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Current Newsletter: Volume 2, Issue 2 |
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Full Newsletter (Requires Adobe Acrobat Reader) page 1 Note From We are quite certain that the current eighteen month downturn in the stock market has caused you to become concerned on more than one occasion. In fact, the concern is probably increasing as the downturn has grown in severity and duration. We understand your concerns and share your frustrations. We also are focused on the future because that is what will impact your future investment performance. What we see is a stock market that is creating significant opportunities for a broad variation in future investment performance due to wide ranges in current stock valuation. We believe that the best way to capture those opportunities for our investors is to increase our research capabilities in order to improve our chances of separating the good from the bad. Our latest addition to the Shaker Investments team is Richard S. Campagna, who has come aboard as Managing Director – Equity Research. Rick reports to Ray Rund, who heads our research team. Rick has more than 12 years of experience in the financial industry as a senior analyst and co-manager of mutual funds, including stints at Manning & Napier Advisors, Inc., McKinley Capital Partners, Ltd. and Morgan Stanley & Co., Inc. He earned an MBA from the Harvard Graduate School of Business Administration and a B.S. in Biological Sciences and Economics from Duke University. On our back page Analysts Report of this issue, Rick notes that short-term phenomena can mislead investors into believing that long-term socio-economic trends are no longer viable. He points out why the future outlook for energy, transportation and several other key areas of our economy continues to look bright. Similarly, I have used the front page of our newsletter to focus on those areas in the beaten-down communication sector that will benefit from growing worldwide demand for their products. As always, we welcome your comments and suggestions. Commitment to Communications The communication revolution is not over. Our current investment strategy clearly reflects this view with 23% of our total portfolio invested in communication technology stocks. Approximately three quarters of this allocation is in semiconductors or optical component stocks, while the balance is allocated to communication equipment shares. As investors continue to worry about disappointing earnings and the economic slowdown, our favorable long-term view of the communication technology sector merits some clarification. Clearly, we are more optimistic than most about this sector and individual stocks. Our optimism is based upon the following three factors: 1. Growth in Data Traffic 2. Changing Technologies, and 3. Stock Valuations I. Growth in Data Traffic - Short Term and Long Term - Recent Analysis of Data Traffic over all networks indicates that the growth in this traffic continues to more than double each year. This growth rate has held within a reasonable range for the last five years. Consequently, this remains a growth industry and any excess capacity will be utilized within a resonably short period of time. From a long-term perspective, we expect communication to be the most rapidly growing sector of our economy for the next 10 to 15 years. In the past decade, this sector significantly contributed to productivity and has helped the overall economy to grow. Its long-term potential remains considerable by any industrial measure. In many countries around the world, the process of technological modernization has hardly started. The potential demand from these areas will result in increasing orders to the U.S. communication industry. Within the U.S., as well as overseas, we anticipate demand from both business and private consumers for broadband and Internet-related products to once again increase at a robust pace. II. Changing Technologies - The slowdown in the economy as well as the move to more DSL and Cable Modem Internet connections are providing the opportunity for telecommunication service providers to move away from spending on expensive voice technology to spending on much more efficient Internet Protocol (IP) technologies. Consequently, we expect spending on high speed optical and electronic communication equipment to grow even as the overall capital equipment budgets remain flat or decline slightly. III. Valuations - In hindsight, we underestimated the potential decline in this industry both from a revenue/earnings standpoint and a stock price standpoint. Clearly, we could have and should have been more patient in making investments. As valuations have continued to decline, we have chosen to put more money to work because these stocks are extremely cheap relative to their three year growth prospects. In the last 12 months, the communication stocks in which we are currently invested have seen stock prices decline 89.4% from their peaks to their current values. On average, these stocks now sell at 4.0 times tangible book value (cash, accounts, receivable, inventories and fixed assets less any amounts they owe). Since most of their real value is in intellectual property, these values are cheap. Lastly, most of our investments in this sector are in semiconductor communication chip companies (e.g. AMCC) or optical component companies (e.g. JDSU or New Focus). These stocks have suffered disproportionally due to inventory reductions by their major customers. Once these inventories are fully reduced (which is occurring very rapidly) semiconductor and component companies will see a significant increase in revenue and earnings even without growth in communication capital equipment spending. In addition, these companies continue to take a greater share of the total equipment value because equipment manufacturers like Nortel, Cisco, Lucent and Tellabs are reducing their component engineering costs by expanding their use of the standard components sold by the chip companies. |
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