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The Friday Five

Thu, 22 Aug 2013

Five stats from the market and the stories behind them. This week: Europe perks up, perspective on J.P. Morgan's latest headache, Home Depot builds momentum, and more.

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Video Transcript

Jason Stipp: I'm Jason Stipp for Morningstar, and welcome to The Friday Five: five stats from the market and the stories behind them.

Joining me as always with the Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome, Jason.

Stipp: What do you have for The Friday Five this week?

Glaser: We're going to take a look at the numbers 26, $0.25, 6.5%, 10.7%, and 1%.

Stipp: The data this week showed a 26-month high in the Markit Flash Eurozone PMI, but I guess you're going to tell me they're not quite out of the woods yet.

Glaser: Well, maybe not quite, but this is a good sign that Europe is pulling out of this double-dip recession that they've been in for the last 18 months. Bob Johnson has looked at some of the GDP data and sees that it's really turning around, and this manufacturing data--the PMI tracks what's happening in the manufacturing sector--shows that, yes, indeed it looks like a lot of the eurozone economies are looking better.

Germany in particular is looking very strong. They're leading the European economic recovery, as they did before. I think that's pretty important as we look at the eurozone crisis, which … is still kind of simmering on the back burner. It has been quiet, because the ECB stepped in and said we're going to do whatever it takes to save the euro. That really calmed down credit markets considerably, gave everyone time to think about the best way to address some of these structural issues. But none of them have been addressed yet, and they won't really be addressed until we look at things like potentially another bailout for Greece, which the German finance minister talked a little bit about this week for the first time explicitly, which was an encouraging sign that they see that these issues are still out there. Maybe even some kind of debt forgiveness, getting those debt levels down to manageable numbers in Greece and elsewhere.

I think if Germany's economy continues to do well, and Europe's economy is doing well, it just sets a background where it's so much easier to get those deals done and will make it a little bit simpler to get the eurozone crisis fully solved.

Stipp: $0.25 per share is the amount that J.P. Morgan would pay per $1 billion of litigation charges. When you see it in those terms, it really puts a different spin on the number.

Glaser: It really does, especially considering that analysts expect JPMorgan to earn around $6 a share in 2014.

The reason we are talking about this again is that, this week JPMorgan was accused of in China hiring the children of high-ranking officials as an attempt to curry favor, and there are some worries that this might be construed more as bribes than as actual job offers.

I think that this is another scandal they will probably have to pay out some money on potentially. We still have some indictments with the London Whale problems. They are expecting some big payments there. They said in their most recent [quarterly report] that given the amount of money they have set aside for litigation reserves, it might be $6.8 billion above that.

It seems like over the last couple of years, JPMorgan went from the bank that was, if not scandal-free, [at least] had many fewer scandals than some of their peers to kind of joining those ranks again. And some of that is probably just extra regulatory scrutiny: As the regulators regain their footing and are really looking at these "too big to fail" banks with a brighter light, they are finding some of these problems. Some of them are self-inflicted like, the London Whale problem.

But I think investors need to keep in mind that these big banks are going to run into these problems from time to time and try to get the scale of what the potential outcomes are compared to what earnings look like. Our analyst Jim Sinegal thinks that JPMorgan still has good stewardship. This is the management team that doubled book value from the end of 2007 through prudent management, and that you shouldn't be too worried about some of these big headline numbers.

Stipp: 6.5% is still the Fed's explicit target for the unemployment rate in the United States. So despite all the handwringing about what the Fed's going to do and when it's going to do it, there is some consistency in their message.

Glaser: That is there, but we sure didn't get a whole lot of new information from the Fed minutes that were released this week.

This is from the meeting that happened three weeks ago, and we get the minutes that basically said the Fed still doesn't really know what to do and doesn't know exactly when the tapering of their quantitative easing programs is going to happen. Part of it is that they are having trouble reading the economic data. Like many of us, when they look at the data, they're seeing mixed signals. They're seeing some things that are looking better, but others that maybe are showing that the economy isn't growing at a fast enough rate yet, or that employment is at a high enough level yet, that it's time to really start talking about taking some of that monetary stimulus off the table.

It seems like that September timeframe is still quite possible. I think that's one of the big takeaways from the minutes. But it sounds like there is still lot of flexibility there, and if the economy were to slow considerably before then, I think we could see the Fed not being committed to that and very well keeping those bond-buying programs in place for quite some time, if the conditions warrant it.

Stipp: 10.7% was the increase we saw in Home Depot's same-store sales. So even though consumers might not be free spending, they are putting money to work to improve their homes.

Glaser: They are, and I think that Home Depot and Lowe's really could be seen as barometers of what's happening in the housing market. They often are looked at that way, because when you're selling a house, when you're buying a house, you're likely to go there and maybe pick up a few things.

I think what's been interesting for Home Depot at least was that they saw [the number of] purchases over $900 really grew. People were buying things like riding mowers or appliances, things that might be seen as a little bit more discretionary, a sign that people are feeling a little bit freer there, instead of just buying--excuse me--the nuts and bolts of exactly what they need.

Home Depot even was able to improve profitability a little bit, even though some of those appliances have lower margins than some of their other items. Now, Lowe's had a slightly less good quarter, but part of that is that they're going through some internal transitions, trying to get some of their supply chain stuff worked out, and some of the in-store experiences better. They made some progress there as well.

Unfortunately, for investors, the [stock] prices don't look great. R. J. Hottovy, who covers this space for us, thinks Home Depot is about fairly valued, even though it would make a good core holding over time, while Lowe's looks a little bit more rich at the moment.

Stipp: Over in the tech sector, we saw a 1% drop in HP revenue. This is an interesting story, because you have to look at what the business is doing and also what the stock has been doing.

Glaser: HP has been one of these sagas for the last couple of years with all the drama in the boardroom and the executive suite. Now Meg Whitman is really getting down there and starting with some very aggressive cost-cutting across the business, as they really are seeing some pretty significant pressure. You mentioned that 1% drop in revenue; they are expecting around a 4% drop in revenue for the next fiscal year. It's a sign that a lot of their core businesses are under a lot of pressure--things like the printer business, things like PCs in particular. That weakness continues to persist, and HP is not immune to this.

But with some pretty smart cost-cutting moves, with some more investment in things like enterprise and things like software that could have some better growth prospects, the company has held up OK. This quarter was fairly disappointing, but over the last couple of years, it's been OK, and that has sent the stock up considerably year-to-date, over 60% even with the sell-off on this earnings news.

I think it just goes to show how important it is to really think about not just how fast the business can grow, but also what kind of growth is priced into the stock. If you buy something that's cheap enough and you get a narrow-moat business like HP that can continue to generate cash flows, even if they are not going to see enormous growth, there still could be potential in that stock.

Unfortunately, a lot of that potential is now baked in. Grady Burkett, who is our analyst covering HP, think shares are now fully valued after that big run-up. But it's definitely an interesting story of where, even though the fundamentals haven't been great, the stock has performed pretty well over a relatively short period of time.

Stipp: We always get great returns from The Friday Five thanks to you, Jeremy. Thanks for joining me.

Glaser: You're welcome, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

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