DirecTV vs. DISH

One way to buy stocks is to concentrate on companies that make products you know and like. For me, DirecTV (DTV) falls into that category. Over fifteen years ago, I moved to a rural area that did not have cable TV. DirecTV (founded in 1994, see history here--I've been a customer since 1996) was the only option. Over the years, I have become a fan of the company as have many of my neighbors and many people I meet casually. The video above provides the CEO's take on the company prospects (I was a little surprised that more streaming content would not appear until 2013).

My telephone provider, Telephone & Data Systems (TDS), offers a bundle that includes DirecTV's primary competitor, DISH network (DISH). I have often looked at the TDS-DISH bundle but have never thought the price and channel selection was good enough to switch.

How do the Random Stock Walker models compare with the result of personal product experience? Bottom line: DirecTV is well linked to growth in the world economy while DISH is a business-as-usual (BAU) stock.
The DTV forecast (based on the WL20 model) is presented above. Strong growth is predicted throughout 2012. The analyst opinion (here) is mostly "buy" with a high price target of 60 (well above the 98% prediction interval for 2012) and a low target of 43 (reasonable for 2011). DTV's P/E ratio is almost 30 with a forward P/E of almost 12
The DISH forecast is presented above. The forecast is for the price to rise into the 30-35 range until about 2015 when no further growth is predicted. The analyst opinion (here) is also mostly "buy." If you accept the BAU forecast above, only the short-term looks promising. The long-term upside potential is not very strong. DISH has also had a choppy history, peaking during the dot-com bubble and not performing very well after than.

An eNRGetic Random Walk

NRG Energy, Inc. (NRG) is a wholesale power generation company. The part of their business that interest CNBC's Jim Cramer in the video above is NRG's retail electricity business in texas, particularly their plans to provide charging stations for electric cars.

Cramer thinks that the electric car market is poised to take off by 2013 and that NRG will be well positioned to take advantage of the added demand for electricity. In the words of David Crane, CEO of NRG, the electricity car is what the air-cconditioner was to demand for electricity.

What does the Random Stock Walker think about NRG. Unfortunately, the stock is a random walk. The figure above shows the random walk forecast out to 2013. Since 2004, the stock has been driven by shocks. The analyst opinions are also not very positive with 6 out of 10 downgrading the stock (here) and predicting a media price target of 23. From the random walk forecast, any stock price different from 20 would be unexpected.

Charting vs. Random Stock Walking

Random Stock Walking is a form of technical analysis. On Mad Money tonight, CNBC analyst Jim Cramer did a good job of analyzing the stock OCLR (Oclaro, Inc.) using charting concepts, another approach to technical analysis. In this post, I'll compare the two approaches.

Oclaro, Inc. is a provider of optical network components. Cramer thinks that the stock has a bright future given the future of telecommunications and the lack of competitors. Cramer also thinks that both the fundamental and the technical analysis support the positive forecast.

In the video above, Cramer presents a technical analysis that uses some of the following concepts: trend lines, head and shoulders, and relative strength index. As a statistician, I'm not sure what to make of chartist concepts. Here's a start on that project.

From the standpoint of random stock walking, OCLR is a stock that is hard to distinguish from a random walk. The business-as-usual model (OCLR[t] = 0.49 + 0.85 OCLR[t-1]) with 98% confidence interval [0.70, 0.85, 0.94]) shows that a random walk is somewhat improbable. The graph above displays the dynamic attractor for the model. Notice that 2006 to 2010 draws most of Cramer's attention with a lot of weight being given to the "break out" after 2010.

Given a dynamic attractor that is below the current stock price, it's not surprising that my future forecast is not very encouraging. There aren't many analyst opinions on this stock (here) and the one analyst opinion available suggests a high price target of 23, which is about the upper 98% bootstrap prediction interval for the stock.

The Random Stock Walker approach finds little evidence for a "sky-is-the-limit" breakout that Cramer's technical analysis is suggesting. It will be interesting to follow this stock over the next few years and see where it goes. Cramer does admit that it is a speculative stock.

Worry, Worry: Steve Jobs Six Weeks To Live?

The National Enquirer (that's right) is reporting that Steve Jobs has six weeks to live (here). Stock analysts are keeping a level head in the face of this "news" (video above). One analyst on Yahoo Finance (here) downgraded AAPL from "Strong Buy" to "Buy" and another analysts upgraded the stock from "Neutral" to "Buy".

The stock was up to 364.90 yesterday but dropped down to the 358 area for most of the day today. The Random Stock Walker models (here) suggest that a stock price between 300 and 350 will be very close to the dynamic attractor for the next few months.

Should You Hold On To ARM Holdings?

CNBC stock analysts Jim Cramer recently pick ARM Holdings (ARMH) as one of his growth stocks (discussed in a prior post here). Unfortunately, the Random Stock Walker didn't validate ARMH as a growth stock even though it did validate the other stocks Cramer picked (AAPL, CMG and NFLX). What's going on?

First, as a company ARM doesn't actually make anything! It is a supplier of semiconductor intellectual property. It designs chips used in smart phones but it then licenses the designs to semiconductor manufacturers. ARM provides economies of scale in R&D in what has become a commodity market (semiconductor manufacturing).

Because ARM technology is so central to smart phone design and because cell phone technology is switching from "dumb" to "smart" phones, ARM should be well positioned to ride the "mobile internet tsunami".

If you look at the Random Stock Walker models, ARM is clearly a business as usual (BAU) model driven by shocks and a "short-memory" for the stock price (see THEORY below). It is not a growth stock (long-memory for shocks and stock price) and it is not particularly well linked to the U.S. economy. Therefore, even though the performance for ARMH (in the graphic above) shows improbable growth (beyond the 98% prediction interval) for early 2011, the forecast for the rest of 2011 is for a return to the long-run attractor at a price between 20 and 25 roughly.

Analysts don't like this stock very much either (here): it has a high P/E ratio, eight-out-of-ten analysts have recently downgraded the stock and given it a price target between 10 and 12!
Cramer acknowledges that people got burned by this stock during the dot-com bubble as can be seen from the long-term Random Stock Walker forecast above. Yet, he thinks it is a compelling story. Only time will tell. From the modeling perspective, this stock does not behave the same as other momentum or growth stocks and should not be put in the same category statistically.

THEORY. The BAU model is P[t] = a + b P[t-1] + V where b is less than unity. A pure growth stock would differ in that b would be greater than one. In the random walk, of course, b is (in probability) precisely unity. Since b=1 is actually quite unlikely, what the random walk designation should mean is that the stock price is dominated by random variability and cannot be effectively forecast.

METHOD. Looking at the behavior of ARMH during the dot-com bubble around 2000, one approach would be to eliminate this "shock" from the model and re-estimate. I've re-estimated the model starting in 2003 and the results are fundamentally the same as reported above.

What's Different About High-Growth, Momentum Stocks?

Tonight on Mad Money (video above), Jim Cramer argued that growth or momentum stocks are in a unique class and have to be judged differently from other stocks. For example, Apple (AAPL), Chipotle (CMG) and Netflix (NFLX) are typically downgraded by analysts because their P/E ratios are to high, that is, they are too expensive.

Cramer's argument is that for these momentum stocks, what really matters is that the smart money (hedge funds and mutual funds) want to hold growth stocks. Regardless of price, you can ride the momentum of these stocks as long as you are willing to take profits after a good run.

What interested me about momentum stocks is their properties when estimated with the Random Stock Walker models. What I have found is that these stocks all have significant unit roots (growth dynamics) and their attractors are also significantly related to (being driven by) growth in the U.S. economy.
The bootstrap forecast using the USL20 model shows strong growth potential but also shows a strong downside (the lower 98% prediction interval).
Chipotle also has strong growth potential but does not have the same downside risk. The same is true for Apple.
The Random Stock Walker models suggest that Netflix, at least, should be viewed cautiously. Too bad! Netflix is a product I like although many analysts think it has a difficult future ahead given potential competitors.

ARM Holdings (ARMH) is also mentioned in the Mad Money video (above). It is different from the other momentum stocks Cramer mentions (AAPL, CMG and NFLX). I'll talk about ARM Holdings in a future post.

THEORY and METHOD There are some interesting issues here. It is very difficult, because of the unit roots, to clearly determine whether these stocks are random walks (P[t] = 1 P[t-1] + V), business-as-usual (pure momentum, P[t] = a P[t-1] + V, a gt 1) or stocks that are linked to growth in the U.S. economy (P[t] = a P[t-1] + b S[t-1] + V, a lt 1). The models look very similar using the Akaike Information Criteria (AIC). It is necessary to look at the bootstrap confidence intervals for coefficients in the US index models. All the stocks are significantly related to growth in the U.S. economy and the unit roots are removed from the model when the state variables for the U.S. economy are included.

Notice also that Cramer talks about normal stocks being "driven by news." In terms of the Random Stock Walker models, news is the variability term, V, in P[t] = P[t-1] + V.

This Is Gambling

Back in October of 2010, Dan Nathan proposed (on CNBC Options Action, here) a way to play Akami (AKAM) stock using the strangle. AKAM is a tech stock and Akami provides services for accelerating and improving the delivery of Internet content. It seems to be a very popular stock among CNBC commentators. From the graph above with 98% bootstrap confidence intervals, it doesn't seem to have done much after the dot-com bubble.

What Dan Nathan was proposing was to buy the November 2010 50-strike call and the November 44-strike put. The strangle would be profitable if Akami traded above $53.10 or below $40.95 by the November expiration. What do the Random Stock Walker models think about AKAM and the strangle?
The models show that AKAM is a random walk. The business-as-usual (BAU) model was only slightly different from the random walk so it's forecast is displayed above. For the BAU, the November bootstrap prediction interval was (47.14, AKAM=54.13, 61.13), showing that Mr. Nathan's 50-call strike was just below the stock's expected value giving him some probability of success.

The AKAM strangle was discussed again tonight on Options Action because AKAM took a nose dive on Thursday, dropping below 42, which is still within he February 2011 prediction interval (45.10, AKAM=48.44, 51.78)--notice the downward trend . What to do? If I heard correctly, Mr. Nathan wants to stick with the trade, but it really doesn't matter. Since AKAM is a random walk, he's really just gambling. The stock could go anywhere. Maybe he'll be lucky.

Walk On Bye

Baidu (BIDU), China's Internet search engine, has generated a lot of interest among stock analysts (here and here) although the analyst opinion is not uniformly optimistic (here). What do the Random Stock Walker models show?

Unfortunately, Baidu is a random walk. There is some indication in the analysis, however, that if Baidu could link itself with growth in the world economy, it could become a growth stock. The bootstrap forecast above, made using the WL20 model, basically suggests that while there is some upside potential for Baidu, the stock has to get past significant downside risk extending well past 2015. That seems like a long time to wait for growth. And, since the stock is currently a random walk, short-term trading is really just gambling.

TARP Success "Probably" Depends on AIG

Everyone seems to hate the federal government's Troubled Asset Relief Program (TARP) except CNBC's Jim Cramer who thinks that TARP worked and "...was a necessary rescue of a critical industry that ended up working better than anyone could have imagined...". Tim Massad, US Treasury Secretary for Financial Stability, also thinks the program was a success (interview video above). The assessments of Cramer and Massad might prove accurate except for one problem institution, AIG (I'll get to this bad boy at the end of the post). My models suggest that there is still some probability AIG will fail and the government will loose the $40 billion invested in the company.

Cramer points to two banks as success stories. Fifth Third Bancorp (FITB) recently payed back $2.4 billion in TARP funds and SunTrust (STI) is about to make a secondary offering to raise funds to repay TARP. Cramer wants his viewers ready to buy the secondary offering. What does the Random Stock Walker think about these banks?

Neither bank is a random walk and both are strongly linked to the US economy. A boostrap forecast for First Third Bancorp is displayed above. In 2011, the trouble period has passed (the stock could have totally collapsed in 2009) and the stock is now on the way to recovery.

The same can be said for SunTrust. The stock is not a random walk and is well linked to the US economy. SITI could also have failed in 2009 but now is predicted to recover quite well in the future.

The recovery of AIG will not go as smoothly and it is not entirely past its trouble period. My model shows that there is some probability AIG will fail before 2015. AIG's collapse was more centrally related to the entire subprime mortgage crisis since it was one of the major insurers of structured debt securities backed by subprime loans. It will take a lot longer to unravel the mess created by AIG business practices and, not surprisingly, there is some probability the mess cannot be unravelled.

Quick Update: Apple Computer

At 345.03 today (not quite back to the month high) the AAPL stock price is still close to its dynamic attractor for early 2011.

The bootstrap forecast and 98% confidence intervals show that the stock price might be outperforming a little.

The dynamic attractor line also suggests that there could be a small downward correction, but 345 is still pretty close in probability. For me, it still remains a time to hold.

They're Nuts, They're Nuts! They Know Nothing!

It's August 3, 2007 and the Subprime Mortgage Bubble is about to burst. Jim Cramer is screaming at Erin Burnett on CNBC that the Federal Reserve should Open the Discount Window. The first systemic shocks were about to hit. On Aug 9, 2007 BNP Paribas (France's biggest bank) would suspend withdrawals from three money market funds because of subprime exposure (Bear Sterns had already on June 7, 2007 halted redemptions in two of it's mortgage related hedge funds).

More information on the Subprime Mortgage Crisis Timeline can be found here and, particularly for 2007, here. I'm reading Andrew Ross Sorkin's Too Big To Fail (Cramer's rant is described on page 87) and have just complete William Cohan's House of Cards about the Bear Sterns collapse. And, I'm still grinding my way through the Financial Crisis Inquiry Commission report which is not quite as interesting!