What We Invested In This Week, January 28

This was an interesting week, with the President’s State of the Union speech (well delivered but underwhelming in content), numerous earnings reports and the late week developments in Egypt. Is it really possible that George W. Bush’s vision of democracy spreading throughout the Arab world, inspired by Iraq, may have some future? This unlikely thought occurred to me as I pondered some of the possible outcomes of what’s unfolding on CNBC live from Cairo. It’s likely we’re watching history unfold once again.

Microsoft’s earnings disappointed the market and the stock price weakened as a result. From its valuation (around 10X estimated 2011 earnings once you deduct $2 per share of cash on balance sheet) it appears to be unloved. Windows and Office are relentless cash generators, and the constant drain of supporting its investments in online services and gaming has resulted in slower growth in free cashflow to equity than in net income. However, many commentators find it attractive (most recently Charles Clough in Barrons). At its current valuation MSFT appears to offer substantial upside if the company can simply grow its core businesses at nominal global GDP and start to see meaningful results from its heavy investments in online services and gaming. We invested in MSFT this week.

Kraft Foods (KFT) is another large cap deep value stock. They received a lot of criticism for the Cadbury’s acquisition, but the stock price has presumably paid the price for this and Cadbury does provide higher growth than in some of Kraft’s traditional businesses (such as beverages and meats). In addition, Sara Lee’s decision to break itself up rather than sell to a private equity buyer may allow KFT to more readily divest one or two businesses. Food inflation is clearly a concern as far as input costs are concerned, but that is not a new story and we think faster growth combined with its relative underperformance against the S&P500 last year make this an attractive opportunity. We invested in KFT this week.

While the President’s speech was well presented, on reflection it was light on specifics. The focus on deficit reduction from both sides of the aisle can easily be confused with bi-partisan action. Incremental progress is possible in some areas but nothing substantial for the remainder of Obama’s term in office. On deficit reduction, the President notably omitted to endorse the conclusions of his own deficit commission and didn’t offer any leadership on entitlement reform. Bond investors can wait to make that next purchase; supply is likely to remain ample. We continue to maintain fixed income exposure outside the U.S. to diverse emerging market currencies although recent events in the Middle East have clearly helped the US$ and may continue to do so in the near term. Bonds and oil don’t often rally strongly on the same news; they did this week, and while it’s hard to imagine the Suez Canal closing and thus forcing oil tankers to take the long route around southern Africa, if for some reason oil supplies are disrupted it’s unlikely to be a good reason to invest in treasury bonds.  


Disclosure: Long MSFT, KFT, CEW

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