Thursday, February 09, 2006

FI Update - 2/9/06

To: FI Clients

From: Peter and Jack Falker.

Subj: FI Update

Here is a summary of our investment activities over the last several months, along with some of our thoughts:

In early February 2006, we sold ATK Systems (ATK) for a profit of 51 %. The stock had reached an all-time high and was somewhat overvalued based on our modeling assumptions. Also, a question had been raised in the January 9th edition of Forbes Magazine about the size of ATK’s unfunded pension liabilities. After talking with the company, we concluded that, as so often happens in the popular press, the pension issue was probably overblown. However, perception often becomes reality in this world, so we decided to book our profit the day before the company’s quarterly conference call. The street was disappointed by their results (which had little or nothing to do with their pension issues) and the stock dropped nearly $5.00 (6.2 %) that day.

Also in early February, we sold J.P. Morgan Chase (JPM) for a small profit. During the two years we held JPM we collected an annual dividend of 3.5% which was better than we could have earned on cash and approximately equal to the yield of a high-grade bond of similar duration. Now, with cash yields up, we will look for the opportunity to re-deploy this capital in another bank with an equivalent or better dividend and a better potential for a capital gain going forward.

In late January 2006, we sold PNC Bank Corporation for a profit of 18.5%. We also collected a 3.6 % dividend in the 13 months we owned PNC, giving us a 22% overall yield on our investment. We originally bought relatively small positions in PNC and U.S. Bank Corporation (USB) as weak dollar hedges, since they were both undervalued, compared with most other large banks in the U.S. Based on our reading, the thought was that they would make attractive acquisition targets for European banks with a surplus of strong Euros. With the U.S. dollar strengthening in 2005, our hedge strategy became irrelevant, but PNC had good results and the stock responded, making it somewhat overvalued, so we took our profit. We still own USB, which is slightly above our basis and continues to pay us a 4.5% dividend (as good as a 10 year government bond). We may decide to sell USB, as well, when we see a better investment opportunity for the funds.

In mid-December 2005, we sold Briggs & Stratton Corporation (BGG) for a small (.6%) profit. The stock had performed poorly since we bought it last February, and at one point had lost about 20 % of its value. In late October, we talked with the company’s CFO, with a thought toward exercising our long-standing stop-loss policy. After that conversation, we suspected that the company might report a good quarter, based on generator sales after the hurricanes, plus a pricing initiative they had undertaken for 2006 lawn and garden sales. Apparently a few other folks in the market thought so too, because the stock literally rocketed up in December. On the old theory of not looking a gift horse in the mouth, we sold BGG and reclaimed our capital investment. In January, BGG reported a disappointing quarter and the stock has subsequently gone back down.

In late October 2005, we sold Techne Corporation (TECH) for a profit of 54 %. While we still really like this little-known Minneapolis biotech raw-materials supplier (and know them very well), our analysis indicated that it had reached a valuation we felt was unsustainable. We believe we will have a chance to own it again when its valuation is more in line.

In late September, we sold Conagra Inc. (CAG) at a small (3%) loss. Unfortunately, we had seen a nice profit in the stock erode on the basis of disappointing results, and decided that things might get worse before they got better (we were right). Fortunately, we had collected an annual 4.6 % dividend on the stock over the two years we owned it resulting in an overall 2 year total return just over 6%.

Most of our remaining portfolio is doing quite well, with a few exceptions such as Dell, Wal-Mart and Gap, which all should recover in time. We are holding a little more cash than normal, because of our recent profit-taking, but we are also looking at a few companies we would like to own at the right prices. In the meantime, money market yields have improved considerably and we can afford to wait. In that regard, it still seems likely to us that bond yields should move higher over the next year or so. If and when those yields become as attractive as overall market expectations, we may want to hold a few bonds.

Best regards,

Peter and Jack