Make Sense and Money in "Non-Negotiables"

The past few weeks have been busier than usual for me because I just moved into a new apartment in San Francisco and had some furnishing to do. The most important item I needed – in time for the NCAA basketball tournament, aka "March Madness" – was a nice-sized high-definition flat-screen TV.

It's funny – almost nine years ago to the day, I acted totally out of character and was an early adapter of new technology. I purchased a couple of plasma TVs for my new home for about $5,000-$6,000 a piece. I don't know what was I thinking, as I usually like to wait until the majority of consumers have adopted a product – and prices are much lower.

Today, as a comparison, my new 40-inch LCD plasma TV cost around $800 and now plasma technology is clearly inferior to LCD and LED technology. Of course, even today, I paid more than I wanted to and chose one of the higher-rated models, but at least I didn't go for the very top-of-the-line LED technology, which would have cost 20-40% more.

This buying experience sparked a couple of interesting observations – of course related to investing and making money.

Both Retailing and Consumer (Technology) Products Segments Can Be Tough Businesses

So I as started to shop around I realized that Best Buy (BBY:NYSE) stores dominate San Francisco and I didn't have many options. Since Circuit City went bankrupt, it seems like Best Buy has a monopoly on electronics in certain regions.

Yes, there are some mom and pop stores still around to keep them honest, but it looks like stores like Wal-Mart are going to have to keep electronics and technology gadget prices competitive and keep Best Buy in check.

And, of course, with Best Buy's dominance (at least here in San Francisco), I wasn't surprised by its strong earnings report and outlook that came out last week. Actually, I was expecting a little higher forecast for 2010 same store sales; more than the 1-3% they gave. But I guess that's in line with GDP this year and it will compare to a strong rebound year in 2009. ("Same store sales" look at retail sales of existing stores and exclude sales contributions from newly opened stores or acquisitions. It gives a truer measure of a company's organic sales performance.)

It's just amazing how technology prices have come down. Whether it is TVs, computers or cameras, the price today is significantly less than just a few years ago. Even with a great industry position and highly valued products, Best Buy is in a tough business.

Pricing for almost all of their products declines quickly. So while consumers are starting to spend again, the average selling prices are declining. Case in point is that the crazy prices I paid for my flat-screen TVs have come down substantially today, while the technology has gotten significantly better. That will always be the case.

For technology-oriented retailers, it will always be a battle between selling new technology products that allow high prices, and the fast unit growth of these products versus their rapidly declining prices.

Keep that in mind when you think about investing in consumer technology and the companies that sell them. Finding the next "killer application" is one thing, but be careful investing in companies that have to constantly create new products, features or technologies to combat the decreasing prices of their products. Look for products where the growth rate or penetration (adoption) rate is growing rapidly enough to offset price declines.

"Non-Negotiable" vs. Non-Discretionary Products

Another important observation that came out of Best Buy earnings was a comment made by Best Buy CEO Brian Dunn, regarding discretionary items. He said:

"Staying connected has become a non-negotiable for millions of people… some of the things we offer no longer fall under the category of discretionary purchases."

I was intrigued by that comment. Was he exaggerating? Yes and no. Technically all of the items in a Best Buy store are discretionary items, which, according to Investopedia.com, are "non-essential" goods and services. We know you won't die if you don't have a TV or MP3 player or computer.

But beyond the technical definition, it gets blurry. What Dunn was trying to say is that some items in society have become essentials for the majority of the population.

Imagine (or recall if you're old enough) when the radio, television and telephone were first adopted. They were luxury items. For big events like sports or elections, people would go to their neighbor's house to either listen on the radio or watch the big news activity of the day.

Today, according to Corning (GLW:NYSE), LCD TV penetration in North America will approach 90% this year. Folks like me (and probably you) can't live without a nice TV. So in my humble opinion, I'd call a lot of these items "near-essential" items. We won't die without them, but our lives would be significantly affected (for me, especially during March Madness and football season).

The same applies for cell phones. With children (and the elderly to a lesser extent), the safety "value" of cell phones for parents makes them even more "essential" and perhaps non-discretionary. And of course for business whether you're an entrepreneur or traveling salesperson, the cell phone is pretty much mandatory, or non-discretionary, if you want your business to "live."

Even in places like India, where the average annual income is under $1,700, flat-panel display TVs have been growing at 80-100% and only 50% of the population owns TVs.

Specifically regarding cell phones, the global facts concur that "staying connected" is essential and maybe non-negotiable. Cell phone penetration exceeds 100% in some European countries – including Italy, the United Kingdom, Norway and Sweden. (Greater than 100% penetration means the number of cell phone accounts are greater than the number of people – not that every person will have a cell phone. Some people will have more than one cell phone.)

In the United States, cell phone penetration is over 90%, with 100% penetration expected by 2013. As the chart shows penetration will continue to rise above the general population count.

But smartphones, which allow Web access, text messaging and camera functions, are only at 17% penetration in the U.S. compared to the global leader Italy at 28%. So there is a lot of growth for these phones.

In emerging markets, landline telephony and the more expensive infrastructure required to install them are being skipped. Cell phones are the prime and sole means of communications for most consumers in developing countries like Africa, India and China. The growth is impressive. In Africa, the number of mobile telephone lines grew at 54% compound annual growth rate from 15.6 million in 2000 to 135 million in 2005, compared with a 24% growth rate globally!

How to Play the "Non-Negotiables"

For the most part, I would look abroad for ways to invest in this global technological adoption process regarding cell phones and flat panel TVs. Mobile phone operators in emerging markets have generally been great stocks for 2011, but with a little patience, I'm sure there will be an opportunity to buy the key phone and equipment providers in fast-growing regions like Asia, Africa and Latin America.

Regarding U.S. companies, there is Corning. Corning has a 75% global market share in LCD glass displays for TVs, monitors and computers. They are expanding in emerging markets to take advantage of the rapid growth I have been talking about. Actually, my comrade Michael Robinson, who is the editor of Taipan's American Wealth Underground, has Corning in the portfolio and is bullish on its global position and leading technological advantage.

Of course, you could look at U.S. retailers too, as at certain times these familiar stocks can be great investments. While the issue with declining prices is always a concern, we can look around us and see that consumers are viewing laptops, flat screens and MP3 players as "non-negotiables." Then Best Buy does become an interesting idea. It's not expensive (roughly 14 times 2010 earnings) if you believe its guidance of 10% to 14% earnings per share growth for 2010 and its growth in international markets like China will continue to pay long-term dividends.

How to Become the Perfect Hunter, Bear-Style

Justice has been teaching the art of shorting in installments for several weeks now… and with good reason. Even though the Dow moved slightly higher this week, jumping on Friday on news that unemployment numbers remained steady… the market turbulence is not out of the woods. Just ask Adam, who believes that we're just biding our time until another big crash comes this fall.

This week, learn more about how to become the perfect hunter in a bearish market… why we may (or may not) be witnessing a new great decoupling phenomenon… the next brick wall in the Greece fiasco… and much more…

The Fine Art of Shorting

A wise market bear patiently waits for investors to bid up a best stock for 2011, an index, a commodity or what have you when general conditions (and the charts too) do not justify the hope of a higher price.

But there is an old trader's saying that "bull markets roll, but bear markets spike." So how do you learn to be patient in a turbulent market… and come out on top? Justice explains here…

Is It Time to Buy Berkshire Hathaway?

In times of crisis and opportunity Warren Buffett gets a lot of attention as his investment activity and his spoken word are closely followed. The performance of Berkshire Hathaway is closely monitored too. In other words, when Warren Buffett speaks, everyone listens.

For quite a long time, the shares of Berkshire were at nose-bleed prices, exceeding tens of thousands of dollars, so many of us couldn't afford to own a piece of Mr. Buffett's empire.

But with the recent $26 billion acquisition of Burlington Northern, new shares were split and issued, with Berkshire Hathaway B shares currently priced at $80/share. So is it time to buy? Kent Lucas explores the pros and cons here…

The Other Great Decoupling

Chances are you've heard about "the great decoupling." This phrase has been in vogue for some years now. It describes the belief that emerging markets will break away, or "decouple," from the aging West in terms of long-term economic results.

This week, something curious happened. The market responded vigorously to positive consumer data points in both the U.S. and Asia. Equities both foreign and domestic went into bullish breakout mode. But crude oil did not.

Hear why the current bizarrely strong price relationship between oil and top stocks for 2011 makes Justice think we're witnessing the next great decoupling relationship here…

The Dangerous Scenario Looming

U.S. stocks are pretty much the same price today as they were some six months ago. Indecisive runs like this are by definition the result of mixed news, or perhaps more precisely, mixed understanding of the facts on the ground on the part of investors.

It's a funny little supply and demand problem. The lack of consensus creates demand for the one thing that is in shortest supply: a clear vision as to what's really going to happen next.

The throwdown continues as Adam Lass weighs in on roadside bombs and the next market crash…

Why a Greek Bailout Will Not "Resolve" the Problem

There has been a lot of chatter in the financial press about a potential "resolution" to the Greek debt crisis. There has further been plenty of assumption that, once Greece's problems are "solved," the euro's problems will be solved too.

But Greece is not a standalone problem. It is more like the tip of a very large iceberg – an iceberg of runaway spending, broken promises, and the creeping specter of deflation.
With the Greece situation, the financial base has been remarkably off base in their reporting. Every time European politicians move closer to a "deal," the press gets excited, as if the close to the crisis were at hand.

Is the Stock Market Always Right?

How do you do well in the best stock markets in 2010? Easy – just buy low and sell high. Make sure the trend is your friend, then cut your losses and let your profits run. If you can just remember that it's mind over matter and practice makes perfect, in no time at all you'll be on easy street.

Okay, enough of that. Ugh.

The point of that opening paragraph – sarcasm, as you've surely now realized – was not to impart timeless pearls of stock market wisdom. It was meant to demonstrate the tired, worn-out nature of the hoary old trading cliché.

Now, granted, many of the old sayings have stuck around for good reason. There are certain truths that apply just as much today as they did 100 years ago. Woe betide the trader who forgets or neglects those truths.

But some popular trading and investing clichés are little more than a waste of breath... a lazy man's substitute for clear thinking.

Here is one your editor has never, ever liked: "The stock market in 2010 is always right."

What the Heck Does That Mean, Anyway?

When traders use this phrase – "The stock market in 2010 is always right, you know!" – they never define their terms, or bother to address the clear exceptions to the rule.

For instance: Was the market "right" in the early 1970s, when incredibly valuable franchises like the Washington Post were trading for something like a half or a third of conservatively estimated intrinsic value?

Was the stock market "right" in January of 2009, when high-quality oil service companies with low debt and ample cash flow were trading at an insanely cheap three times earnings?

And was the stock market right in 1999, when various "dot-bomb" top stocks for 2010 were priced at multiples of infinity (because actual earnings were zero and "burn rates" were sky high)?

No, the best stock market is not always right. There are clearly times when the stock market goes off its rocker, in both directions. And because prices are always changing, one could just as easily say "the stock market is always WRONG." (Some traders do, in fact, operate profitably off such a principle.)

I can hear the objections: "Now just hold on a second JL, you're not being fair. Traders who say 'the stock market is always right' don't deny that valuations can run to high or low extremes. They are just trying to point out that, for the trader (if not the value investor), arguing with the stock market is generally a bad idea."

Yep. Fair enough. Your editor still maintains, though, that "the stock market is always right" is an exceedingly poor choice of words. If what you really mean is "don't argue with the market," why not just say "don't argue" instead?

And yet we still have a problem. Every position is an "argument" in the sense that it represents a disagreement with the prevailing market judgment. The purpose of buying or selling, be the intent to hold for three years or 30 seconds, is to make a profit. That implies a belief that, for whatever reason, the market has a better than sporting chance of moving favorably in the direction one anticipates.

But this amounts to disagreeing with the market's current assessment of what the future holds, does it not? Were the market not in error, where would the opportunity come from?

How, then, can anyone truly think "the market is always right" without being 1) vague on meaning, or 2) a useless academic (i.e. a believer in the efficient market hypothesis)?

It's one of those sayings that only works if you don't think it through.

The Parable of Three Umpires

For a better alternative, consider the following anecdote.

Three baseball umpires are sitting in a bar watching the game. The discussion comes round to defining the strike zone – what counts as a "strike" and what counts as a "ball."

The first umpire says: "I just call 'em like I see 'em."

The second umpire says: "I call 'em exactly the way they are."

The third umpire drains his beer and replies: "They ain't nothin' until I DECIDE what they are."

The market is like that third umpire. The price ain't nothin' until the ump makes the call.

"Hold on," some of you say. "Isn't this the same as saying 'The stock market is always right'"?

Nope. Not by a long shot.

How many umpires do you know who have never made a completely screwy call? How many times have you seen that agonizing slowroll video footage showing how badly blown a decision was, or heard groaning sports fans (perhaps including yourself) lament the lack of replay footage in the first place?

The umpire always has final say, but that isn't the same thing as being right.

And this particular ump (Mr. Market) can't be fired, despite his crazy tendencies. Sometimes he shows up to the ballpark drunk. Other times he's hopped up out of his mind on stimulants. Still other times, our beloved ump gets morbidly depressed, or decides to redefine the strike zone based on some wacko new theory from his favorite astrologist.

He Sobers Up Eventually

The guy does have at least one redeeming quality though. He always sobers up eventually.

The key qualifier here being "eventually." You can't always know how long it will take. So you keep a close eye on the old ump... you get to know his habits, his tendencies and quirks. Eventually you develop a feel for when he is out to lunch, and when he's starting to come back around.

Admittedly, "the stock market is a drunken umpire" may not be as pithy or straightforward as "the stock market is always right." It will probably never make it onto that hallowed list of trading aphorisms that never die. But your humble editor considers the umpire metaphor an upgrade nonetheless, because it manages to encapsulate a subtle yet important trading and investing principle. Arguing with the stock market in the short term is an exercise in futility – all it gets you is frustrated, or maybe even thrown out of the game. At the same time, though, there is no reason to assume the best stock market is infallible. Authority and omniscience are far from the same thing.