No Bull: Updating the Bearish Plays, Part 1

Editor's Note: Arne Alsin's column runs exclusively on RealMoney.com; this is a special free look at his column. For a free trial subscription to RealMoney.com, click here. This article was published Feb. 19 on RealMoney.

The story of the financial markets over the past 20 years can be summed up in one word: excess. I've written a number of columns trying to expose some of the excess, targeting stocks that are overloved, overowned and, by my calculations, overvalued.

The point of my bearish columns on specific stocks is not to highlight shorting opportunities. Not all of these stocks are headed south. Many times, an overvalued stock simply treads water for a few years while the underlying business catches up to the stock price.

Coca-Cola(KO) stock, for example, has made no progress for several years running. There's nothing wrong with Coke's business model. Similar to many of the stocks (12 in all) that I'll discuss in this three-part series, Coke's stock price simply got far ahead of the business value. While an investment in Coke has been a poor use of capital for a few years, it hasn't been a compelling short.

Kohl's

Kohl's(KSS) is an example of a stock price that's far ahead of reality. I wrote a bearish column on Kohl's 13 months ago, when the stock was trading around $68; it closed Friday at $68.50.

Kohl's Treads Water This retailer grows while its stock stands still

Since that column appeared, Kohl's business has been growing at a fast rate, while its stock price hasn't made any progress. I think a stagnant stock is the best that Kohl's shareholders can hope for in the next few years.

According to my analysis, it will take another three to four years of heady growth for this retailer's business to catch up to its current stock price. Like all retailers that are in a high-growth phase, Kohl's will eventually run out of steam.

To the extent that Kohl's stumbles, the fall will be fast and furious. Even if the stock had a price-to-earnings ratio of 25 for the fiscal year ending January 2003 -- too rich for me -- it would yield a price of $43, substantially below the current level.

IBM

I first wrote a bearish column on IBM (IBM) one year ago, when it traded at $115.10. It closed Friday at $102.89, down $5 on controversy about the inclusion of a gain that shouldn't have been included in operating income.

Bearish on Big Blue Its accounting does look aggressive

After wading through the financial statements of this behemoth one more time, I think that IBM's statement Friday that its "accounting is conservative" is pure fancy. Consider pension income, which contributes 10% of pretax profits. IBM's use of a hefty 10% rate of return assumption -- artificially pumping net income -- is patently aggressive.

Here's why: IBM's pension is invested approximately 65% in the bond market, with only about 35% in equities. Anybody familiar with the fixed-income market knows that bonds aren't going to return 10% per year, not with yields of quality bonds in the 6% to 7% range. It means, of course, that the equity portion of the pension will have to make up the difference.

Either IBM is foolish enough to believe that the equity portion of the pension will make 16% to 18% annually (so it can meet the 10% rate of return assumption), or it's aggressively managing its earnings. I'd like to see IBM generate earnings-per-share growth the old-fashioned way, through sales and operating improvements, not through financial engineering.

Oracle

Everything you look for in a quality business is at Oracle (ORCL): high return on equity; a clean, strong balance sheet; and superior growth prospects. Everything, that is, except a decent stock price. In my column a year ago, when Oracle was trading at $24 per share, I maintained that $15 would be a reasonable price, based on historical valuation norms. It closed Friday at $15.49.

Oracle Slips But it's still not a buy here

Despite the decline in Oracle stock, I'm not a buyer. The stock still has some heroic growth assumptions built into its price. And holding Oracle doesn't mesh with what I think is a multi-year correction phase in technology.

Dell Computer

I penned a bearish column in August on Dell (DELL) when it traded at $28.15. It closed Friday at $25.60. Dell is similar to Kohl's in that the underlying business needs a few years of compelling growth to justify the current quote.

Down With Dell Despite its advantages, it still sells a commodity

I know all about Dell's competitive advantages: scale, distribution, etc. But the end of the day, it's still selling a commodity product in a saturated market. Aware of this problem, Dell management is plowing resources into other ultra-competitive markets, such as network servers and storage. Unfortunately, Dell's new markets are going through the same problems as PCs: lots of competition and rapidly declining prices.

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Look for Part 2 of this three-part series in a few days, when I'll update my bearish columns on General Electric(GE), Tyco(TYC), Intel(INTC), Apple(AAPL) and Disney(DIS).

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