Hey, Big Spender

"Don't let your mouth write a check your ass can't cash", is an old Flip Wilson line that has crept into our modern lexicon almost half a century later. Because renegade computer scientists, mathematical prodigies, and degenerate gamblers have hijacked the market through quant funds and High Frequency Trading, I wanted to update you on the yearly performance of the Ithaca Experiment Portfolio. Since investing is all about the smell of money, I think it's only fitting that I keep you abreast of what I'm doing.

It should be noted, I'm trying to beat the house just like all of these hyper-connected computer networks but take more of a laid back approach to my investing style. I still believe in a fundamental, buy-and-hold investing strategy, but have increased the table stakes by continuing to own inverse and leveraged ETFs. The major holding in the portfolio is the ProShares UltraShort S&P 500 (SDS), with a small percentage allocated to the Direxion Daily Small Cap Bear 3X Shares (TZA).

Because the S&P 500 ended the year exactly where it started, you would think that I broke even for 2011. That's not the way these leveraged ETFs work. I was slightly down for the year. If you are buying and holding leveraged ETFs for a sustained period of time, volatility does not work in your favor. That is an issue I was well aware of from researching my initial purchase, but am still letting the money ride because if the market cascades downward again, I will make supersized gains.

Is this an ill-fated experiment? There is no way of knowing because I haven't sold anything. Whether I fell for the doom and gloom scenario hook, line and sinker, time will be the judge. I still believe that we haven't gotten past the 2008 financial crisis on a worldwide basis, and that there is still more reckoning to come. I'm not smart enough to time the market short-term, so for the mean time, I continue to wait for more opportune moments to place my wagers except for my short positions.

With the exceptions of Apple (AAPL) and Netflix (NFLX), I've taken a neutral stance on the stocks I've covered, although I like a lot of the companies I've been writing about. Most are down significantly and that's what I've been looking for - excellent companies with reasonable P/E Ratios. I thought that Apple had too big of a market cap and did not want to own it because of the law of large numbers. I still feel this way although I do enjoy their products. With Netflix, I thought it was just hype. The stock is down almost $200 since I panned it and still would not want to own it.

However, for the most part, I would like to take positions in a majority of the equities I've covered over the past year when conditions are more favorable. My playbook is to continue following the approximately thirty companies I've been blogging about. What am I looking for? Single digit P/E ratios in the stocks that comprise the S&P 500. That's where the market stood in both the 1930's and the 1970's. As an economy, that's where I think we are now although the market doesn't reflect that - yet.

On a final note, I read a considerable amount of investing books and, without question, the best of the bunch this past year was Crapshoot Investing by Jim McTague. It's all about High Frequency Trading and its proliferation into the market since 2007. Like shady sports book operations, this is high-stakes gambling. No matter what size your bankroll is and if you want to maximize your gains, you should buy this book before you let the stock market take your action. It's the rise of the machines, and McTague's publication let's you know how dangerous and fragile this electronic ecosystem really is.

Verifone Gets Read The Riot Act

VeriFone Systems (PAY) got broadsided the last two weeks. Even before its December 14th, Q4 Conference Call, the stock was getting crushed, falling from $44/share on December 5th, to $35/share just nine days later. That's more than a slap on the wrist, and, I am not sure it's entirely justified. Sure, they disappointed the street with shrinking margins, but I think they should be taken off the hook based on its overall valuation.

Yahoo Finance consensus earnings estimates gives it $1.90/share for fiscal 2011 (which ended in October), and, $2.48/share for 2012. This gives us a P/E Ratio of 18 for 2011, and, 14 going forward. With earnings growth projected to be 30% next year, and, its compound annual growth rate at 23.5% for the next five, you get a reasonably priced, or even undervalued security. As a long-term investment, earnings may be lumpy over the next few years, but my guess is that it could be a bargain at its current price which is very close to a 52 week low.

Although they utilize proprietary software in their point-of-purchase readers, VeriFone is primarily a hardware company. I am not suggesting they are in the same league as Apple (AAPL) because Apple is in a league of its own, but they may be suffering the same fate in regards to a compressed P/E Ratio. Both are leading edge technology companies, but not software pure plays which get the expanded valuations. This is something to consider if you are tempted to buy it at its current depressed price.

If you are not familiar with VeriFone Systems, you probably use their terminals every day if you swipe your credit card at the supermarket, gas station, fast food restaurant, or, even in a taxi. Although they are growing internationally, most of VeriFone's projected revenue is derived from merchants upgrading their their point-of-purchase readers. The newest upgrade cycle may not take off if smartphones equipped with Near Field Communications capabilities do not ramp up in a timely fashion.

In the last three conference calls, CEO Douglas Bergeron discusses the evolution of his initiatives in the upgrade cycle of Near Field Communications.

• In the June 2nd, Q2 Conference Call: "We recently announced that we are partnering with Google (GOOG) and top retailers to deploy a new NFC-based mobile payment system for trial use throughout the U.S. The trials are occurring at major retailers including American Eagle Outfitters (AEO), Foot Locker (FL), Macy's (M) and Toys "R" Us. Google and retailers are using VeriFone's Near Field Communication-enabled point-of-sale systems to power more engaging consumer-friendly transactions. Our retail presence, security infrastructure and brand recognition is key to the success of the NFC offering. If these trials lead to wide-scale deployment across the industry, we expect a boost to our growth for the next several years by $100 million to $150 million per year in the U.S. and even more internationally.".
• In the September 6th, Q3 Conference Call, his enthusiasm continues: "Visa's (V) recently announced plan to accelerate the migration to EMV contact and contactless chip technology in the U.S., combined with the industry's interest in deploying NFC technologies, creates a unique situation that may stimulate and accelerate terminal upgrade cycles. It's too early to predict what other card networks will do. But directionally, this could mean a complete product refresh over the next several years, representing hundreds of millions of dollars of business.".
• In the most recent Q4 Conference Call, Bergeron updates us on his expanding network of providers: "We continue to make great progress on our strategic relationships. Google, is now live in approximately 40,000 VeriFone lanes across the country. VeriFone has upgraded each of these lanes, with NFC functionality and sold the VeriFone Google application and interfaces at each live location. VeriFone has proven invaluable in the Google Wallet initiative, delivering 12 of the 13 of the SingleTap merchants listed on the Google Wallet website...We also continue to work very closely with AT&T (T), T-Mobile and Verizon's (VZ) payment joint venture called Isis, to support their 2012 pilot plans, as well as scaling to support their national rollout. In addition, PayPal is going extremely well, as we are actively engaging merchants and collaborating with PayPal in how we can support their 2012 objectives.".

Near Field Communications is the technology that enables you to wave your smartphone close to a point-of-purchase terminal and buy a product or service without using your credit card. That functionality will be built into the communications device via an application. It's still in its infancy stages, but I am confident it will be a lucrative source of revenues for VeriFone. The questions remain, when will this technology take off, and, when will it goose the share price of VeriFone?

I believe that this technology will not become universally accepted for another year or two because it is dependent on merchants upgrading their systems, not the introduction of the technology to the consumer. In a world of immediate gratification, traders tend to gravitate towards securities that are on a hot streak. This is not the case for VeriFone, and, I don't see it bouncing back until this new initiative becomes commonplace. The company may very well trade in lock-step with the overall market until it's ready for another close-up.

This stock is not a long shot. Far from it. VeriFone is numero uno globally in their niche. My take is that with handicapping equities in the Vegas-style casino we call the stock market, you have to take catalysts into consideration because we are being ruled by high-frequency trading. If you have a short-term mindset, this is not the stock to be in. If you have a penchant for value, this stock would be a nice addition to your portfolio.

Round-Trip Ticket

The Stop Trading On Congressional Knowledge (STOCK) Act has been getting much needed publicity lately. CBS's "Sixty Minutes", The Economist, and, even my local paper have been reporting on the legal insider trading that happens on Capital Hill. The catalyst for all of this ink and airtime stems from a recently published book, "Throw Them All Out", by Peter Schweizer. The publication dishes the dirt on our elected officials from both sides of the aisle, and even brings to light the hidden agendas of some of our most respected financiers like Warren Buffett and George Soros.

Although investing and politics are interconnected, I'm not going to go into great detail about the book because I'm not at the high-stakes table, or have an informational edge by being in public office. Like most of us, I'm on the outside looking in and use the time-tested investing tradition of searching for value in an inefficient market. However, I want to highlight a quote from Mr. Schweizer's work: "There is a rule of thumb in the financial industry that 75% of options are worthless when it comes time to redeem them, and that 80% of options traders lose money.".

I'm not trying to use scare tactics to get you out of your options bets, just point out the facts. I don't know how these power brokers on CNBC, newsletter writers, or, bloggers in cyberspace make money using derivatives. They can't all be beating the point spread. I'd like to see their actual profit and loss statements from their brokers. It would give more credibility to the source. Otherwise, it's just a three-card monte ruse.

I use options indirectly in my leveraged/inverse ETF's. ProShares UltraShort S&P 500 (SDS) and Direxion Daily Small Cap Bear 3X Shares (TZA) are what I'm primarily invested in. They utilize derivatives to pack a punch, but are actively managed. I let the professional traders do my bidding and so far, they've been exactly as advertised. You have to have a certain risk/reward profile to want to invest with these financial instruments, but I did a significant amount of research before allocating resources to them. If you have been following this blog, you know that on paper I'm down from my original investment. I would not recommend them to a majority of retail investors.

That said, I think they are a terrific way for experienced investors to play the macroeconomic picture if you have the stomach for the volatility. I believe I'll get my money back and even more, so I'm sticking with my initial wager. If you want an adrenaline flow, or your endorphins running without a lot of hassle, leveraged ETFs are the way to go. You just buy and sell them with your broker. No margin requirements or the messy business of dealing with options. Just put your keys in the ignition and drive. Nothing has changed in regards to asset allocation in The Ithaca Experiment portfolio since the blog's inception. That's where I stand.

The title of this posting is "round-trip ticket", and it reflects the direction of this blog the last few months. I don't believe in get-rich-quick schemes and prefer to make informed investing decisions, so I'm following up on the stocks I originally wrote about in the first half of this year. Really like a lot of the companies I've been revisiting: Acme Packet (APKT), F5 Networks (FFIV), and, Dolby (DLB), just to name the more recent ones. Most of the securities I cover are in ValueLine, but I find their research somewhat incomplete and untimely, although very valuable as a starting point. This is why I write this blog.

Conference calls are where I get most of my material. They are a storehouse of information and give you the intangibles. Just don't trust sell side analysts. Many times they are trying to pull a fast one on you for the benefit of their employers, not the individual investor. From all of the research I've done, my take is that although companies in the United States appear to be mean and lean, they do a considerable amount of business with Uncle Sam and in Europe. A majority of the companies that I've been covering fall into this category. These are areas that will suffer significant cutbacks in the next year.

I believe that there will be a major contraction in both earnings and P/E Ratios in 2012, resulting in lower stock prices. However, and it must be noted, I've been expecting a significant correction, if not double dip recession for some time now. I try to compensate for my lack of market timing skills by giving you well balanced articles on securities I believe will be benefiting from the exponential innovation that is engulfing us today.

Best-case scenario, I double or triple my original bet with the inverse ETFs in just a few short years, then begin to buy individual securities that I have already researched here on this blog. Worst-case scenario, I lose some money in my short positions, but since I'm also hoarding cash, I'll still have an ample amount to invest. If I do lose a percentage of my original bankroll, I don't think it will be that much, which is why I continue to hold steady. Sometimes it comes down to dumb luck.

The longer I maintain my position, the more probable it is we will be heading for a worldwide recession. This is by no means a foolproof business plan, but one I'm comfortable with. Until I divest my ETFs, I'll continue my intelligence-gathering mission on what looks good going forward. Next on the docket is Verifone (PAY), then United Therapeutics (UTHR).

Dolby Laboratories Has Been Short-Changed

Dolby Laboratories (DLB) has been chaffing under the yoke of a late August announcement that Microsoft's (MSFT) Windows 8 may not be incorporating their technology. Microsoft dropped a bomb on Dolby. Just two months ago on October, 3rd, the stock traded at $26/share, almost equal to its price of $25 during the dark days of late 2008, early 2009. It was priced like it was Mr. Irrelevant, the last pick in the last round in the NFL Draft. If you bought at the October low, you may have been involved in a legal bank heist.

Even at today's closing of $32, Dolby Laboratories is still selling at a decent valuation. Yahoo Finance consensus earnings estimates gives it $2.57/share for fiscal year 2012, which closes in September of next year. This calculates into a P/E Ratio of 12. When you take into consideration the projected 5 year compound annual growth rate of 15%, you come away with a manageable, if not compelling PEG Ratio.

However, this not to say Dolby Laboratories will be the high flier it once was, at least not near term, only that it's a blue chip technology with an established world-wide brand. Patient investors could do well with this security if they don't have a short attention span. Is it a value trap? Maybe, but, if you look out a few years from now, I believe the stock will be much higher. Dolby's average annual P/E Ratio has been 25 the last five years with the exception of 2009 when it was 16. The voice of reason would tell you that there is a very good probability that this equity will move up in value.

The projected loss of revenues from the exclusion of Dolby technology in the Windows 8 operating system will not be a factor until 2013. CEO Kevin Yeaman clarifies this in the August 4th, 2011, Q3 conference call: "...we don't think this has a discernible impact on 2012 when we're still going to be on a Windows 7 year. We see Windows 8 coming into play during 2013. Once we are at Windows 8 adoption, if Windows 8 does not include our technologies, then we would expect the world to migrate to a place where there is one Dolby Digital decoder per PC, which is, of course, something the world had begun migrating to...".

The missive from Microsoft came out of left field, and, without question, put some pressure on Dolby. But, you don't stay in business for 45 years without a Plan-B. In addition, let's not forget that DVD drives in laptops and PCs are not necessarily ancient history but are being phased out with the advent of streaming. You know anybody with a floppy drive on their computer?

But going back to the Q3 conference call, CEO Yeaman spins damage control by stating: "If our technologies are not included in the commercial version of Windows 8, we expect to support DVD playback functionality by increasing licensing our technologies to OEMs and ISVs (independent software vendors), and we will seek to extend our technologies to further support online content playback.". Some of these online content providers include Netflix (NFLX), VUDU, Amazon (AMZN) and Apple (AAPL).

I believe it was "Deep Throat" who said to Bob Woodward, "Just follow the money.". That's exactly what Dolby is doing, following the money which in their business is the technology. In the November 17th, 2011, Q4 Conference Call CEO Yeaman explains: "Today we are seeing a shift in our core audio business from optical disk playback to digital broadcast in the media content...In fiscal 2011, we estimate that 52% of licensing came from non-optical disk base revenue, compared with 45% in fiscal 2010. This includes revenue from products such as TVs, set-top boxes, mobile phones, as well as our processing technologies on a wide range of devices.".

Yeaman expounds on this later on in the Q&A session: "...one of the things we have highlighted today is the amount of revenue we have coming from non-optical...which is not engaged in any way in optical disc playback. And that's been growing quite well, 22% in '10, 27% in '11. The biggest drivers, of course, are broadcast and mobile. And we do see growth in those areas in 2012. I think beyond 2012, still in front of 2012 is the bigger adoption in markets like China, India and Russia...This is where we expect a lot of television growth in the future.".

I originally wrote about Dolby Laboratories in early April, and, in that posting, broke down its business model. 10-K's only come out once a year, so I won't go over old material. However, I liked the company but thought the equity was still radioactive since it had been in free-fall for three months due to a slowdown in global PC shipments. If we don't experience economic blight because of the European financial crisis, my take is that this is a good buying opportunity for those interested in Dolby.

F5 Networks Gets a Second Wind

Long-term shareholders of F5 Networks (FFIV) have had a white-knuckled ride with this revenue-generating enterprise. Going back to the market bottom in 2009, it was selling for $18/share, then obtained security stardom by reaching $144 in mid January, 2011. No small feat. Investors got fat holding this company which manufactures load balancers that optimize the delivery of network-based applications. Think Cloud Computing and the build-out of Internet 2.0. This is not your father's Arpanet.

Although F5 Networks is a microcosm of the evolutionary expansion of the Internet, the stock closed at $71 on October 1st, 2011, a 50% decay in share price in only 10 months. If you were drinking the momentum Kool-Aid last Winter and, bought at the top, you probably got fleeced because the average holding period is now two and a half months. It had a P/E Ratio of 40 and only a 17% growth rate. If you go by the rule of thumb to liquidate growth stocks when their PEG Ratios go over two, then that would have been the time to sell. I'm primarily old-school and staunchly believe in earnings over hype.

Investors got squeezed because of three consecutive quarters that disappointed the powers that be. At 71$, it was priced for a doomsday scenario, and, couldn't get arrested. However, after a strong Q4 conference call on October 25th, the security is back in motion, closing at $113 Friday.

If we move past the previous hysteria in F5, we can get a good look at their numbers and see if investors will get bilked by buying the equity at its current price. According to Yahoo Finance consensus average earnings estimates, the company is slated to earn $4.42/share in the current fiscal year which ends in September of 2012. We're right of the beginning of that cycle, so I'll use that number to calculate the forward P/E Ratio of 25.5.

That's not too bad when you consider their 5 year compound annual growth rate is expected to be 21%. It gives you a PEG Ratio of 1.2. Not bargain basement but very reasonable. The laws of arithmetic would tell you to go out and buy this stock if you have both value, and, momentum leanings. But before you pull the trigger, let's take a look at some of the intangibles.

Going back to the Q4 conference call, CEO John McAdam states:

• "We made significant progress in increasing our addressable market by delivering solutions to our core ADC platform in adjacent markets, including remote access control, optimization, and security".
• "...we continued to generate significant revenues from our partnerships with large application solution suppliers, including Microsoft (MSFT), Oracle (ORCL), and VMware (VMW), where the ability of our products to optimize the performance, security, and availability of mission-critical business applications is unparalleled".
• "...our new ground-breaking iApp technology simplifies deployment of applications, enabling 10 to 100 times faster application delivery through the network".

Although this is a plus for F5 Networks, Mr. McAdam also makes comments about the worldwide economic environment: "As far as the outlook is concerned, it’s appropriate to be cautious about the global economic situation, and we remain committed to strong profitability. Clearly, there are numerous uncertainties present in the overall economy as we enter fiscal 2012. Obviously, as the current macroeconomic conditions weaken, then overall global IT spending could be reduced.".

He reiterates his stance in the Q&A later on in the conference call: "... let me give you the caveats once more that we read out, which is in terms of the annual growth guidance that we’ve given. That is absolutely based on the macro economy staying in the same condition. If it deteriorates, by definition we will have issues there, so there’s no question about that.".

Most of us are well aware of the difficulties facing the economies in the "civilized" world. Making a bet on a solid company like F5 Networks or any company for that matter is the level of your risk tolerance. My migratory dollars have gone to cash, but you may feel differently. That said, I like this organization and want to take a closer look at what may be in store for them going forward via the November 3rd, 2011, Shareholder/Analyst Call.

If the Shareholder/Analyst Call was a television transmission, it would be like a science fiction infomercial hosted by the F5 Networks' company brass. This is not a left-handed compliment. These are progressive thinkers, and they presented a 3-5 year plan that is not only F5's story, but the future of the entire Internet infrastructure industry. It's a lengthy document, 42 pages, and, I thought the company showed tremendous business acumen by demonstrating what may happen to server virtualization and data centers as we move onward.

According to the document, one thing is for certain and that is the Internet is going to be more powerful and more ubiquitous: "..there are about 4 billion devices connected to the network out there in various forms, looking out to 2015 going up all the way to 15 billion and then stretching out to 2020 estimated at about 50 billion devices. So you think about those electric meters and sensors and - so it's a lot more stuff than just mobile phones that are being connected to the network...Intel is saying in 2018, that servers will be about 125x more powerful than they are today.".

That may be a no-brainer to those that are familiar with the evolution of the World Wide Web, but what does it have to do with F5 Networks and their leading position in load balancers and application delivery? It means they are expanding from their core competency of primarily a hardware based business and are entering the software arena much the way that Apple (AAPL) did. They even state that they are taking a page from the Apple playbook. That is not to suggest they are competing with Apple; they are in different sectors of the technology industry.

With the amalgamation of hardware and software, F5 will potentially be able to obtain a bigger piece of the pie by offering such services as optimization, remote access, file virtualization, and, application level security. With their penetration into the Fortune 500 at 64%, and, 52% of the Footsie 500, they have a very good chance to be last man standing in what appears to be a slugfest when liquid data centers try to virtualize everything. That 5 year consensus CAGR at 21% as reported by Yahoo Finance earlier may be on the conservative side if the company's expansion plans pan out. If you want to play the favorite, you might consider F5 Networks.

To avoid revisionist history, I'd like to point out that I wrote a previous posting on F5 Networks last April when the stock was selling for $95. I liked the stock then. I like it even better now, however, I am out of the market. That price of $144 it was selling at back in January may not be its pinnacle, but, the 52 week low of $71 may not be the bottom either. My bet is that there will be low-hanging fruit again in 2012, just like there was in 2008-2009. I am waiting for P/E Ratios to contract, like they did in earlier periods of economic strife. When I do put my money to work, I will probably be taking a position in F5 Networks.