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38

“You only find out who is swimming naked when the tide goes out,” Warren Buffett wrote in a 2001 letter to Berkshire Hathaway (BRK.A) stockholders. That’s wildly inaccurate beach advice. However, taken as financial advice, it’s the sort of vague gem that always seems to apply to the crisis of the moment. It’s timeless.
Recommendations to buy particular stocks don’t last nearly as long. Investors who follow t
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he advice of Wall Street analysts should always check the date. Dozens of studies of analyst recommendations published over the past two decades point to two broad findings. First, stocks with heaps of “buy” recommendations attached to them tend to perform no better than other stocks. Second, stocks with recent, positive changes in analyst opinions—to “buy” from “hold,” for example—tend to outperform the broad market over the following year. The difference is timing. Five “buy” recommendations issued a year ago hold less predictive power than one issued yesterday because factors like price/earnings ratios, sales growth rates and economic trends can change sharply in a year.
At least one analyst covering each of the three stocks below changed his or her published recommendation to “buy” (or “outperform”) this week.
Alaska Air
Upgraded to Buy from Hold Sept. 22 Helane Becker, Jesup & Lamont

Alaska Air Group (ALK) flies passengers to almost as many cities in California as in Alaska (and has its corporate headquarters in Seattle). Its sales are forecast to decline 10% this year. That’s not so bad when compared with giant airlines like American and United, whose corporate parents are expected to suffer 2009 sales declines of 17% and 21%, respectively. On Tuesday, Alaska Air lowered its third-quarter estimate for fuel costs and said some key sales measures (sales per passenger and per seat/mile) improved in August from July. A new baggage fee helped. Helane Becker of Jesup & Lamont upgraded the stock, citing valuation in a Tuesday note. Shares sell for less than 12 times the 2009 earnings consensus.
Gymboree 
Upgraded to Outperform from Market Perform Sept. 22Adrienne Tennant, FBR Capital Markets
Just over a year ago this column recommended  shares of Gymboree (GYMB) as a safe haven in stormy markets. They’re up 27%, vs. a 13% decline for the broad-market S&P 500 index. Once a play center and now a kids’ clothier, Gymboree is increasing its sales this year, unlike competitors The Children’s Place (PLCE) and Gap (GPS). In a Tuesday investor note recommending the stock, Adrienne Tennant of FBR Capital Markets wrote that the company is gaining market share because of “compelling” products, that potential exists for sustained sales improvements at longstanding stores and that the stock is still cheap. It trades at 15 times earnings.
Dish Network
Upgraded to Outperform from Market Perform Sept. 22Marci Ryvicker, Wells Fargo Securities

Dish Network (DISH) offers satellite television service that competes with cable and with the satellite service of Direct TV (DTV). Because cable companies sell bundled television, telephone and Internet service, satellite companies must pair with telephone companies to compete. AT&T (T) dumped Dish for DTV earlier this year, so although DTV is expected to increase its sales by 9% this year, Dish’s sales are forecast to rise less than 1%. Perhaps that difference is more than reflected in the two stock prices, though. DTV sells for 19 times earnings and Dish just 10 times earnings. In a Tuesday upgrade note, Marci Ryvicker of Wells Fargo Securities wrote that Wall Street’s expectations for the company are too low and that the share price should rise as the economy pulls out of recession.
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3
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33

For most of this decade, Americans could be counted on to buy more than 16 million cars a year. Last year sales barely topped 13 million. This year industry forecasts call for 10 million.
America’s car makers are thus struggling to survive. On the eve of a government-mandated restructuring deadline, Chrysler was scrambling to partner with Fiat, win cost cuts from the United Auto Workers union in exchange for a big ownership stake and convince debt holders to accept less than they’re owed — and perhaps less than physical assets would fetch in a liquidation. On Mo
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nday, General Motors (GM) said it will cut 2,600 dealers and eliminate its Pontiac brand, and will either sell or close Hummer, Saturn and Saab. It faces a June 1 deadline to restructure, or file for bankruptcy.
I wish both companies success, but for America’s car business to have a shot, policy makers and Detroit executives must come to terms with three ugly truths.

The new sales pace is closer to normal than sickly.

America’s car count has grown well faster than its population over the past half century (see graphic below). Credit two trends: Incentives for house buyers have pushed citizens away from cities in search of affordability, giving them long commutes, while the cost of living has outstripped wage growth, leading to a surge in two-worker, and two-driver, families. But our stock of cars couldn’t grow that fast forever. We’re already well past the point where our cars (close to 250 million of them) outnumber our drivers (just over 200 million).
I’m guessing the bubbly pace of sales we took for normal a few years ago was driven far more by fashion than utility. The suburbs, after all, put neighbors’ cars on naked display. In 2002, the average new car buyer kept his car for just over 49 months. Whether because consumers can’t borrow more or because flashy displays of wealth have fallen out of style, that number has since crept up to 56 months. It can surely climb higher.
Sales of 10 million cars a year are enough today to keep every driver in his or her own car (already an astounding thing), with many of them driving new cars and none driving ones built much earlier than 1990. That’s enough. It’s not like new technology demands a stampede to showrooms. Tree lovers who buck up for a Toyota Prius today will go five fewer miles on a gallon of fuel than I went at age 16 in a Volkswagen Rabbit with a diesel engine. It was made in 1980.

Recent boom years weren’t so great for car makers, and Congress is partly to blame.

General Motors didn’t turn a profit in 2005, 2006 or 2007, years of relative opulence. Even before that, profits came largely from lending, including for houses, and not from making and selling cars. Operating margins for the car business have been more or less in decline since the 1960s. Health-care costs have steadily risen. General Motors famously spends more than $1,600 per car for employee health care.
In the U.S., government payments to the middle class for health care are decried as socialist, but the money is nonetheless needed, so we route payments through employers using a giant tax subsidy, and somehow convince ourselves that we’re more capitalist for it. The money ultimately comes out of workers in the form of lower wages and take-home pay instead of taxes — a subtle enough difference, except the scheme also leaves employers on the hook in the event of a sudden rise in plan costs, which we’ve had over the past decade. Nonunion companies and ones without steep obligations to retirees can adjust. Car makers can’t. On some level, rather than boo them we should applaud them. By losing money to health-care costs, they’ve taken on a responsibility that politicians have shirked.

Jobs worth saving generally don’t need saving.

Over the past year policy makers have lent car companies billions of dollars on the theory that if we keep them alive long enough the economy will pick up and good jobs will be saved. But financial failure for a company doesn’t mean that it ceases operations. Often, it means it drastically shrinks, takes on new management and forces otherwise impossible concessions on its unions and creditors. That might be just what’s called for.
Last week I wrote that what some politicians call extraordinary times, financially speaking, are really a return to normalcy. Personal savings (what consumers don’t spend) has recently risen from less than 1% of after-tax income to more than 4%, but its long-term average is 7%. After-tax corporate profits have fallen from 7% of the nation’s income to 5.1%. Their long-term average is 5%. If sales of 10 million cars a year is the new normal, too, we still need plenty of car workers — just not as many as we have today.
One recent proposal by lawmakers would give $4,000 to $5,000 to a consumer who buys a new car by year’s end. It seems like an easy fix. I can picture cashing my $5,000 check and driving off in a new Ford with the thought that I’ve helped my fellow American earn a decent wage. But giant car incentives will only lure Americans into buying more of something when they don’t truly need it, in the same way that giant house incentives have doubled America’s average house size since 1950, even as families have shrunk.
Better to let the car business shrink to a healthy size, whether through bankruptcy or selling brands and closing production lines. Send more taxpayer cash to Detroit if need be, but use it to help our former car workers find and qualify for good new jobs that need them.
More Cars Than Drivers


Source: U.S. Department of Transportation

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32

ELECTRIC-UTILITY STOCKS may lack sizzle, but many sport attractively low price-earnings multiples and offer ample dividend yields.
Regulated utilities now trade for an average of 12 times projected 2009 profits, a sharp discount to the Standard & Poor's 500 stock index, which, at around 1040, fetches around 17 times this year's anticipated profits. Based on 2010 earnings estimates, the utilities' P/E multiple of 11.5 likewise is comfortably beneath the broad market's 14. Utility dividend yields average just over 5%, more than double the 2.1% of the S&P 500.
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br />The yield spread between the utilities and the S&P 500 is near a five-year high. The utility dividend yield also stacks up well against 10-year Treasury bonds, which now yield 3.3%, and top-grade 10-year municipal bonds, now yielding 3% or less after the sharp muni-market rally this year. Dividends paid by the major regulated utilities look safe, and investors could see modest annual increases, enhancing the appeal of utility stocks relative to bonds.
Most utilities are expected to report average earnings gains of 6% to 7% in coming years -- impressive for a supposedly dull industry. Warren Buffett is a fan of the sector, admiring its predictable, if moderate, gains. One of the largest divisions within Buffett's Berkshire Hathaway (BRK.A) is MidAmerican Energy, which owns regulated utilities in Iowa and the Pacific Northwest.
Investors won't make a killing in the major utility stocks. Still, many of the shares could see upside of 10% or more in the coming year; include dividends, and the total return might top 15%. And given their defensive characteristics, utilities are apt to hold up better than the S&P if the stock market corrects.
Utilities are a contrarian investment these days. Hoping to capitalize on a recovering economy, many investors are piling into "offensive" shares in the faster-growing financial, technology and industrial sectors. Reflecting this mood, most equity strategists featured in Barron's cover story in our Sept. 7 issue urged investors to underweight utilities.
"This is not ordinarily a time to buy utilities, given the economic recovery and the associated risk of higher inflation and interest rates," says Hugh Wynne, the utility analyst at Sanford C. Bernstein. "But utility stocks may already have factored in the threat of higher rates as well as the risk of increased taxes on dividends when the Bush tax cuts expire in 2011. You shouldn't assume they will underperform." Dividends are now taxed at a favorable rate of 15%. Historically, the bulk of utility returns have come from dividends.
Wynne likes PG&E (PCG) and Edison International (EIX). To those who argue that utilities will underperform in a market rally, he and others counter that this already has happened. The Dow Jones Utility Average is up about 25% from its March low, roughly half the gain of the S&P 500. But year to date, the utility index is flat, versus the S&P's 15% rise. Stocks such as Southern Co. (SO), American Electric Power (AEP), Entergy (ETR) and Exelon (EXC) are down in 2009.
The risks to utilities appear modest, especially compared with the threats facing big telecoms, such as Verizon Communications (VZ) and AT&T (T). Most utilities are in the midst of big capital-spending programs to rebuild their power grids, construct new transmission lines and open new plants.
Utilities typically are allowed to raise electric rates to fund new infrastructure. Most state regulatory commissions agree that the companies need roughly 10% equity returns on their investments in order to keep building capacity. Power demand has dropped about 4% in the past year, owing to the recession -- but that hasn't hurt most utilities. Over time, U.S. electricity demand is likely to rise modestly, spurred by population growth, a recovering economy and increased ownership of electric cars.
There's little variation in the P/E ratios of the big regulated utilities. Companies such as Southern, Consolidated Edison (ED), PG&E, Duke and American Electric are among the safest in the group, because they get the vast majority of their revenue from regulated power operations and little from independent power divisions, whose profits swing, based on market prices for electricity. Prices have been weak because of the recession, a cool summer in much of the country and falling natural-gas prices.

MOST UNREGULATED POWER producers own low-cost nuclear and coal plants. When natural-gas prices are high, open-market electric prices tend to increase, providing a pricing umbrella for the independent power operators. With gas tumbling this year to $3 per thousand cubic feet, power prices have fallen, reducing the independents' profits.
Among the big regulated utilities, Wynne favors PG&E, which serves the northern and central parts of California. Its operations are almost entirely regulated, and its shares trade around 40, or for nearly 13 times projected 2009 profits of $3.16 a share and almost 12 times estimated 2010 earnings of $3.40. Wynne contends that PG&E's profits can expand at an 8% annual clip in the coming years, fueled by capital spending, primarily on new transmission and distribution infrastructure. His price target is 45

A CASE CAN BE MADE for most of the major regulated utilities. Con Edison is low-risk because it is involved mostly in the transmission and distribution of electricity and gas. It is largely out of the power-generation business, and is allowed to pass on changes in purchased-power costs to its New York customers. It yields nearly 6%. Southern historically has had one of the highest P/Es in the group, owing to a favorable regulatory environment and good growth prospects. Its stock has lagged this year, leaving it undervalued.
Citigroup analyst Brian Chin favors American Electric Power, which has one of the group's lowest P/Es. At 30, it trades for less than 11 times projected 2009 profits and yields 5.3%. With operations in the Midwest and Texas, American Electric Power is more exposed to weak industrial markets, and the regulatory environment in Ohio is viewed as difficult. Also, environmentalists and others have stalled construction of a half-finished $1.6 billion coal plant that an American Electric unit is building in Arkansas.

EDISON INTERNATIONAL, Dominion Resources (D), Entergy, Exelon, FPL Group (FPL) and Public Service Enterprise Group , or PSE&G (PEG), are integrated utilities, which have a mix of regulated and unregulated operations. Thus, they carry more risk than regulated companies. Their stocks have trailed those of regulated operators, reflecting weakness in power prices.
Wynne likes Edison International, the parent of both Southern California Edison and independent power producer Edison Mission Energy, which owns a group of coal-fired generators. He has called Southern California Edison "perhaps the fastest-growing, most favorably regulated electric utility in the United States."
SoCal Edison, which is expected to contribute about 80% of Edison's projected earnings of $3 a share this year, is capable of generating 11% growth in annual profits in the next five years. Wynne values SoCal Edison alone at $33 a share, in line with Edison's current share price. That means that investors effectively get Mission Energy free. Wynne has a price target of 36 on the stock.
Edison's profits are expected to fall almost 20% this year, reflecting declining earnings at Mission. If power prices recover, Mission will do better, potentially lifting the stock. It peaked around 60 in 2007.
Exelon, with the largest independent power unit fueled by nuclear plants, is a play on carbon legislation. The more onerous the burden on carbon-heavy coal plants, the better the outlook for Exelon's low carbon-emission nuclear plants.
In sum, electric utilities, with safe and ample dividends and decent growth prospects, are good bets for investors seeking income or protection from the next slide in stocks.
SMARTMONEY ® Layout and look and feel of SmartMoney.com are trademarks of SmartMoney, a joint venture between Dow Jones & Company, Inc. and Hearst SM Partnership. © 1995 - 2009 SmartMoney. All Rights Reserved.

39

Think carefully on this: Are you more or less happy today than a year ago? It might seem an absurd question. In America as in much of the world, stock and house prices have plunged over the past year and jobs have grown scarcer. Yet 35% of people surveyed in mid-April described themselves as “very happy.” That’s the same percent as a year earlier.
The pollster, Harris Interactive, draws a tempting but wrong conclusion from the results. “Money and Happiness
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Really May Not Be Tied Together” reads the title of a report issued Friday. Don’t suggest that to a jobless parent collecting the last of their unemployment checks as their health insurance lapses and their mortgage payments back up.
There’s an important relationship between wealth and cheer, but it’s tricky. In 1972 economist Richard Easterlin, then a professor at the University of Pennsylvania, reported an odd finding from happiness studies compiled from 19 countries since World War II. Within single countries, the rich are generally happier than the poor -- little surprise. But as a whole, rich countries aren’t much happier than poor ones, at least among countries with enough income to meet basic needs. Moreover, as a country’s overall wealth increases, its average level of happiness does not.
The Easterlin paradox has since defined the direction of happiness economics, a chipper-sounding but contentious branch of the dismal science. Researchers have a couple of explanations. One holds that people care more about relative wealth than absolute wealth. For suburbanites, whose success is put on naked display for the neighbors, household income of $150,000, triple the U.S. average, seems meager if the Joneses make $400,000. That would explain why poor countries are as happy as rich ones (so long as they aren’t subjected to too many images of them, perhaps).
Another theory holds that people adjust their ambitions with remarkable speed following improvements in economic circumstances, as in the case of the lottery winner who develops a taste for exotic cars. This “hedonic treadmill” helps explain why more gross domestic product per head doesn’t necessarily bring more smiles per head.
Some economists insist the Easterlin paradox is a flawed finding, and that changes in absolute wealth indeed drive happiness, but with diminishing returns. Politics threatens to creep into the research. If relative income influences happiness more than absolute income, the Dutch might be sensible for forfeiting half their pay to the state in exchange for universal healthcare, pensions, daycare, textbooks, vacation funds and more. If not, low taxes and few social programs are better.
Assuming relative wealth is at least a significant determinant of happiness, America’s “very happy” 35% might be poorer than a year ago, but no worse off than their neighbors. After all, few investment classes and vocations have been spared a downturn. If you’re not already a member of this fortunate bunch, ponder people who’ve got it worse, which, perversely, might make you feel better. Average income in America was $38,615 in 2007. SmartMoney’s marketers tell me readers of this column likely make well more. Average net worth for American households led by persons age 45 to 54 is about $94,000. If you’ve got more, great. If not, think about what you haven’t lost: That figure is down 45% since 2004.
Even if you don’t stack up well on U.S. measures, consider how things look for some peer nations about now. U.S. government debt will soon pass 80% of GDP, but Italy and Greece already owe more than GDP and Japan owes almost double. America is borrowing like mad at the moment, so its net government bond sales will total 12.7% of GDP this year. Britain’s will total 17.9%, reports Barron’s. America’s economy is shrinking, but starting with last year’s downturn and running through 2013, it’s expected to grow by 0.7% a year after inflation, according to the Economist Intelligence Unit. The economies of Japan, Germany, Italy and the U.K. are expected to shrink over the same period.
Things are grim all around. So try your best to have a happy Memorial Day weekend, relatively speaking.
SMARTMONEY ® Layout and look and feel of SmartMoney.com are trademarks of SmartMoney, a joint venture between Dow Jones & Company, Inc. and Hearst SM Partnership. © 1995 - 2009 SmartMoney. All Rights Reserved.

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