Profiting from SHEEP...

Focus on Housing Sector Jobs, Not Housing Prices!

2008-06-21T16:53:00.001-07:00

This article is a reprint form my original post of November 2006, I was a bit too early but right nonetheless. ..

Today, most people would agree that the growth in the housing market has slowed and that the decline in demand for single-family homes has already begun. Although most experts agree on the direction of the current trend, opinions begin to diverge with respect to the degree of the slowdown in the housing market (also known as the “soft” or “hard” landing scenario). There are many factors that contribute to the economic trends of housing, but there is one important force that cannot be ignored, the health of the U.S. job market. This is very crucial because no matter what the price of a house is or how creative you can be in financing it, you must have a job to pay for it.
So, let us examine the effects of the housing market slowdown on the employment environment and the general economy. In the most recent published data, housing starts, or the number of permits issued for new unit construction, have fallen from a high of roughly 2.5 million in early 2006, to about 1.0 million today (see figure above) , a decline in permits of approximately 1 million. This decline in permits issued could be looked at as a good sign for real estate owners, since fewer houses being built means tighter supply and higher prices. However, let’s remember that we are not interested in the prices of homes currently; instead, we are interested in the impact of the building slowdown on the job market.
In order to link the decline in permits for new housing starts to its impact on employment, all we need to look at is one number that is issued by the National Association of Home Builders. It states that, for every new single family home that is built in a given year, 2.5 new jobs will be created in the economy, specifically in the construction industry. Remembering that permits for new unit construction have fallen by approximately 1 million for the current year, we can deduce that about 3.75 million jobs (-1.5 mil new permits X 2.5 jobs per new unit permit) will be at risk of being lost in the near future.
The reason the unemployment index does not yet show signs of these impending job losses is because it is a lagging indicator. It takes an average of 9 months to build a house, thus signs of rising unemployment due to a building slump would show up months after the decline in new building permits, in my estimation 1-2 years for the full cycle.
To further grasp the degree of impact to the general economy, we can look at the Clinton administration of the 1990’s, where 9 million total new jobs were created in 8 years. In the recent Bush administration, 6 million new jobs were created in the most current economic expansion. Therefore, the loss of 3.0 million jobs, 30-50% of new jobs created in a decade, would be large enough to put a hefty dent in the economy.
In addition, it has been noted that almost half the new jobs created in this decade have been in the construction sector (50% x 6 million = 3.0 million), which correlates well with the 3.0 million number we estimated earlier. These two separate estimates that yield very similar results point to a “hard” landing scenario. With 145 million American hard at work, job loses on the scale of my estimates is sufficient to cause drastic changes in the unemployment rate. Right now unemployment is at 4.5%, but with these impending jobs loses in the housing related sectors, unemployment could easily reach 6-7%, unemployment levels not seen since 1970's. The impact of my estimates does not take into account all those households who have used their home equity as a “second job” or additional source of income, the unknown factor that can only serve to worsen the impact of the housing correction!

Technical Analysis for FRPT !

2007-08-27T15:55:00.000-07:00

Here is the technical analysis for the FRPT trend reversal and possible breakout.

The first chart is the 6 month daily, the channel lines drawn by me (pink lines) are to indicate the trend reversal of the downward channel. Notice that the stock stopped making lower lows and lower highs. Also, it broke the channel's downward trend with its movement in the past week. The volume associated with this move is also healthy, i.e. above average.
The second point of interest to look at is the orange circle drawn on the chart. It shows that the stock is about to cross its 50 day moving average, another key indicator of the stocks strong move to the upside, again with above average volume.

I have also included a second chart to show what happened the last time the stock exhibited a similar pattern in March. Again, when the stock reversed out of the the downward channel, it crossed the 50 day moving average and went on to gain 100% in two months.

Please stay tuned for more concrete due diligence- DD on this stock in general and the favorable economic trend for the company put in place by Congress a few weeks ago. The congressional debates on MRAP's is available on CSPAN. What I got out of CSPAN's coverage of the congressional hearings/debate was the following; 1) both the democrats and republicans are on board and is their #1 priority to get these vehicles out in the field in Iraq ASAP, since 70% of deaths in Iraq are caused by IED's, 2) they have put money aside for 8,000+ vehicles, going so far as to buy basic materials and tires for the vehicles so that there are no bottle necks in deployment, 3) the vehicles will be left in Iraq for the Iraqi armies use once we pull out, so there are no financial risks to the U.S. government, mainly b/c we know their credit is good, i.e. they have OIL.

The 25% short interest is also worth noting.

Time to Buy Force Protection, FRPT !!!

2007-08-27T12:06:00.000-07:00

To my readers, I don't have much time today to give details on this trade, but I bought FRPT today at $18.39 per share, a good entry in my opinion. I didn't want you guys to miss out, so that's why I'm doing a quick post on Force Protection - FRPT.

It is making a trend reversal, from lower highs and lower lows, to higher higher and higher lows. Look at the 6 month chart for clarifications on the technicals, I will elaborate more on this in my next post in a day or two.

Also, it is a good buy in a slowing economy, as congress has already put money aside to replace all Humvee's in Iraq with MRAP vehicles, like the ones FRPT makes.

Target of $30 per share by year end, delivering another triple digit gainer for my loyal readers.

A 20 dollar bill on sale for 15 bucks, Guaranteed!!!

2007-07-03T13:25:00.000-07:00

That's right, I have found a way to buy $20's for $15. My next triple digit gainer is Sun Healthcare, Nasdaq symbol: SUNH.

This is a name that had its initial debut on my blog in December/2006 when it was ~ $11 per share, it has risen close to 40% since then, but the stock's run is far from over.

This nursing home operator is poised to go to $24 by the end of the year and it seems that the heavy institutional buying recently will move it to that price target rather quickly. Amid recent news regarding the private equity buyout of Manor Care-HCR, the sector valuations are going through a readjustment. Approximately one year ago, another nursing home operator was also taken out by private equity and that company was Beverly Enterprises-BEV. Both buyouts of HCR and BEV have established a price for longterm care facilities. Based on these valuations paid by private equity, the price of SUNH based on the number of its licensed beds and revenue should fairy value SUNH in the 20 dollar range per share. The upper limit of the stock being $32 per share and lower target of $24 per share.

In addition, technically, SUNH is coming out of a 3 year cup with handle base, which could add fuel to fire. But regardless of the technicals, SUNH is worth $24 per share and it should reach that target by years end. Also, since SUNH is a nursing home that is not levered to the general economy, it makes it a perfect play for the uncertain times we are in right now. With the subprime/housing mess on one side and global political risk rampant, owning SUNH is a good way to stay long the market while having the potential for huge upside due to the favorable trends of aging baby boomers.

I don't feel that SUNH is a good buyout candidate by private equity, as stated in Wall Street Journal this week, due to the fact that it only owns 40% of it operational real estate. However, there is a good chance that it might be taken private because it is one of the last remaining large nursing home operators. The other nursing home operator that is a good buyout candidate is Kindred Healthcare, NYSE symbol: KND. Kinderd Healthcare is the largest remaining public nursing home operator and there is more. Its number one institutional holder, Franklin Mutual Advisers, which owns about 19% of the outstanding shares, was one of the key players that took Beverly Enterprises private. So, it seems that they have similar plans for KND, as they have been increasing their position in KND. Both KND and SUNH are the last two major longterm care facilities that are public, so if you are private equity looking for favorable long term trends in the aging of baby boomers, there are only two players left.

In conclusion, if you missed my last triple digit gainer, CLRK, it's not too late to make some $$$, buy SUNH.

Big Wig at Pimco is Still Renting!

2007-04-18T22:21:00.000-07:00

Mark Kiesel of Pimco, the bond giant, comments on the current climate of the housing market. The article has great charts and is a must read for anyone thinking of buying residential real estate.

Click on the link below for the article:
Pimco Still Renting

Once in a lifetime Opportunity!

2006-12-21T22:36:00.000-08:00

The light bulb was invented about 130 years ago and ever since its debut, the light bulb’s design hasn’t changed, that is until NOW. 2007 will be the year of the LED, also known as solid state lighting. Light Emitting Diodes are pea sized solid chunks of semiconductor material, like the Intel Pentium processor in computers, that glow when electricity is applied. Up to now light bulbs have been glass vacuum tubes with a glowing tungsten wire inside, just the same as when Thomas Edison designed them more than a hundred years ago. LED’s are going to soon displace the old vacuum tube light bulbs; they are 100 times smaller, 10 folds more efficient, and practically last forever.

LED’s have been around for more than 50 years and they are currently in multiple electronic devices in the home, just look at the power “on” indicator on your T.V. or any other common home electronic device and you’ll probably see an LED light indicator. So why is it that they have been around for decades but haven’t replaced the conventional vacuum tube light bulb? The answer to that question is easy; until recent advances in materials engineering, LED’s were not bright enough and too expensive for general lighting applications. But now, advances in technology coupled with more efficient manufacturing methods have yielded the solid state LED feasible for general lighting applications.

The great thing about this entire story is that we are in the midst of an energy shortage and most electricity grids in the U.S. are working at overcapacity. LED’s offer a real viable solution to help ease the energy strain, because as you remember, they are more than 10 times more efficient than conventional light bulbs. This fact alone makes them less likely to be sensitive to the general economic climate, because they offer an alternative to building more nuclear or coal burning power plants. Power plants take years to build and nobody wants them in their backyard, but changing the conventional light bulbs in our homes and businesses with more efficient LED’s is a very painless option.

Our number one stock pick for this sector is Color Kinetics, CLRK, listed on the Nasdaq stock exchange. The company holds the worldwide patent rights to the technology in controlling the color output of LED’s. This is important because one of the advantages not yet mentioned in this article about LED’s over conventional light bulbs is that each lighting fixture can output close to 5 billion colors. That’s right, with a single bulb, called a “node”, the color and intensity output of the light fixture can be controlled electronically. Just like the dimmer switch control on some present lighting systems, but with far more intelligence and capabilities. That’s why LED lighting systems are called “Intelligent Solid State Lighting”; they can be programmed to do almost anything.

We are confident that CLRK has strong fundamentals, good management, and huge market opportunity. Usually these are the winning traits of a “triple digit gainer” and we therefore predict a price appreciation in the hundreds of percent in 2-5 years for this company. This company’s success lies in its patents and their ability to hold up against infringement, and they have successfully fought and won court cases against patent infringers in the past. In addition, multiple leading companies in this business segment have signed licensing agreements with CLRK already, and the revenue from these royalties should begin to show up on the bottom line in the second quarter of 2007. Unlike the manufacturers of the actual LED’s, CLRK is not levered to the outsourcing of manufacturing to China or other places because they are a “fabless” company with a business model that is based on royalties from their intellectual property. And in the 21st century, that’s the sweet spot to be in!

Are Houses Fairly Priced in Today's Market?

2006-11-29T16:29:00.001-08:00

Although one might initially think of many differing contributions to home prices, anyone wanting to dissect the issue further would have to simplify the picture a bit and look at the two main components of housing prices; 1) the cost of the labor and materials, and 2) the cost of the land.

These two main components are the underlying drivers for changes in housing prices. Both parameters can be quantified rather easily with current market information, and we shall do an example calculation in a second. By doing these estimates for a given home in a given area, we can uncover any part of the pricing component that may be deemed “over priced”. What I mean by that, to be clear is that lets just say that the cost for labor and materials for building a house rise, this would in turn increase the sales price of a given home, because it cost more to build that home. This seems reasonable and as a component of the cost of home building, one would not be alarmed to see housing prices rise due to increase in the costs of building. However the second component of housing prices, land costs, is subject to more scrutiny. Because unlike the general market prices for labor and materials, land prices are more likely to be priced on subjective basis, such as geographical location and local demand. Therefore, one could argue that inflated levels of land value as a percentage of total price is a better way of gauging current real estate pricing conditions, “over priced” or “under priced”, than looking at just the total price alone. In order for this to idea to set in deeper, let’s do an example calculation.

I live in Orange County-California, so I’ll do an example estimate for an average home in my local market. Right now in my local market, an average 2500 square foot home would cost about $1 million. The current costs for building residential construction are about $100 per square foot (sqft). So a house that is 2500 sqft would cost about $250,000 to build, at a total price of 1 million, would implicate that the land is valued at $750,000 ($1 mil – $250k = $750k). The ratio of the price of the land to the total price of the house would be 0.75 or 75%. It might not surprise you that 75% of the price paid for a house is the price of the land, but that number with respect to historical standards is very high. The historical ratio of land value compared to total prices in my local area, the west coast, have been somewhere around 50% throughout the last two decades. Quickly we realize that in this most recent housing boom, land values have risen much faster than the costs of building. This of course is less of a problem in areas like Manhattan-New York, because building space is limited, however, in areas like mine that are 1/10^th as saturated, there is much room for price adjustment. Please look at the figure above for the land value ratios for other regions in the U.S.

In conclusion, most people buying a house never pay attention to the different components of housing prices, cost of building and land costs, it is one of the most crucial parameters to gauge in determining whether real estate prices are under valued or over valued in your local area. My estimate above shows that the real estate prices on the west coast are on the over valued end of the spectrum, with significant room for correction.

Focus on the Housing Sector Jobs: NOT Housing Prices!

2006-11-17T13:49:00.000-08:00

Today, most people would agree that the growth in the housing market has slowed and that the decline in demand for single-family homes has already begun. Although most experts agree on the direction of the current trend, opinions begin to diverge with respect to the degree of the slowdown in the housing market (also known as the “soft” or “hard” landing scenario). There are many factors that contribute to the economic trends of housing, but there is one important force that cannot be ignored, the health of the U.S. job market. This is very crucial because no matter what the price of a house is or how creative you can be in financing it, you must have a job to pay for it.
So, let us examine the effects of the housing market slowdown on the employment environment and the general economy. In the most recent published data, housing starts, or the number of permits issued for new unit construction, have fallen from a high of roughly 2.5 million in early 2006, to about 1.5 million today (see figure above) , a decline in permits of approximately 1 million. This decline in permits issued could be looked at as a good sign for real estate owners, since fewer houses being built means tighter supply and higher prices. However, let’s remember that we are not interested in the prices of homes currently; instead, we are interested in the impact of the building slowdown on the job market.
In order to link the decline in permits for new housing starts to its impact on employment, all we need to look at is one number that is issued by the National Association of Home Builders. It states that, for every new single family home that is built in a given year, 2.5 new jobs will be created in the economy, specifically in the construction industry. Remembering that permits for new unit construction have fallen by approximately 1 million for the current year, we can deduce that about 2.5 million jobs (-1 mil new permits X 2.5 jobs per new unit permit) will be at risk of being lost in the near future.
The reason the unemployment index does not yet show signs of these impending job losses is because it is a lagging indicator. It takes an average of 9 months to build a house, thus signs of rising unemployment due to a building slump would show up months after the decline in new building permits, in my estimation 1-2 years for the full cycle.
To further grasp the degree of impact to the general economy, we can look at the Clinton administration of the 1990’s, where 9 million total new jobs were created in 8 years. In the recent Bush administration, 5 million new jobs were created in the most current economic expansion. Therefore, the loss of 2.5 million jobs, 30-50% of new jobs created in a decade, would be large enough to put a hefty dent in the economy.
In addition, it has been noted that almost half the new jobs created in this decade have been in the construction sector (50% x 5 million = 2.5 million), which correlates well with the 2.5 million number we estimated earlier. These two separate estimates that yield very similar results point to a “hard” landing scenario. With 145 million American hard at work, job loses on the scale of my estimates is sufficient to cause drastic changes in the unemployment rate. Right now unemployment is at 4.5%, but with these impending jobs loses in the housing related sectors, unemployment could easily reach 6-7%, uneployment levels not seen since 1970's. The impact of my estimates does not take into account all those households who have used their home equity as a “second job” or additional source of income, the unknown factor that can only serve to worsen the impact of the housing correction!