SuperModels Inbox: More Grist on General Mills

Cereal and picks under $20 were among the top subjects of reader mail in the past month. So while I vacation in the tropics, I hope you enjoy this installment of SuperModels Inbox.

I enjoyed the breadth of information in your column on General Mills ( GIS) and see value in shorting on a rally. However, with the CEO and CFO agreeing to certify their financials from a press release on Aug. 5, it appears the unusual or other costs should be explainable. Thoughts? -- Mike Chadwick

I wouldn't take much comfort from the certification process. First of all, the CEO and CFO were liable for the accuracy of the books with or without the certification. And ultimately they all have to sign. So it's really an election-year charade. If the Securities and Exchange Commission ultimately finds problems in the books, you can bet the CEOs will have a battery of attorneys explaining why their miscue was merely a misinterpretation.

After all, the very first clause of the SEC disclosure form offers them an out. It begins: "To the best of my knowledge. ..." They can always pull a Ken Lay and say they didn't know. Anyway, the earnings-quality issues that I referred to at General Mills have to do with the overly liberal use of legal book-plumping.

How does a guy with a journalism degree become so adept at high finance that he can rip a company so authoritatively? Most of your "analysis" boils down to General Mills having some unforeseen problems digesting Pillsbury. General Mills has been a huge free-cash generator forever. They decided, in light of mid-single-digit unit growth, to make a big acquisition in their field of expertise. How much you want to bet they succeed? -- George Burman

I may only have a degree in journalism, but I also spent about a thousand breakfast-hours of my youth eating Cheerios. General Mills has indeed been a prodigious cash generator for years. But they bit off more than they can chew with Pillsbury. I'm not the one who cut the outlook on its unsecured senior debt to negative -- the credit-rating agency Moody's did.

Good article on General Mills. I immediately checked out the long-term return on capital relative to their five-year average, and the difference is shocking. Currently, it's only about 5%, a huge drop from historical levels in excess of 25%. No way they can cover their cost of capital. I'm baffled by analysts recommending this as a defensive stock. I am quite worried that shoddy analysis is being done, because of the repercussions it has for the market. I know there have been a few articles about the use of pension gains to plump up profits, but if I am not mistaken, this is still largely undiscounted by the market. -- Eve Kendall (former sell-side and buy-side analyst and fund manager)

I agree that there are still potential negatives that remain undiscounted by the market. The use of pension gains to boost profit is one. The other is the issue of expensing stock options. Even if neither Congress nor the Financial Accounting Standards Board ever requires companies to expense options, the fact that many large companies such as Coca-Cola ( KO) and General Electric ( GE) have decided to do so voluntarily, changes the game entirely. Investors will estimate the amount that options cost and deduct them from net income. Unfortunately, I am afraid that estimated options expenses will wipe out earnings at many large technology companies and put a lid on the advance of the Nasdaq for years. The issue will not affect many old-line companies, such as General Mills, that never handed out many options below the top executive ranks.

I'm searching for the "right" $9 stocks. Any opinions you may have, with prices up to $20, would be appreciated. In my humble opinion as an economist, I believe we're in the beginning of a recovery much like the early '70s. -- William C. Fields

You are one of many people from the old mania days who have written lately, stating that they went high, fell back a bit, got out and are now considering wading in a toe at a time. Walter Industries ( WLT) is an interesting reorganization story down in Florida. It operates businesses in iron pipes, foundry coke, aluminum, single-family homes, modular homes, home financing, water, coal mining and methane gas. Management, which is affiliated with the leveraged-buyout firm KKR, is trying to streamline operations, and they seem to have a decent chance of getting more out of less. Its management has certified its financial statements, and it recently raised earnings guidance for the current fiscal year. Cash flow is improving, and debt is being repaid. If you think the economy is improving, this relatively cheap potential turnaround stock could offer some decent upside, possibly to $16 or better in a year from its current perch around $12.25. One way to play it might be to attempt to purchase it on a buy stop at $13 to clear local resistance, with a stop-loss around $11. Look out for a potential double-top at $15.

While Jon Markman cannot provide personalized investment advice or recommendations, he invites you to send comments on his column to 7jonmail@microsoft.com. At the time of publication, he did not own or control shares in any equities mentioned in this column.

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