Terrorism Doesn't Pay

At least, not as well as it used to.

OJSC Izhmash, maker of the legendary Kalashnikov assault rifles (favorites of terrorists and rebels worldwide for their remarkable reliability) filed for bankruptcy last week.

Though OJSC’s product line remains extremely popular, the AK-47 and other famous rifles have been relentlessly copied and sold by foreign manufacturers.  These mostly inferior copies – for which OJSC receives no royalties – have long been biting into the company’s bottom line.

Similar to a US Chapter 11 filing, OJSC Izhmash has proposed a restructuring plan that will allow it to maintain regular business operations until the restructuring takes hold.  To help out the iconic brand, it’s widely expected that the Russian government will place large, unnecessary orders for new weapons (how do you say “bailout” in Russian?).

OJSC Izhmash’s long-term strategy is to develop a new family of automatic weapons to retrieve its falling market share.

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"I'm proud of my invention, but I'm sad that it is used by terrorists.  I would prefer to have invented a machine that people could use and that would help farmers with their work - for example a lawnmower."

Mikhail Kalashnikov, age 82

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I Hate Banks but I love JP Morgan

Contrarian investing is, in concept, one of the simplest things in the world.  It says that the masses are idiots and are always wrong; therefore, doing exactly the opposite of the masses is the correct thing to do.

The problem with contrarian investing is that the masses are sometimes right.

In 1985, faced with high interest rates, the masses said that interest rates could still go higher (and long-term bond prices lower)  – and they were right.  In 2009, despite falling markets and great valuations, the masses said that stocks would still go lower – and they were right.  Doing the opposite of what the crowd recommends isn’t always the best course of action.

And yet, contrarian investing works, largely because people make investment decisions based on emotions rather than logic.  Case in point: CEO Jamie Dimon's annual newsletter, released Wednesday.

In the newsletter, Dimon pointed out that JP Morgan Chase had record earnings of $19 billion last year (that’s the best year ever).  He added that the earnings would have been even better if it had not been for still-high mortgage related losses.  As time has gone forward, these losses have been declining.

Most interestingly, Dimon hinted that the price of JP Morgan stock was likely low because of “hostility” toward him and to the banking sector in general.  Based on the comments seen after the newsletter was released, Dimon is right: he was called a “criminal,” “manipulator,” “slime ball,” etc.

By now, I’m sure Dimon is immune to such disparaging remarks.  As a banker myself, I occasionally have clients tell me that they “hate banks,” which I consider a polite (weak?) way of saying, “I hate you.”  Then again, I also have people tell me that I’m wonderful but that they hate bankers: is that a compliment or an insult??

Emotions aside, here are the facts that investors should be interested in:

-         Record earnings of $17 billion, up from $12 billion in 2009.

-         Return on equity of 15% (which Dimon thought was low).

-         Market share growth in almost every area.

-         Approved to implement stock buybacks.

-         Opening 120 to 200 new branches a year.

There are many headwinds in banking, to be sure, including new regulations, housing weakness, and worldwide economic uncertainly.  But none of these are reasons to not buy a company.

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“We all have a vested interest in getting this right.”

Jamie Dimon

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AIG gets its Pants Back On

There are some companies that the average investor simply will not touch; American International Group is one of them.  AIG is, after all, a poster-child for the excesses of the 2008 banking fiasco.  While America burned, AIG executives dressed in togas and had grand parties – literally!

At The Frost Report, however, we recognize that companies the public hates are often good bargains.  When the numbers make sense, we let bygones be bygones.

This Wednesday, AIG paid back the US Treasury an additional $1.5 billion in TARP money, eliminating the government’s preferred share stake.  Tim Massad, the Treasury department’s assistant secretary for financial stability, had this to say about the event: “In the dark days of the financial crisis, when commitments to AIG totaled $182 billion, few would have believed that we'd already be able to reduce that amount by more than 75 percent, or that we may be able to recover every single dollar invested in the company.”  And yet they have – ahead of schedule.

Consider these statistics: AIG has a book value of $55 per share, yet today’s closing price was only $28.27.  In what always strikes me as one of the wonders of Wall Street, you can literally buy $55 worth of goods for $28.27.  Of course, "book value" is useless if AIG is forced to have a fire sale on its goods and sell them for less than cost.  So, is the company profitable?

AIG had annual sales of over 64 billion dollars in 2011, with profit of $15 billion on 1.9 billion shares outstanding.  Return on equity also handily beat the market at 26%.

Like other companies in the pariah class, there is no big rush to buy AIG.  The government will be selling its stake for some time, and the stock will not likely jump until that selling pressure is over.  Having said that, the government has done a good job of letting other companies it owns (like Citi) rise steadily in value, selling them in a mellow and responsible manner.

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"I would suggest the first thing that would make me feel a little bit better toward them [AIG executives] is if they'd follow the Japanese example and come before the American people and take that deep bow and say, I'm sorry, and then either do one of two things: resign or go commit suicide."

Senator Charles Grassley, 2009

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Disclosure

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

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