AMSWA’s SGS swan song

• Sell AMSWA around 9.29

We are selling American Software (AMSWA) on the recent price spike as we seek to take profits on our marginal positions, solidify our strong long-term convictions, and wait for the next big opportunities. While AMSWA is a solid, growing company that has beat the market during our holding period, it has been somewhat of a disappointment.

We based our recommendation in part on the under-appreciated 88% interest that AMSWA has in Logility (LGTY), a fast-growing provider of supply chain management software. Or should I say “was” fast-growing. While Logility had routinely been seeing 20% quarterly sales growth, the second quarter brought only an 11% bump. More discouraging were the comments from the conference call, where the CEO underwhelmed investors by predicting that “the third quarter has an opportunity to be better than last year’s third quarter.” Not exactly the kind of words that give one confidence in what is supposed to be a high-growth company. Perhaps for these reasons, Logility’s stock has dropped nearly 40% since we recommended AMSWA, thus significantly diminishing the value of AMSWA’s “hidden” asset.

AMSWA still has a sparkling balance sheet and a tempting dividend. But we are taking a cautious approach to this market, and believe that we will find better opportunities in the near future.

Disclosure: SmartGuyStocks is no longer long AMSWA

Nasdaq on track

It’s been tough to jump into this market. Nearly every day, the pundits seem to change course on whether we’ve already hit bottom or are only at the tip of the recessionary iceberg. At SmartGuyStocks, we have decided to generally sit on the sidelines for now with our favorite long-term plays and wait for things to shake out a bit before taking any new positions.

So while we’re waiting to jump back in, I wanted to take this opportunity to catch up with one of our favorite companies, Nasdaq Stock Market (NDAQ). Despite a market slump, the stock is up nearly 30% from where we recommended it in July, and we believe it will continue to be a winner for years to come.

Last week, Nasdaq followed the huge swings of the market, temporarily nose-diving on fears of a recession. Ironically, Nasdaq is minting cash out of those fears in the form of transaction fees from record share volume. Last week, Nasdaq CEO Bob Greifield announced “At the moment, our business is doing better than it ever has because the volumes have been incredibly high,” he said. “So, it’s (the recent period of high volatility) been very good for us.”

And don’t be distracted by the hubub over the potential reduction in IPOs that has caused some to worry; initial listing fees accounted for less than 1.5% of Nasdaq’s record 1.7B in 2006 revenue. The success and growth of Nasdaq comes down to three simple words: volume, volume, and volume.

And the long-term growth of trading volume is one trend that we can count on. The World Federation of Exchanges has some great data showing the incredible growth of exchanges since 1990. Just for illustration, the value of shares traded on the Lima Stock Exchange (Peru) has increased 55-fold, while the Tokyo Stock Exchange has increased 600% despite a lackluster economy. Even own own mature financial market grew overall volume by 25% in 2007 alone. And if that’s not enough to juice growth, new exchanges in emerging markets like Vietnam, Colombia, and even some African countries are beginning to take hold.

The opportunity for the largest exchanges like Nasdaq and NYSE Euronext to consolidate this fast-growing and fragmented space is obvious. Economies of scale are especially valuable in the exchange business, where trading is done by computer networks that require large fixed costs. Consolidation can lower trading costs, which attract more traders and listing companies. Larger exchanges also create increased liquidity, helping share prices move more quickly and efficiently.

As expected, we are seeing a lot of acquisitions, with NYSE buying Euronext and AMEX, and Nasdaq buying OMX (Nordic exchanges) and the Philadelphia and Boston exchanges. It looks like we are indeed moving towards the vision presented last year in The Wall Street Journal: “The accounting world has the Big Four. The auto sector had the Big Three. And stock exchanges, once a fragmented industry with dozens of players, may be headed toward a Big Five or Six.” Nasdaq has announced that it will spend 2008 integrating its three acquisitions, but will again be on the prowl for new buys in 2009.

Nasdaq’s recent deal with Borse Dubai perhaps foreshadows things to come. As part the OMX acquisition, Nasdaq and Borse Dubai traded stakes in their respective companies. The Dubai Exchange will be re-branded as the “Nasdaq DIFX” and will leverage Nasdaq’s software platform for expansion. It’s a promising development that the world’s next great financial center places immense value on Nasdaq’s platform, brand, and expertise. As the global economy continues to grow, more emerging markets will no doubt see value in partnering with the market leader.

Not only is the size of the pie growing, but Nasdaq appears to also be doing a good job taking a bigger slice from competitors. Last year, Nasdaq became the largest U.S. exchange, processing 29% of all equity trades in December, up from 27% in 2006.

Nasdaq reports earnings before the market opens this Thursday. I would use any negative market reaction or near-term weakness to pick up more shares, as this is a long-term story that is just starting to play out…

Disclosure: SmartGuyStocks is long NDAQ

Is the Fed Pandering or Too Late?

In case you were brilliant and went on vacation last week after raising 100% cash before Christmas, you may have missed the emergency Fed rate cut and the Britney Spears like attention on a rogue trader who nearly crashed the global markets. An interesting debate has emerged as to whether the Fed pandered to the equities markets and cut to stop the bleeding caused by the rogue trader, or whether the Fed applied “too little, too late” after the US equities markets already lost all gains made in 2007 and housing persists in free fall.

A few respected market commentators opined the following:

John Mauldin: Fed had to cut pre-meeting to break up the abnormally large reduction in rates.

Barry Ritholtz: Fed pandered to the markets.

Joseph Stiglitz: Too little, way too late.

I tend to believe that all three perspectives played a role. Nothing is black and white, and managing global market action is one of the more complicated pseudo-sciences in existence. I say the Fed offered too little too late because they should have used legislation and regulation to stop the mortgage market from expanding into an unsustainable ether (i.e., issuing debt to those who could not service it). I say the Fed pandered to the markets because they may have stopped what could have been a major market crash. I say the Fed broke up their cuts because one huge cut is too extreme for our analytical brains to digest (and, therefore, subject to harsh reactions).

I also add that Monday morning quarterbacking of the Fed is near worthless banter. First, the Fed can do no right because the media needs to dramatize everything. Thus, if the Fed did not cut, the market may have crashed and the Fed would have been blamed (note today’s WSJ front page article about Bank of England Chief King and the criticism he faces for letting markets unwind freely).

Second, what the Fed should and should not do is a philosophical issue (and largely depends on your personal asset allocation, job, etc.). The more valuable approach is to accept that the Fed exists, the Fed affects the markets, and we must determine how to plan our investment action steps as the Fed alters the landscape.

In the coming weeks SmartGuyStocks will discuss how the Fed action and other events signal what we can expect for markets in the midterm. But for now, we are still recommending bearish trades, raising cash into rallies, and nibbling at rare exceptions such as Pet Med Express (PETS).

Until then, we also recommend entertaining yourself with a fun Hollywood version of this week’s rogue trader debacle. The movie, Rogue Trader, stars Ewan McGregor (Trainspotting, Moulin Rouge) and is based on a similar true story from the late 90’s. (I guess that means rogue traders no longer qualify for the trendy label “black swan.”) Enjoy!

PETS a bright spot during market downturn

Despite the market taking yet another hit, SmartGuyStocks selection Pet Med Express (PETS) gave us something to smile about, shooting up over 20% yesterday. PETS beat analyst expectations for its third quarter as earnings rose 60% on the strength of a 19% jump in sales. The company also continued to deploy its strong cash position towards buybacks, purchasing 1% of the float in the quarter.

While the company has yet to release detailed financials, we can guess that overall margins improved due to the strength of re-orders and internet sales, which both outpaced overall sales growth. These are extremely positive trends for the company. Re-orders indicate that customers are happy and the company may be able to rely less on Betty White and more on word-of-mouth advertising. Online growth means that customers are moving away from the more overhead-intensive phone ordering.

Hopefully, yesterday definitively proved to investors that PETS is not a consumer discretionary stock. Note the contrast with leading pet retailer PetSmart (PETM), who last night slashed its forecasts on weak consumer spending. As I have been saying repeatedly, consumers increasingly think of pets as members of their families, and medications for family members are necessary purchases. PETS will continue to profit from this whether or not there is a recession, and we will continue to hold our shares.

Disclosure: SmartGuyStocks is long PETS

SGS Five Investing Pitfalls: #2 Buying “cheap” stocks

I wish I had a dime for every time in the last month I’ve heard a market commentator argue that a beaten-down stock is a buy solely because it is “cheap.” Maybe with all that money, I could pay investors back for all the money they’ve lost buying these supposedly bargain stocks.

At a recent visit to a bookstore, one of the financial publications was touting Wachovia (WB) as a buy at 40. The logic was basically “the stock has gone down a lot already, the PE is only 9, and it pays a 6% dividend while you wait for it to go up.” This might make sense if:
1) The stock hadn’t gone down for a good reason (write-offs, and an uncertain credit and banking market) and
2) Future earnings and dividends are guaranteed (many on Wall Street worry that WB may cut its dividend and earnings forecasts like other banks)

But the magazine didn’t mention these caveats, nor even attempt to give any catalyst for upside to the stock aside from the fact that it was “cheap.” Well apparently the market didn’t think so, and the stock is down another 20% in a matter of weeks.

While WB may yet end up being a long-term buy at 40, the reason is not because it was “cheap”. Rather, its business or the overall economy will have improved. With financial stocks in the toilet and nearly everyone jumping on the recession bandwagon, this is not the time to buy something without strong conviction. Investing 101 dictates that no matter how bad things may seem, they can always get worse.

Why try to guess the bottom instead of waiting for at least a modicum of evidence that things are turning around? Ask the Caylon Securities analyst who kept a “Buy” rating on Capital One (COF) despite its recent earnings warning (he’s had a buy rating on the stock since $80!). “I think it’s dead money for a while. I think that if you bought this stock at $40, in two years, you’d be happy if you did.” And yet he still recommends buying it now? Personally, “dead money” didn’t make my list of top investments for 2008.

Similarly, shorting a stock simply because it appears expensive can be a similar exercise in futility. Just look at the run of Salesforce.com (CRM), which looks pricey by almost any metric. And it’s been practically a daily ritual for someone on Seeking Alpha or another investing site to call the top on white-hot solar stocks like First Solar (FSLR). As you can see by the chart, it’s a dangerous exercise trying to get in front of the hype train.

As evidenced by our success in shorting Build-A-Bear Workshops (BBW), sometimes shorting “cheap” stocks can be the most lucrative. Wall Street is no different from any other market- too often you get exactly what you pay for.

At SmartGuyStocks we hate leaving money on the table. Too often, popular beliefs about investing lead to that result. We have identified five common mistakes that investors make. Stay tuned for the next three installments of “SGS Five Investment Pitfalls.”

Taking the squeeze off of Build-A-Bear

• Buy (cover short position) BBW around 12.10

We are closing our trade on Build-A-Bear Workshop (BBW) after a 20% gain in one month. The stock quickly fell from our sell point at over 15 to the low-12s, where it has been holding steady for the past couple weeks.

Despite the barrage of negative retail news this year, BBW has shown some recent strength. While I am not ready to definitely call a bottom on this dying retail concept, the company’s valuation is now well below other specialty retail shops (as it should be), and BBW is still sitting on $17M in cash and a large stake in the promising Ridemakerz concept. Given these factors, we think it is prudent to take our gains.

Disclosure: SmartGuyStocks is no longer short BBW

Locking up gains on Martha Stewart Living

• Sell MSO March ‘08 $15 puts around 9.20

Our sell order for Martha Stewart Living Omnimedia (MSO) puts filled today at 9.20 for an 84% gain in 6 weeks. Although we still believe that the future outlook for the company is dour, the margin of safety on this trade has diminished due to the stock’s fast and furious decline. The company’s P/S is finally now below other media companies, and let’s not forget that Martha is still sitting on a nice nest of cash.

There’s even a slight chance that this quarter’s earnings might be ok, as there will be a big (and final) payment from K-Mart combined with the initial returns from the full Macy’s roll-out. But the bottom line is that Martha’s popularity is waning and her company will have to diversify or sell itself to succeed. If MSO pops on a fed cut or general market rally, we will be right there again to buy puts.

Disclosure: SmartGuyStocks no longer holds MSO puts

Bed, Bath & Beyond finds some support

• Sell BBBY Feb. ‘08 $30 puts around 4.60

We are taking a nominal gain on our trade of Bed, Bath and Beyond (BBBY). Following disappointing earnings, the stock has shown surprising strength in the past couple weeks in the face of more negative retailing news. A couple analysts, along with the Motley Fool, have come out with articles extolling BBBY as a superb value play. I’m not so sure they have me convinced, but given the positive sentiment out there, we’ll take a small gain and save our pennies for a better trade…

Disclosure: SmartGuyStocks no longer owns BBBY puts

SGS Five Investing Pitfalls: #1 Going Long-Only

In Ben Stiller’s parody of the fashion industry, Zoolander, the protagonist possesses a critical flaw preventing him from regaining kingship of the runway world: Zoolander does not turn left. As an avid reader of the mainstream financial media, I have noticed a similar critical flaw: many of my peers do not sell short or buy puts. If the market can go up and down, we need to learn how to invest for up and down. Otherwise, we are like Zoolander or a car driver who turns only right: we lose ground when we need to go left. Thus, investors are not whole without shorts and puts.

I agree that shorting and buying puts has risks. However, I have read numerous recommendations in the financial media to buy homebuilders and banks while these industries are experiencing a crisis, and such buying has proven extremely risky (if not detrimental). On the other hand, short sellers and those buying puts of homebuilders and banks have crushed the markets with superior gains. SGS has achieved gains of 21.6%, 36%, and 65% selling short Build-A-Bear Workshop (BBW) and buying puts of Blockbuster Inc. (BBI) and Martha Stewart Living Omnimedia (MSO), respectively. Consequently, investors who only buy are stubbornly losing hard earned capital and opportunities to profit in down markets.

If you are not interested in selling short or buying puts, sit tight and relax in cash while waiting for the next bull run. You can do a lot of research on potential buys while the markets are down-trending - but you must also resist the temptation to go bottom-fishing. Bottom-fishing in a down-trending market is like shorting stocks in a high flying market: you can never predict how long the irrational trend will sustain from inertia (and it’s usually much longer than your stomach or investment account can handle).

I agree that cash is a poor investment for the long run. Money market returns are not strong in the face of core inflation at 3% and healthcare-energy-food-education inflation much higher. However, a 4% money market return may be stellar if the markets go negative. Many people forgot this golden rule of capital preservation when the dotcom bubble burst. I, for one, wish I had held more cash at the time.

In addition, if you are sitting in cash watching the market whip-saw, keep in mind you need only a handful of strategic investments to score superior returns. You do not need to continue investing every time you have spare cash. If you trade too often (from impatience or a tendency to enjoy the rush), you risk making many mistakes. If you trade too rarely (from paralysis by over-analysis or fear), you risk missing opportunities. The key is to be savvy and strategic rather than fall victim to these extremes.

For example, even if you sit out of the market for the next six months, if you grab shares of KBW Bank ETF (KBE) and end up doubling your money in 3-5 years, it will have been worth the wait. A wise ancestor of ours once noted that patience is a virtue.

At SmartGuyStocks we aim to maximize our return on investment (ROI). We are not interested in how many transactions you make (c.f., brokerage houses), we are not here to cheerlead the market and economy (c.f., mainstream financial media, government, Federal Reserve), we do not pretend to know the future (see above), and we do not stubbornly offer you one way (e.g., buy and hold) to play a multidimensional investment market.

We believe you are smart enough to follow what the market and economy tells you. We believe you can make money no matter which way the markets trend. We believe you have the discipline to step aside if things are too chaotic. And we believe you can have fun while beating the market and avoiding the herds.

If you have not already learned about selling short or buying puts, spend time surfing the web or reading some good books. If you don’t like what you read, no worries - cash is king when the market and economy starts to recover and excellent stocks are on sale. However, if you are interested in selling short or buying puts, stay abreast of what we are writing and put your toe in the waters with some small investments. As Zoolander would say, “you too can turn left!”

At SmartGuyStocks we hate leaving money on the table. Too often, popular beliefs about investing lead to that result. We have identified five common mistakes that investors make. Stay tuned for the next four installments of “SGS Five Investment Pitfalls.”

KudSiegStein: The Bagholder Bulls

Investors want to maximize profits and minimize losses. However, a three-headed monster has been created to use spin and logic tricks to keep the masses buying and holding while smart money sells or goes short. This monster is none other than the financial “buy, buy, buy” bobble-head known as KudSiegStein (AKA: Larry Kudlow, Jeremy Siegel, and Ben Stein).

KudSiegStein acts in three separate parts, yet mumbles in a singular voice. No matter the details of any individual article, interview, or show episode, the main message is “buy and hold for the long run.” The science and charts behind this message are simple: over the long term, stocks rise; therefore, keep buying no matter what, and time will smooth out everything in your favor. The more rigorous web surfer can find an amazon forest’s worth of literature proving why this investing philosophy does not maximize profits, but I simply want to point out some major reasons why you should ignore these ignoramuses.

First, KudSiegStein is never accountable for anything because its time horizon is forever. If you lose money in the market, you simply didn’t live long enough to see your stocks come back. If you are a real person living in the real world, this reasoning has no practical value.

For example, let’s look at the Nasdaq 100 index ETF (QQQQ). According to KudSiegStein’s strategy you should have bought the QQQQ like clockwork every month, quarter, or year when you took your paycheck surplus and invested. Let’s say you graduated college in 1999 and bought $10,000 at the beginning of every year starting in 2000 at 90. Then you invested $10,000 in 2001 at 60, $10,000 in 2002 at 40, $10,000 in 2003 at 25, $10,000 in 2004 at 38, $10,000 in 2005 at 40, $10,000 in 2006 at 40, $10,000 in 2007 at 42, and $10,000 in 2008 at 50. Today you would have a cost basis of 47.2 and the QQQQ closed yesterday at 48.18. That’s a 2% gain over seven years!! Other indexes may have fared better, but return on investment (ROI) depends on when and in what you invest, not on a one-size-fits-all buy and hold approach.

Second, KudSiegStein prides itself on being a red-blooded, patriotic free market capitalist, yet hypocritically begs for Federal Reserve and government stimulus. If someone has a major inconsistency in his or her guiding framework, find a new mentor. The internet has birthed an indie movement in finance for realists, so do not feel forced to swallow KudSiegStein’s manure in the mainstream media.

Third, KudSiegStein helps its elitist finance friends sell their bags to the masses when the business cycle slows or contracts. If KudSiegStein told you to sell when the smart money sold, then the market would fall much faster and KudSiegStein’s friends would lose more money than if you bought their bags on the way down. Moreover, retail brokers and finance media such as Charles Schwab (SCHW) and CNBC (GE) do much better in bull markets, so they want finance journalists pushing stocks as much as possible. Also, like all media, the finance media is tainted by press releases and publicists. Thus, KudSiegStein & Co. are not the objective market scientists they hold themselves out to be.

Fourth, KudSiegStein is comprised of a journalist (Kudlow), an academic (Siegel), and a game show host (Stein)! Kudlow is bullish because being bearish doesn’t get ratings, Siegel is pushing his ETF (Wisdom Tree Investments) and books, and Stein is making money in books and journalism too. Consequently, KudSiegStein has the tendency to get lost in theory, err in application, and be heavily biased on the bullish side. And as for the game show host, isn’t he inclined to treat your investments like a big game?

Lastly, but possibly most important, KudSiegStein has denied the housing crisis the entire way down. Only as of very recently has the permabull monster admitted issues with housing. I am not sure when interest-only “no doc” loans seemed sustainable to KudSiegStein, but such hogwash thinking discounts anything further it says about the economy or any asset market. In short, KudSiegStein’s lack of common sense has lost a lot of people a lot of money.

KudSiegStein is not completely flawed. Sometimes it has a few reasonable things to say. But don’t let its moments of reason fool you into blindly following this new age mass media monster. Otherwise you too will be a victim of the Bagholder Bulls.

SmartGuyStocks.com is holding a contest for the World’s Best KudSiegStein graphic art. Please email submissions to smartguystocks@gmail.com.