Useful Calls

Finance is prone to problems and complaints. There's too much regulation, then not enough. There's the politically valuable common man (the "working class") and there's Mr. Burns. Financial information is abundant; there's too much. Jim Cramer should annoy most sane people.

So when you open floodgates of financial media, you either have to ignore most noise, or only rarely but deeply pay attention. Faro prefers the former. Selecting what is newsworthy is hard given the prevalence of financial data: CPI, Case-Shiller, employment, level of the Dow vs eight days ago (who really cares?), oil, commodities, trade imbalances, inflation, etc.

These all have value. But meaningful short-term economic forecasting is extremely difficult. There is, however, a great source of data that come direct from companies (though you should be selective since most CEOs are salesman). Only pay close attention to companies whose business models you admire or that have a compelling special situation scenario--real "change" in the works.

This site is following three companies during this week's earnings calls: Borders, Costco and Tiffany & Co. All are household names and operate in the easy-to-understand worlds of books, food and electronics, and high-end jewelry.

All should add insight to investors on commodity costs, consumer behavior, and luxury consumers. Borders is in the news as a potential acquisition target for Barnes & Noble. A combination would have 30% of the book market. Costco brought in 1.3B in membership fees, curiously close ((1.2x) to its reported FY2007 profits. That's a fair trade-off for good food, a 90-day return policy, and tasty Saturday samples. Tiffany seems immune to the current economic woes. Drop in USD will be interesting in results, as will expansion plans.

Grab a pen, pay attention and ignore the buzzwords.

Wednesday: Borders

Thursday: Costco

Friday: Tiffany & Co.

Disclosure: None

Image: http://www.bradleygoughdiamonds.com/pictures/diamond.jpg

On Restaurants

Restaurants largely deserve their reputation as poor businesses. Any business with low barriers to entry will never make much more than its cost of capital*. It's capitalism 101. You don't need to read strategy guru Michael Porter to know that.

Long waits and good food don't equal a buy signal. The Cheesecake Factory, other than its bad name, is famous for it's dairy desserts and long waits. I wouldn't salivate over the stock, however. All capital expenditures, in excess of actual cash generated, are understandable plowed back into growing store count. But the incremental returns on capital are mediocre 13% / 8% (levered to unlevered).


Costs across restaurants are fairly consistent: about 1/3 of sales is food, 1/3 labor, 25-30% SG&A and other, and the other 5 cents flow to the bottom line.


Ticker ROE (ttm) ROE (w/o debt) Profit Margin


CAKE 13.0% 8.4% 4.51%
DRI 28.6% 12.6% 5.83%
EAT 24.7% 12.6% 4.71%
MCD 16.7% 10.0% 10.86%
RUTH 20.4% 9.1% 4.76%



Problems

• higher wages: minimum wages will jump 12% in some states this summer.
• low barriers to entry
• exposure to fluctuations of commodity costs while unable to pass on costs.
• consumer fundamentals: there were 524,286 eating and drinking places in the U.S. in 2006 -- a 45% increase from 1990, according to the National Restaurant Association. The U.S. population rose 20% during that period, according to census figures.**"
• People aren't eating out more frequently than 10-15 years ago.
• The solution: crimp on extras, cut hours, or offer specials.

The thought of a smaller burger patty brought by a disgruntled waiter annoys me.

In business, just like airline seats, the middle sucks. The low-cost fast food restaurant (e.g., McDonald's) or the high-end (Ruth's Chris) will be most likely to succeed in the long-term. A restaurant that can earn barely in excess of it's cost of capital is a wonderful restaurant, not a wonderful business.


Notes:
*return a firm would earn on an investment of similar risk
**Wall Street Journal
Image: http://www.shyiam.com/wp-content/uploads/2007/06/cheesecake.jpg

Hyping Stocks

Anyone who pretends to give stock tips should report transparent performance. Faro holds itself to that standard. Below is a brief update of all companies recommended on this site, with an unbiased view of how the three stocks have done. There's no massaging the numbers, no justifications or excuses; it's just the performance based on the adjusted closing price as of 5/9/08. All positions are still held in the Faro portfolio with no plans of selling. Additional shares of LOJN were purchased after the stock dropped 25%.

Nordstrom (JWN)
April same-store sales figures came in at -3.8%. That's a bigger decline than the '01-'02 downturn. There could be more shoes to drop. The Nordstrom name and franchise, however, is strong. JWN trades at a forward multiple of 12x earnings, 6.7x ebitda, .85x sales; it earns an enviable return on equity of 43%; Interest coverage ratio is 15x.

-10.8% vs. S&P -8.6%
Recommended: 10/27/07

Discover Financial Services (DFS)
In the current economic environment, few companies--outside mortgage originators, "greedy" banks, and brothels--get more flak than does DFS. Households continue to worry about expenses. Credit card issuers are often the scapegoats for America's vast financial illiteracy. A key indicator of the firm's business, the net charge-off rate, stood at 3.84% for fiscal 2007. Discover is priced at 11x forward earnings, 2x sales, and has 17.29 in cash per share.


39.3% vs. S&P 5.9%
Recommended: 1/20/08


LoJack (LOJN)
People keep stealing cars. Revenue for LoJack, however, fell 15%. The company faces a challenging near-term outlook as cash-strapped consumers delay big-ticket purchases. Car dealers are focused on clearing out sales lots and less on the added revenue from LoJack units.
Shares are at 10x forward earnings and .83x sales. The company earns a slight excess of its cost of capital: return on equity is about 14%.

-28.7% vs. S&P 1.7%
Recommended: 2/23/08


Is this site worth reading? You decide.

Image http://www.edmunds.com/pictures/VEHICLE/1993/Ford/7227/1993.ford.tempo.3624-396x249.jpg

Beyond The Klamath

If it were any other time of year, you'd wonder why 31,000+ went to Nebraska for a single event. This weekend, however, thousands converged on the surprisingly pleasant city of Omaha for the Berkshire Hathaway shareholders' meeting. Most came to hear from Warren. A handful came to protest. The protests did impact the mood.

The event continued. Despite efforts by the misguided few to protest the Klamath river hydroelectric dams of Pacificorp, a Berkshire-owned regulated utility. Capitalism and modernity never please all parties.

The trip to Omaha is a yearly journey thousands make in hopes of hearing the next piece of investment wisdom, thoughts on the economy, and political opinion. Many learn. Most of us, however, listen and forget. Advice, when truly needed, is seldom heeded. To paraphrase Munger's past comments on this, when people ask for advice, they often mean: spoon-feed me advice so I can be rich, only more quickly.

It is valuable time for friends and investment advisors to reflect on the past year and to consider their next capital allocation decisions.

The questions, however, were surprisingly poor given the financial hurdles of ownership and the intellectual make-up of the party-goers. Most of what was asked is found in past annual reports, books, or public comments. The true gems stemmed from the inspiration of the simple economic truths of Buffett's approach of analyzing people and businesses.

Below is a summary of a few points Buffett and Munger (Co-Chairman) made that I pondered both on Saturday, and on the return flight.

Noise

We ignore 99.9% of what we see in the market (stocks)

Communication

Communication--written and oral--is enormously valuable and under-taught.

What determines dividend policy

Whether you can earn more than $1 of market value per $1 of retained earnings.

Integrity

When we make a deal, there are no special clauses.....Whether Ben Bernanke runs off to Brazil with Paris Hilton, or if a nuclear bomb explodes over NYC, the deal will go through.

It's refreshing to hear such simple advice from a candid, smart, but imperfect man. Hopefully we listen. And hopefully we learn when, where, and to whom we protest.

Disclosure: none