Christmas is coming, and that means two sets of flurries are on the horizon – snow and retail news. Now that the aftershocks of the 2008 financial collapse have had time to set in, this year will be a test to see how resilient consumers are in spending for the holidays. Retailers, for their part, have been preparing by slimming down; most are carrying record low levels of inventories to avoid the need for post-rush markdowns. But as the fundamentals are uncertain, retail stocks have been rallying with the rest of the market – the Retail HOLDRs ETF (RTH) is less than 13% off its all-time high in July 2007, led by large allocations to Wal-Mart (WMT), Home Depot (HD), Target (TGT), and Walgreen’s (WAG).

Large-cap, diversified retailers lack the appeal of a growing niche apparel company, for instance, but in many cases they look to be safer bets with decent upside in a market that’s looking increasingly overextended. Wal-Mart and Home Depot attract my attention with relatively stronger moats for the retail industry and a consistent history of posting ROEs in the double-digits, and although they trade at higher earnings multiples than a company like GameStop (GME), I believe the sustainability of earnings favors the stodgier retailers. Earlier this year, investment funds that I co-manage (BCIC) sold GameStop stock on a belief that it is a value trap with illusory single-digit forward earnings multiples, as competition for video game sales increases, and video game makers look to connect directly with consumers and disintermediate brick-and-mortar stores. That stock is down 15% in the last week and is close to its 52-week low, one of the exceptions in a market that is making new 52-week highs.

There will be plenty of news on short-term sales trends involving consumer spending in the month of December, but there might be limited comparability with past years because the paradigm may have shifted in this newly frugal economy. If you’re going to play with retail stocks, then, stay high quality and go with solidly entrenched middlemen. Bed Bath & Beyond (BBBY) is one retailer more off the beaten path that also fits that definition – a differentiated inventory strategy, improved pricing power after the Linens ‘n Things bankruptcy, and a modest valuation – and I’m happy BCIC owns it.
On the apparel front, Goldman Sachs (GS) analysts believe the sweater will be the go-to gift of 2009; while apparel is admittedly not my specialty, BCIC recently established a position in Ralph Lauren (RL).

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Originally posted here.

Stephen Frankola sends: As I begin this, Vonage (VG) is trading at over $2.40 in the aftermarket.

Vonage was trading below $.40 just five days ago.

The (investment) world is looking for an explanation. Barron’s tech writers have been blogging frequently over the past few days, marveling at the huge move. The Yahoo! message boards are abuzz.

To me, this looks like a euphorically-driven chain reaction.

A short squeeze might have triggered this rally, but it isn’t responsible for the majority of today’s move. According to Yahoo! Finance, around the end of July, there were 4 million shares sold short. 41 million VG shares traded today, so short covering can’t be credited with this move.

There also hasn’t been any significant news within the past few days. Vonage reported optimistic results in the recent past, and they also announced a new international phone service last week. Vonage’s comment on the situation seems to imply that the entire world just realized these couple tidbits and all tried to enter at once. I’m not buying that. I think that’s the equivalent of saying “we have no idea why our stock is up 500% in a week, but we’re just as estatic about it as you are!”

So my conclusion is that this is a euphoric rally driven by people going long. Owners at $.40 (who may have been underwater from previous purchases) probably aren’t selling into strength, driving price even higher. Coverage in the media likely attracts new investors to this hot stock.

VG has been prone to such explosive moves; I was lucky enough to own it in the past prior to a positive announcement; shares jumped 100%.

Buying (or shorting) VG today or tomorrow is simply gambling. Without a clear driver of this extreme movement, there’s no concrete reason why shares are worth so much more today than they were last week. At the same time, shorting against such powerful upward movement is insane. Three times during the day today, VG moved up over $.20 (representing 20+% moves) in mere minutes. That’s not the kind of momentum I’d want to be shorting into.

This is certainly an interesting story, and it’ll be interesting to see how and where things settle down. Stay tuned.

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I recently finished reading Stephen McClellan’s revised and updated book Full of Bull: Unscramble Wall Street Doubletalk to Protect and Build Your Portfolio. McClellan spent over 30 years as an analyst of technology stocks, and had a front row seat to the evolution of the modern sell-side analyst.

McClellan covers a diverse set of topics, and although there are occasions when the book doesn’t flow right – he frequently jumps back and forth between advice and sometimes tenuously-connected anecdotes – that’s a minor problem at worst. More glaring - and perhaps a consequence of when it went to press (February 2009) or his personal investment outlook - is the negative undertones and myopic focus on the current bear market. I wonder if recent market events have changed his disposition…

The best lesson this book offers is for the individual investor who believes they can benefit by listening to headline recommendations of upgrades and downgrades – i.e. new “buy” (or equivalent) calls. Wall Street analysts, as McClellan says, aren’t judged by the accuracy of their stockpicking, but instead by client relations and related business they generate. Helping individual investors is at the bottom of their priority list.

By now, that overwhelming urge to be optimistic (at least in public) about stocks should be well-known, even if the situation doesn’t warrant it. Most research disclosures still show that a “sell” rating is used less than 20% of the time, and that’s part of the game played by analysts with the company’s they cover – many of whom McClellan says take petty actions against analysts who aren’t favorable on their shares.

Another important takeaway for emphasis: the short-term is overanalyzed, and individual investors don’t really have a chance of gaming those movements. Particularly in the large-cap space, dozens of analysts will be following a company, and there’s no edge to be had from ratings changes or earnings estimate revisions. Stick to the small-cap space where more inefficiencies can be found, and take a longer-term view of a company’s competitive positioning.

One prominent part of the book that won’t directly help you as an investor, but I nonetheless found to be great reading, was the description of how the analyst’s role has evolved. Research has become entwined with other functions at an investment bank, and most research today is paid for indirectly. McClellan bemoans this, and how it compromises the ideal purpose of research, but no solution to this problem is offered. That’s one idea I’d like to see more thoroughly developed should another edition of Full of Bull ever be published.

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Disclosure: The book publisher provided me with a free copy to review. If you purchase the book using a link from this page, I earn a small commission, but that does not result in you being charged anything extra.

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