started writing about the housing bubble.  I started out talk about how consumers started buying homes using more and more leverage.  In the second post in the series I talked about how the investment houses began writing insurance policies on the baskets of loans, figuring that home prices could never fall enough for those insurance policies to be used.  Today I’ll talk about how the bubble burst, what government officials did, and what the results were.

On the public side, people had bid up the prices of homes to insane levels.  In order to pay these huge prices people were taking out interest only loans or even loans in which they did not even pay the interest each month so the amount they owed actually increased each month.  Some people were speculators who were using these types of loans to be able to buy several houses and have very low payments each month.  Others were people who wanted to buy a house but did not have the ability to afford the payments for the homes they wanted with a standard loan.  Both knew that the interest rate would reset within a year or two, and when it did the payment would be a lot higher, but they figured that the value of the house would increase by then and they would sell the house before that or just refinance into another loan, perhaps even taking out some cash for a vacation or a new kitchen.

On the investment house/mutual fund/hedge fund side, managers had bought baskets of these loans that the loan companies happily packaged up and sold so that they could make more loans and rack up fee income.  Some had also sold insurance policies that would cover the losses of the buyer if the price of this basket of loans went below a certain level.  To protect themselves in case the market did fall (not that they were expecting it to) they themselves bought some of these policies, perhaps with an earlier expiration date.  In this way they made some money and protected themselves, they thought, against losses.

Eventually we got to the point where there were a lot of these loans outstanding, ready to reset their rates.  As with all bubbles, we ran out of new people to pay even higher prices and those who had been paying high prices could borrow no more.  At that point people began defaulting on loans as the interest rates reset and their payments went up.  Because there was no one left to pay the huge prices the current owners paid for their homes, let alone pay more to allow them to recoup their realtor fees and other things they had rolled into the loans, the homebuyers were trapped with a payment they could not afford and no way to refinance.

They also stopped spending as much on other things like travel, restaurants, and shopping, both because they were paying more towards their mortgages and because they could no longer put the money they owed on their credit cards into their home loans. This resulted in businesses laying people off or closing completely.  This meant that even more people were unable to afford their home loans and housing prices dropped further.  Eventually people who could afford their payments but saw that the price of their homes was less than the loan value stopped paying because they felt it was unfair that they should continue making payments when the house was not worth the amount they owed.

The speculators on the banking side suddenly saw the baskets of loans drop in value, with many more defaults occurring than they ever thought was possible.  Because of federal “mark to market” rules, which required the banks to guess the fair value of assets each day and report losses if the value is less than they paid, huge losses were recorded by the investment houses even though the true value of the baskets of loans was unclear since they were not being traded.  Suddenly the insurance policies they had written were being used, but the companies that wrote the policies were unable to pay the claims.  Because they could not be paid for the claims they were making, they could not pay the claims that were being made against the policies they had written.  Thus we had a circular firing squad where everyone owed money and everyone was owed money.

Worst of all, money market funds, which can suffer losses but which make every effort not to, started to take losses.  This made investors pull out of money markets.  Because businesses rely on short-term loans from money markets to cover their expenses until they are paid for their services, it began to look like a lot fo companies would not be able to make payroll or buy supplies.  This rattled the core of the financial markets and brought the Federal Reserve and the federal government in to save the day.

The most sensible thing that the government could have done was to become the money markets, providing the needed short-term loans until the regular money markets straightened out and could fill the need once again.  This would have been very low risk to the American taxpayer.

Instead the government made loans to the large investment banks and insurance companies which were failing, essentially paying the claims these companies owed for them.  This allowed these companies to keep operating (sometimes being sold to other companies through government arranged sales such as the sale of Merrill Lynch to Bank of America).  This put the American taxpayer into a very risky position since they were making loans to (and then investments in) companies that were on very shaky financial footing.  Instead of buying AAAA money market funds they were buying the junkiest of junk bonds.  Officials at AIG, one of the companies that the government made huge loans to, went on their yearly spa retreat in the middle of the chaos despite the fact that, save the government loans, their company was bankrupt.

Also in this time period, the government went in and bailed out the auto industry, making huge loans to them that they may never repay in full.  If this were not bad enough, they pushed these companies through bankruptcies in which bond holders in the companies, who normally would be paid first in a bankruptcy, were paid second or third and ended up taking pennies on the dollar instead of dimes on the dollar as they would have gotten in a normal bankruptcy.

This had a profound effect since it voided a fundamental requirement for a free enterprise society – that contracts be enforceable.  Without this, people are reluctant to make new loans since they don’t know if the terms will be changed and therefore can’t determine their risk.  This is probably the most damaging result of the whole crisis and is probably affecting the ability of the economy to recover today.

In the next post I’ll discuss government intervention into home loans and the effects.

Please contact me via or leave a comment.

Follow me on Twitter to get news about new posts: @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Upward Mobility in the Land of Opportunity

I read a wire service editorial in the local paper today.  (Apparently the editors of our paper don’t have enough opinions of their own so they need to buy one once in a while.)  It was labeled as “Distributed by Creators Syndicate,” and was entitled Opportunities Uneven in the Land of Plenty.  (I looked up Creators Syndicate on the web.  Apparently they are an outfit in LA that provides copy and other materials to publishers who can’t create their own.)

The piece was, well, disturbing.  Not because of what it said, but because of how low an opinion its writers had of the country in which they live (presumably they’re Americans).  The editorial first talks about a Pew research study that found that 53% of blacks who were in the lowest income level would stay there, compared with 33% of whites.  Also, 56% of blacks who were raised in the middle tier fell to the lowest tier in their lifetimes, while 32% of whites did the same.

The conclusion of the editorial were that “no matter how hard you work, if you were born into a certain category (apparently, poor and black), there is a chance that you will be stuck there,” and that “there is precious little mobility.”  They then went on to spew the normal bromides about how the issue could be solved through more education, and that we need to funnel kids into trade schools and fund high quality  preschools for low income families.

I say this is a load of hog wash.

There is still more opportunity available in America for people to move from poverty to success than in 99% of the countries in the world.  Take the example of Pejman Nozad, whose life is described in Forbes, who came to America with $700 in his pocket and a few words of English.  He is now an extremely successful venture capitalist (you know, the people like Mitt Romney who we are all told are the bad guys) with a net worth in the millions of dollars.

For every Pejman Nozad, there are tens of thousands of people who come here in poverty who don’t make it to his status, but at least reach a middle class lifestyle and are able to send their kids through college.  This doesn’t happen in places like Mexico and India.

So how is it that some people can become so successful, starting from so little, while such a large percentage of people born in poverty stay in poverty, all in the same country?  I believe it has nothing to do with education (although those who become successful usually do get at least a high school education).  It has to do with whether you are a taker or a giver.

Those at the lowest end of the poverty spectrum in America are told from an early age that they deserve to get things because they are poor.  Unwritten in that message, but clear to most, is the implication that they are somehow defective and therefore need help because they would be unable to do for themselves.  The most vile and insidious form of racism left in America is the notion that minorities – blacks in particular – are in need of assistance because of their race.  This comes both from the welfare advocates in Congress and their family and neighbors.

Nobody who “works hard” stays in poverty.  If you are willing to really work to provide value to your employer and his/her customers, you will rise to at least middle-class income levels.  If you are willing and able to expand the reach of the value you are providing to people, you can become very wealthy.

A great teacher who really cares about his students and provides a great education will do well.  An individual who creates a company selling products that help a whole generation of children learn will become rich.

A mechanic who provides great service to the customers of a repair shop such that people continue to bring their cars to his employer’s shop will do well.  An individual who opens a chain of repair shops and ensures that his mechanics give great service, meeting a whole city’s need for quality auto repair, will become rich.

Getting an education, even if it is a doctoral degree, will not necessarily lead to a life of wealth (just ask the plethora of Gen y’ers with a doctorate in French Literature living in their parent’s home playing World of Warcraft until 3 AM and sleeping in until noon).  Attending school to gain skills needed to help meet other’s needs is useful.  If you can attend a trade school and learn to repair large motors, you can get a good job in a factory.  Likewise, if you can find somewhere to work and learn from experienced mechanics how to fix large motors, you can get an equally good job in a factory.

The secret to creating mobility is not education or Head Start.  The secret is to stop telling people that they are somehow defective and deserve to spend their lives getting stuff from society.  We need to start telling people that we expect them to contribute and do their part to help society.  We need people to build bridges.  We need people to make cars.  We need people to design buildings.  We need people to educate our children, clean offices, trade securities and run companies.  We need to tell then that the path to prosperity doesn’t come from a check in the mailbox, it comes from finding a need and filling it.

Please contact me via or leave a comment.

Follow me on Twitter to get news about new posts: @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.