The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

31 July 2006

Getting Out Just In Time

It seems highly likely that Michael Shropshire and the rest of the team at InnerWorth read this blog. Today's essay (below), for example, recalls the conversation late last week re Rackable Systems/RACK and the proper use of stop loss orders.
-- David M Gordon / The Deipnosophist
What is your tolerance for pain? Consider the following scenario. You have 10% of your account balance on the line. For the past two days, the stock has been going in the direction you had anticipated, but today, it was announced that materials for the company’s biggest selling product are now in short supply. The media has been covering the shortage, and the stock price has started to drop. All your profits were wiped out in an hour. What will you do? Sell? See if the price will recover? At times like these, it is useful to have a clearly defined trading plan with a specific exit strategy.

Trading is inherently uncertain. You never know exactly what will happen next. That’s what makes the business exciting to some traders but nerve wracking to others. How you handle adverse events that make a stock fall hard depends on your personality. The best way to protect your capital is to use protective stops. When formulating your trading plan, you must decide how much pain you can tolerate. How much money can you lose before you have to exit the trade? You can set this exit point as a formal stop loss, you can use the automatic settings on your trading platform to set a stop, or you can use a mental stop.

The problem with a formal stop loss procedure, whether it is a formal order or an automatic setting on your trading platform, is that a transitory change in price can “stop you out” if the placement of your stop loss does not adequately account for volatility. It’s hard to know how far a stock may move and a temporary drop can ruin your trading plan when a protective stop is not set properly. Mental stops may be more useful. You can decide how far a stock price must fall before you will sell. When the stock price reaches the exit point, you can decide whether the low price is transitory or represents a significant change in trend. You can then exit the trade.

This all sounds good in theory, but depending on your personality, you may not be able to carry out this strategy. If you have trouble controlling your emotions and you use a mental stop, for example, you may have trouble closing the trade when it reaches your exit point. Some people panic and out of fear don’t close their position when their mental stop is reached. These people may need to impose the proper amount of discipline on their trading actions by using an electronic stop or a formal stop-loss order.

Minimizing trading losses is the hallmark of successful trading, but not all traders are equal when it comes to their ability to trade decisively under strain. If you want to trade profitably, it is vital to work around your personality. If you are cool headed and disciplined even under the most stressful conditions, you can use mental stops to protect your capital. But if you are easily shaken by choppy market action, you might want to use electronic, automatic stops to protect yourself. Whatever you do, however, minimize losses as much as possible. It’s the only way to trade profitably in the long run.

27 July 2006

They shoot horses, don't they?

Well, in the end, Rackable Systems/RACK declined. Hmm, plummeted would be the more appropriate word. This breakdown highlights the reward of discipline and patience; when trading the extremes (~$32 and ~$42), you could be wrong -- as I am, in this instance -- and yet still make money. For example, entering a market order to sell as soon the stock breached $37. Why at that price? See the chart below...

[click on image to enlarge]

Remember, today's trading, including after hours trades (after the news release), qualified as an inflection point or seminal moment. I explained yesterday why that is. Thus, I was busy today watching the intra-day periodicities for subtle clues. And I got precisely that, with the reversal bar at $38+. I did not sell immediately, however, because what then followed might prove to be only intra-day volatility. So instead I drew a line in the sand at $37 -- the important albeit not crucial breakout level that should be support. As soon as that level failed, I entered market orders for clients and me. I filled between $36.75 and $36. Trading was sloppy (a rapid decline) immediately subsequent to breaching that level, as the chart above shows.

These sales proved to be the correct action, as the stock was annihilated in after hours action in response to comments from the conference call re future revenues. But an investor never knows that an oscillation is something more than mere intra-trend volatility; even a confirmed breakdown could retrace the breakdown. In the case of RACK, however, the breach was valid, true, and correct. Ouch! See chart below...

[click on image to enlarge]

The chart above shows only after hours trading (well, it includes the final minutes of the regular session in the left margin). The trend lines circumscribe the former band of support between $34 and $32. Note the sudden plummet when $32 failed.

The truth of the matter is that, in re RACK's pattern, I am wrong. Horribly so. Nonetheless, traders and investors could have sold profitably (at $36+, as I did in anticipation of a breach), or breakeven (in after hours trading) when the breakdown was confirmed. The plummet is due to everyone scurrying for the exit at the same time. But waiting for the breach is just another quest for certainty.

By selling when I did, I was lucky. But only in retrospect. The shares could have gone the other way. When I saw the stock fail again at resistance (today's lower high), the reversal bar at that high trade, and the breach of important support, I sold. At that moment, I reasoned I would rather forego the opportunity for a profitable trade than lose money. I could always re-enter the position, although at a likely higher price. I figured that a breakdown would result in a plummet, whereas a breakout would result in more meandering albeit at higher prices while the base completed itself. Too, I struggle never to allow a profitable position to become instead a loss. This effort requires diligence -- or entering orders at pre-assigned levels.

This entire post, upon re-reading, seems like an elaborate defense of my stupidity. That is not my intent, however. What is my intent is to perform a necropsy of this 'dog' to show you what went wrong, how you could protect yourself, and how experience provides wisdom. At some point, science (charting, etc) leaves the scene and art enters. The art of interpretation, itself based upon experiential wisdom.

I was lucky to escape the wrath of an angry market. I hope you were as well.
-- David M Gordon / The Deipnosophist

26 July 2006

Stretched on the rack

By now, it is obvious to all that Rackable Systems/RACK trades in an ever-narrowing range, bounded at the extreme by ~$42 on the high and ~$32 on the low. This narrowing range is due largely to professional traders who know patterns and thus expect certain set-ups to build; in this case, the convergence of two simple moving averages, the 50 and 200 day.

This is a pattern I formulated years ago alongside Steve Shobin; as he put it then, "When a flat to declining 50 day sma comes down to meet a flat to rising 200 day sma, close your eyes, hold your stomach, and buy the stock." This pattern does not work out all the time (it is of intermediate-term proportions), and there are subtleties; notably, that the pattern builds over ~6 months, or the disparity of time between the two moving averages.

[click image to enlarge]

Datapoint #1 is the all time high for RACK, set ~3 1/2 months ago. #2 is yesterday's ugly price reversal. Ugly, that is, until you place it in context: noise within the budding intermediate term base (#3). Note that, since the low trade of mid-June, the stock has built a very minor pattern of higher lows and lower highs; i.e., a symmetrical triangle.

At this specific moment, I have zero notion of how RACK will trade in the immediate future. I do know, however, that its future has itself become event-driven: Rackable Systems will report its earnings after the close tomorrow (Thursday). Subsequent to that report, the stock will break one way or another. A failure to hold at $34-32 despoils the bullish setup; contra, a breach above crucial resistance at $42 changes the dynamics materially. In fact, bullishly.

Will this post prove to be my final update re Rackable Systems/RACK? Only time will tell that tale; in fact, ~48 hours from now. I should add that while a breach of support at $34-32 would change my bullish interest in RACK based upon this setup, it is not necessarily reflective of changes at the company. As an investor, I rely on visual clues; when I seek a pattern, and that pattern builds, then I invest, and should the shares instead go opposite to my perception, as fortune would have it, I simply sell and move on. I no longer feel the need to be right, only to make money.
-- David M Gordon / The Deipnosophist

Google's numbers visualized

This fellow, Hakim Bennis, does something few people before him have done: he takes the same old boring table display of an earnings report and transforms those columns and numbers into a gorgeous visual display.

Check it out!
-- David M Gordon / The Deipnosophist

The Fatal-Flaw Myth

James Surowiecki is among a handful of my favorite journalists; I seek each new essay written by him. Each essay tends to be comparatively brief, but packs a wallop. He writes predominately for The New Yorker magazine, which is where his most recent essay appears. While it is available to all readers (not solely subscribers) on the web, it will remain as such for only so long...
"The problem with such prognostications is that they infer basic truths about a company’s prospects from its short-term performance. In fact, present success is often determined as much by context and chance as by fundamental viability."

"People are generally bad at accepting the importance of context and chance. We fall prey to what the social psychologist Lee Ross called “the fundamental attribution error”—the tendency to ascribe success or failure to innate characteristics, even when context is overwhelmingly important ... investors assume that a mutual fund’s record over one year is a reliable indicator of the manager’s skill."
Context and chance are one thing (two things?), but a historical perspective is yet another. Surowiecki shows his readers why that is crucial as early on as his third paragraph.

Pay heed!
-- David M Gordon / The Deipnosophist

by James Surowiecki
Issue of 2006-07-31

Posted 2006-07-24

Every other summer, the aerospace industry gathers in Farnborough, England, for a big trade show. At Farnborough last week, there was one thing on everyone’s mind: the plummeting fortunes of Airbus, the European aerospace giant. Airbus is struggling to find customers for the new plane on which it has staked its future, the superjumbo A380, as airlines wonder whether anyone wants to fly on a jet that seats almost six hundred people. The A380s that have already been ordered will be delivered late, thanks to production snafus that may add as much as $2.6 billion to the original development cost of thirteen billion dollars. Airbus’s other big project, the mid-size A350, is to be completely redesigned, at a cost of ten billion dollars. All the while, its sole competitor, Boeing, has been gobbling up business, thanks to its new mid-size jet, the 787 Dreamliner. In the first half of the year, Boeing took almost five hundred new orders for planes, while Airbus took just a hundred and seventeen.

Airbus is a business-world anomaly. It was created in 1970, by an alliance of European countries, in order to break the American monopoly on the commercial-aircraft market, and it’s currently owned by a defense conglomerate in which the French government has a major stake. This connection has helped the company get access to government-subsidized loans, but has also meant that its corporate strategies have been shaped by politics. Now Airbus’s woes are being held up as proof that it is, in the words of one columnist, “a textbook example of how not to run a commercial enterprise.” The Wall Street Journal explained that Airbus was failing because of its “politicized management,” while the Times suggested that Airbus had to decide whether it was a company or a European “employment project.”

There are reasons to think that politics and business shouldn’t mix, but Airbus’s predicament isn’t one of them. What much of the talk about the inherent weakness of Airbus ignores is that, just a few years ago, it was Boeing that looked fundamentally flawed, while Airbus was seen as the future of the industry. Beginning in the late nineties, Boeing’s commercial-aircraft business went into a long and nearly profitless slump. In 2001, Airbus surpassed Boeing in new orders, a lead it maintained until this year. During that period, Airbus’s unusual structure was praised; its insulation from the stock market supposedly allowed it to invest in long-term research and development. Boeing, by contrast, was thought to be trapped in a short-term, cost-cutting mentality, because, as one analyst put it, “the money guys don’t reward long-term thinking and investment.” In 2003, Business Week declared that Boeing was “choking on Airbus’ fumes,” and warned that Boeing’s “slip to No. 2 could become permanent.”

The problem with such prognostications is that they infer basic truths about a company’s prospects from its short-term performance. In fact, present success is often determined as much by context and chance as by fundamental viability. This is particularly true of the aerospace industry, because success is heavily dependent on a small number of big gambles. If you bet right, you look like a genius for a few years, even if the success of your bet was due to factors out of your control. The 787 may now look like Boeing’s salvation, but Boeing built it only after more ambitious plans—for a plane, known as the Sonic Cruiser, that would have been the fastest passenger jet in the air—fell through, partly because of the slowdown in air travel after September 11th. And had Boeing not been in such straits in 2003 it probably wouldn’t have risked the investment required for the 787.

People are generally bad at accepting the importance of context and chance. We fall prey to what the social psychologist Lee Ross called “the fundamental attribution error”—the tendency to ascribe success or failure to innate characteristics, even when context is overwhelmingly important. In one classic demonstration, people shown a person shooting a basketball in a gym with poor lighting and another person shooting a basketball in a gym with excellent lighting assume that the second person hit more shots because he was a better player. This problem is compounded by the tendency to extrapolate big conclusions from small samples, something that behavioral economists call “the law of small numbers.” In the decade or so that Airbus has been a serious competitor to Boeing, this is its first really bad patch, and its difficulties are due mainly to making one bad bet while Boeing made one good one. That’s a minuscule sample size on which to base any kind of conclusion. But this is exactly what we like to do: sports fans assume that a few excellent performances are proof of a player’s underlying ability, while investors assume that a mutual fund’s record over one year is a reliable indicator of the manager’s skill.

Because we underestimate how much variation can be caused simply by luck, we see patterns where none exist. It’s no wonder that management theory is dominated by fads: every few years, new companies succeed, and they are scrutinized for the underlying truths that they might reveal. But often there is no underlying truth; the companies just happened to be in the right place at the right time. In 1999, after all, it was hard to find a business book that didn’t hold up Enron as the embodiment of one important principle or other. Of course, some strategies and structures work better than others, but real meaning emerges only over the long term. Let’s give Airbus a few more years of floundering before we decide that it should be put out of its misery.
Copyright © CondéNet 2006. All rights reserved

24 July 2006

Another Day in the Frontal Lobe

What can I say? I read two weeks ago an excerpt from Katrina Firlik's book, Another Day in the Frontal Lobe, and became immediately enchanted. I read now the complete book, agog with wonder.

Katrina and her publisher (Random House) graciously offer the excerpt below from her book for your consideration. I believe you will find this book as engaging and intelligent and fascinating as I do.

All comments welcome.
-- David M Gordon / The Deipnosophist


The brain is soft. Some of my colleagues compare it to toothpaste, but that’s not quite right. It doesn’t spread like toothpaste. It doesn’t adhere to your fingers the way toothpaste does. Tofu -- the soft variety, if you know tofu -- may be a more accurate comparison. If you cut out a sizable cube of brain it retains its shape, more or less, although not quite as well as tofu. Damaged or swollen brain, on the other hand, is softer. Under pressure, it will readily express itself out of a hole in the skull made by a high-speed surgical drill. Perhaps the toothpaste analogy is more appropriate under these circumstances.

The issue of brain texture is on my mind all the time. Why? I am a neurosurgeon. The brain is my business. Although I acknowledge that the human brain is a refined, complex, and mysterious system, I often need to regard it as a soft object inhabiting the bony confines of a hard skull. Many of the brains I encounter have been pushed around by tumors, blood clots, infections, or strokes that have swollen out of control. Some have been invaded by bullets, nails, or even maggots. I see brains at their most vulnerable. However, whereas other brain specialists, like neurologists and psychiatrists, examine brain images and pontificate from outside of the cranium, neurosurgeons boast the additional manual relationship with our most complex of organs. We are part scientist, part mechanic.

The scientist in me revels in the ethereal manifestations of the brain: the mind, consciousness, memory, language. The mechanic in me is satisfied by the clear fluid that rushes out of the end of a tube I insert into a patient’s brain to relieve excessive pressure. In everyday surgical practice, the science may take a backseat to the handiwork, and that’s okay. If you have an expanding blood clot in your head, you want a skilled brain mechanic, and preferably a swift one. You don’t care if your surgeon published a paper in Science or Nature.

I’ll give you an example of a most straightforward and manual case. I was paged to the emergency room a few years ago during my training and received the following brief report over the phone: “carpenter coming in with a nail stuck in the left frontal region of his head . . . neurologically intact.” What is going through my mind at this point? Do I hark back to my studies of frontal lobe circuitry and mull over the complex neural networks involved in language and memory? No. I’m thinking concrete, surgical thoughts: nails are sharp; the brain is full of blood vessels; the nail may have snagged a vessel on the way in. These thoughts are instantaneous, of course. I spell out the simple logic here purely for effect.

What I encountered in the ER was a young man, in his thirties, sitting up on an emergency room gurney. Perfectly awake and alert, arms crossed in repose and still in his construction boots, he smiled nervously when I walked in. Was he the right patient? He looked too good.

He was the right one. The carpenter explained that he and his friend were both on ladders along the side of a house. His friend was working a few rungs above. They were driving heavy-duty nails into the siding with automatic nail guns. His friend’s hand slipped upon firing in one of the nails, and the nail entered the left frontal region of my patient’s head below. For the first few moments after impact, the carpenter doubted what had happened. Although he noticed a stinging sensation within a split second of his friend’s slip of the hand, and heard the loud expletive coming from the same direction, there was no trickle of blood and he felt nothing unusual as his fingers frantically searched the top of his head. He wasn’t sure if it went in. His friend knew otherwise.

Upon close inspection of his scalp, past his short crew cut, I could see the flat silver head of the nail, not quite flush with the scalp, but a bit deeper. Apart from the nail, he looked great. I performed a quick five-minute neurological exam and found nothing wrong. I sent him down the hall for a CT scan. The nail entered his brain perfectly perpendicular to the surface of the skull. It had been driven a good two inches into his left frontal lobe. Luckily, it didn’t snag any sizable blood vessels along the way. There was no evidence of bleeding within the brain. Unlike the more common gunshot wounds we see, this was a respectably neat and clean penetrating injury.

At this point, my biggest fear -- bleeding in the brain from entry of the nail -- had been put to rest. Now, do I take a breath and mull over any complex scientific issues at this point? Am I exercising my formidable brainpower as a brain surgeon? When people say, “it doesn’t take a brain surgeon,” they refer to the assumption that we are the smartest ones around. Have I demonstrated this superior intelligence so far? Again, my thoughts return to the practical and concrete. We need to get the nail out of this guy’s head. It didn’t cause any bleeding on the way in. We need to avoid bleeding on the way out.

I walked out to the waiting room. His wife was there and so was his friend, who was pale and despondent, looking down at the floor. I tried to cheer them up a bit. Yes, the nail entered his brain, but his brain function, as far as we could tell, was normal and the nail caused no bleeding. Without looking up, the friend opened his hand and offered me a large silver nail that had been warming in his palm, the same type embedded in my patient’s head. “I don’t know . . . it might help you guys to have one of these . . . so you know what you’re dealing with.” I hadn’t been able to tell from the scan that the nail had two copper-colored barbs sticking out from the shaft at acute angles. I’m not a carpenter, but I figured that the purpose of the barbs was to ensure a strong hold. I thanked him and pocketed the nail in my white coat. On my way back to the ER, I ran my fingers over the pointy barbs and thought about the issue of bleeding again. Avoiding and controlling bleeding are elementary and pervasive themes in surgery -- not quite the stuff of rocket science, but critical nonetheless.

After calling on the appropriate team, including the supervising neurosurgeon and anesthesiologist, I took him to the OR, shaved a small patch of hair around the nail head, and made a short linear incision in his scalp, down to the skull. There are no how-to entries in our textbooks regarding removing nails from heads, so we improvised using common sense. We drilled out a disc of frontal bone from his skull, with the nail head at the center of the disc. Slowly, we lifted this piece of bone up away from the surrounding skull, bringing the firmly embedded barbed nail with it. Although we could see a small jagged tear in the covering of the brain and a puncture wound on the surface of the brain itself, there was no blood oozing from the hole, and we considered ourselves lucky. (“Better lucky than good” is a favorite slogan among surgeons.)

Then, using large tools fit more for our patient’s line of work, we clipped off the barbs and pounded the nail through the disc of skull, backward. After soaking the bone in an antibiotic solution, we neatly plated it back in place with miniature titanium plates and screws and sewed his scalp back together. Actually, rather than suture, we used surgical staples from a staple gun to close the final layer of his scalp, unaware, at the time, of the subtle irony in that move. Within less than twenty-four hours, the patient was on his way home, joking the entire length of the hall with the friend who nailed him in the head.

When I recounted this story to my family and friends after dinner one night, they all nagged me with the same question: “How could he be normal? This went into his brain.” Finally, here’s where the scientist in me gets to pontificate a bit, settling into a fast-paced question-answer session in the comfort of my own home with a captive audience. I am not just a mechanic, after all, and the brain is not just tofu.

How could he be normal? First of all, his brain function was considered normal based on our typical bedside examination, which is, admittedly, a bit coarse. His speech was fluent. He answered simple questions appropriately. I asked him to remember three objects over a five-minute time span, and he did. His pupils reacted when I flashed a light in his eyes and his eyes moved symmetrically. He had no drooping of his face. The strength in his arms and legs was normal and so was his sensation. His reflexes were fine. He was capable of rapid and coordinated hand movements. In other words, his five-minute neurological examination was perfectly satisfactory.

But the frontal lobes harbor quite sophisticated functions, more sophisticated than the relatively simple ones I tested. The frontal lobes make up the largest section of the brain and are the most recently evolved. Compare the forehead of an ape to the forehead of a human. One slopes, the other bulges. We can thank, or blame, our frontal lobes for much of what we consider to be our personality and intelligence. Damage to the frontal lobes can be subtle, including changes in insight, mood, and higher-level judgment (“executive function,” in the professional lingo). I’m not going to detect such changes in the ER during my five-minute exam before he is whisked off to the CT scanner. I’m just the neurosurgeon here. We would need to consult a neuro-psychologist to help us evaluate these more complex brain functions.

“So why didn’t you send this poor guy for more sophisticated testing?” my dinner audience asks in a confused and mildly accusatory tone. Why did I simply proclaim him “fine” and send him on his way? I explained that the foreign object was a nail, not a jackhammer. A relatively miniscule portion of brain was violated. The large frontal lobes, in particular, can be quite forgiving, especially when only one side is involved.
Even if a faint cognitive deficit could be identified with detailed and time-consuming neuro-psychological testing, would our carpenter care? Would he, or anyone else, even notice the problem? Would his life as a carpenter, husband, or friend be affected? Doubtful. On a more cold-blooded and practical note, would the patient or the hospital be willing to pay for these tests? His insurance would certainly balk at the cost and question the necessity.

Besides, given my confidence in the resilience of his frontal lobes, my biggest concern was not sluggish thought but sluggish carpentry: What if he gives up the automatic nail gun altogether?

Excerpted from Another Day in the Frontal Lobe by Katrina S Firlik.Copyright © 2006 Katrina S. Firlik.
Reprinted by arrangement with The Random House Publishing Group.

Google's Q2 2006

Ray Seakan writes,

"I was surprised that GOOG (the stock - not the company) did not react more positively to the earnings report. It looked pretty impressive from the reports on CNBC. Maybe something was hidden in there that they didn't reveal?"
To which I reply,
I view this reaction as a standard oscillation in price; i.e., a hoped for "high level (price) consolidation while the earnings explode upwards causing the PE to shrivel. Of course, at some point the law of large numbers will enter the picture. Many investors hesitate purchasing the stock pending the completion of this particular pattern.

But other people have their own opinions. The commentary below offers an example of just that.

-- David M Gordon / The Deipnosophist
Google Capital Spending Casts Shadow On Strong 2Q Results
Google/GOOG's second-quarter financial results affirmed the company is the most luminous of the Internet powerhouses.

The Web-search phenomenon is now larger in revenue terms than both Yahoo/YHOO and eBay/EBAY. Yet its revenue growth is three times faster and it exceeds both in operating profitability. That makes Google a truly “extraordinary company,” says Pacific Growth analyst Derek Brown.

Still, a nagging investor concern remains: the risk to profits from Google’s escalating expenses, as it rapidly builds out data centers, buys office space and scrambles to hire every genius it can find. So far results suggest Google’s aggressive approach to expansion and investment in growth initiatives is paying off. The company has sacrificed just 2 points of profit margin this year to produce more than 88% net revenue growth, notes Robert S. Peck of Bear Stearns. But investors will continue to watch its costs like hawks.

“The ultimate question mark on the investment thesis for Google is its capital spending,” Peck wrote in a note to clients Friday. “Is Google’s capex spending creating what will be the ultimate competitive advantage/barrier to entry to its hopeful competitors? Or is Google egregiously wasting capital, opening the door for competition?”

Google’s capital expenditures were $699 million in the second quarter, with real estate purchases accounting for $319 million and the rest mainly used for expanding data center and computing infrastructure needs. Excluding the real estate expenses, capital spending was 10% higher than in the first quarter and 140% higher than a year ago.

Total costs and expenses were $1.64 billion in the quarter, up 81% from a year ago. Google’s hiring spree continued unabated; the company had 7,942 employees as of June 30, up 1,152 from the first quarter.

The company promises even more spending, and on Thursday again warned investors that capital spending growth would “substantially” outpace revenue growth this year.

“Realistically, we think we can’t put too much capex into the system. It’s a really critical part of our competitive advantageand our infrastructure. And it’s something that you’re going to continue to see... over the next few quarters,” Chief Financial Officer George Reyes said on a conference call with analysts to discuss quarterly results.

He promised that Google “will continue to make strategic investments to allow us to maintain our leadership position in search and ads and to pursue additional growth opportunities.”

Pacific Growth doesn’t have a business relationship with Google, but Brown owns shares in the company. Bear Stearns has a business relationship with Google.

22 July 2006

You Need To Read This

I enjoy immeasurably articles that delve deeply into matters of our language; the etymology of our words, the philology of our language. Such as this one (see below)...
"The ascendance of need to dovetails perfectly with the long and sad decline of the traditional imperative mood. Sad, because it's a great mood. Without it, the Ten Commandments would be the Ten Suggestions. In our society, where giving offense is always feared, the imperative is rarely heard. So, instead of the pleasingly direct "No Smoking," we have the presumptuous "Thank You for Not Smoking" or the loopily existential "There Is No Smoking." The last remaining preserves of the imperative are the military, traffic signs ("Stop" has an estimable eloquence), innocuous adieus like, "Have a good one," "Take care now," and "You be good," and, intriguingly, the titles of works of art..."

-- David M Gordon / The Deipnosophist

Article URL:

the good word
You Need To Read This
How need to vanquished have to, must, and should.
By Ben Yagoda

George W. Bush sees needy people. "Anyone who harbors terrorists needs to fear the U.S.," he stated recently. And in an address about Iraq: "The American people need to know that we'll keep the forces there necessary to win." And yet again: "State and local law enforcement officials … need to be a part of our strategy to secure our borders."

The commander in chief is hardly alone in his affection for the word need. In the battle for pre-eminence among verbs of compulsion or requirement, need to has won a bloodless and overwhelming victory over must, ought to, should, and the former and longtime champion, have to, which yields only about a billion Google hits compared to two billion for need to.

Its popularity is partly explained by its versatility. Passive constructions in the form of "the floor needs to be washed" or "the video needs to be returned" deftly finesse the question of just who will be doing the washing or returning. And need to is just the thing for the currently very popular tense I call the kindergarten imperative, as in, "I need you to put away your crayons now." This construction is also favored by flight attendants, who often inexplicably add the phrases "go ahead and" and "for me," as in: "I need you to go ahead and put your seat backs in the upright position for me."

The ascendance of need to dovetails perfectly with the long and sad decline of the traditional imperative mood. Sad, because it's a great mood. Without it, the Ten Commandments would be the Ten Suggestions. In our society, where giving offense is always feared, the imperative is rarely heard. So, instead of the pleasingly direct "No Smoking," we have the presumptuous "Thank You for Not Smoking" or the loopily existential "There Is No Smoking." The last remaining preserves of the imperative are the military, traffic signs ("Stop" has an estimable eloquence), innocuous adieus like, "Have a good one," "Take care now," and "You be good," and, intriguingly, the titles of works of art. The biggest trove is pop songs, from "Come On Do the Jerk" through "Love the One You're With," all the way up to "Say My Name." Command titles form a large subcategory of Beatles songs, including "Come Together," "Don't Let Me Down," "Get Back," "Help," "Let It Be," "Love Me Do," "Please Please Me," and "Think for Yourself."

Need to does more than merely soften the blow of an order. Its genius, and the true source of its popularity, lies in the way it psychologizes directives. According to the Oxford English Dictionary, the word need was first used in an emotional context in 1929, in a translation from a French text. The formulation had its date with destiny 14 years later when psychologist Abraham Maslow published a paper that set forth his pyramidical "
Hierarchy of Human Needs." The bottom layer contained the only requirements previously associated with the word, that is, for air, food, water, sleep, and protection from the elements. After these are satisfied, Maslow asserted, human beings are hard-wired to fulfill "needs" associated with safety, love and belonging, status and esteem, cognition, aesthetic appreciation, self-actualization, and self-transcendence.

The notion, tinkered with by Maslow until his death in 1970, had traction and then some. It led to a new and now-dominant meaning for the adjective "needy"—more or less the antonym of "emotionally self-sufficient"—and to a paradigm shift in both popular and academic psychology. I once overheard an undergraduate remark to a friend that she had been taught about Maslow's Hierarchy of Needs in every single college class she had taken.

Maslovian terminology has made such inroads in the language not only because the original idea was so powerful, but because need to is rhetorically brilliant. This was first recognized in the battlefield of child care. A Maslow epigone named Thomas Gordon, founder of "P.E.T." (Parent Effectiveness Training), observed that when children are behaving in a way that "interferes with your ability to meet your needs," shouting direct orders to them doesn't work very well. So, he advised sending "I messages." That is, a better alternative to, "Your room is a disaster area—clean it up this minute," would be something like, "I get embarrassed when Mrs. Johnson is visiting and sees your room looking this messy, so I need you to clean it up."

Gordon expanded the "I message" idea to the adult world. His copyrighted "Credo for My Relationship With Others" includes the classic sentence: "At those times when your behavior interferes with what I must do to get my own needs met, I will tell you openly and honestly how your behavior affects me, trusting that you respect my needs and feelings enough to try to change the behavior that is unacceptable to me."

The Bushian "Anyone who harbors terrorists needs to fear the U.S." certainly isn't an I message, although it does have a petulant, lecturing undertone that evokes the nursery. The point is that the president—like the person who e-mailed me today that faculty members at my university "need to place their orders with the University Bookstore" and the sportswriter who wrote in my local paper that "the players need to be held accountable"—is trading on the word's psychological connotation, with its subtle but ineluctable suggestion of strong inner forces at work. So are people who use it in the first person—"I need to go now." The verb broaches no dispute: How can you argue with necessity?

Need to shines, as well, in passive-aggressive combat. Wife to husband: "Why do you need to play poker with the boys every Thursday?" By the time the husband comes up with the apt riposte—"I don't need to; I want to and I like to"—it's usually too late for anything but l'esprit d'escalier. And on my motel-room dresser last week, I found a deft new wrinkle on a familiar theme: "Should you feel the need to smoke in this room, we will feel the need to charge you a cleaning fee of $100.00."

Need to is slightly infantilizing and definitely underhanded, but it works so well that at this point, it couldn't possibly be dislodged from the popular lexicon. That makes one all the more appreciative of the noble minority who resist it. Whenever I hear a London Underground conductor declare, "Mind the gap," or when I encounter the rare flight attendant who will simply and eloquently quote Bette Davis and say, "Fasten your seatbelts," I have the same grateful reaction:

Thanks. I needed that.
Ben Yagoda is the author of The Sound on the Page: Style and Voice in Writing, and, forthcoming in October, If You Catch an Adjective, Kill It: The Parts of Speech, for Better and/or Worse.

Pandora's (music) box

Allan Harris writes...
This site clearly is the coolest thing I've seen in a long time vis-à-vis streaming music. You tell this free service which musical artists you like, i.e. Nick Drake, Bob Dylan, Paul Simon, etc, and it then plays those artist's music along with other bands that share similar musical characteristics.

21 July 2006

Dumb Mistakes: Everyone Makes Them

The commentary that follows is by Michael Shropshire, creator of the excellent website, InnerWorth.
-- David M Gordon / The Deipnosophist
When your money is on the line, you don't ever want to make a trading mistake. There are times when even a minor mistake can cost you big, but mistakes do happen. Have you ever spent a few days mapping out a trading plan, patiently waiting for the right market conditions, and then blowing the whole thing by making a dumb mistake? Perhaps you were distracted and forgot to close the position at your predetermined exit point. Or maybe you walked away from your screen to pick up the kids and came back to see your profits vanish. The possibilities are endless. What do you do? Kick yourself for making the mistake? Well, it's understandable if you do so, but should you waste your time? You may end up feeling even worse and making even more mistakes. What good did feeling bad about a mistake do then? We are all human, and humans make mistakes, and at times, the mistakes are really dumb. Money is lost for no good reason than shear carelessness. It's tempting to feel extreme guilt or to wallow in self-pity, but it does no good.

Ideally, it would be wonderful if we never made a trading mistake. Think about how great it would be if we never made a wrong calculation. If we had a perfect memory or unfailing concentration, we would make few trading errors. Why not try to be thoroughly competent in all we do? We pay a price for trying to achieve superhuman perfection. If we believe that we must be perfect, we will expend all our precious psychological energy mulling over the negative consequences of failing, rather than focusing on what we are doing in the here-and-now to implement our current trading plan. Traders who believe they must be thoroughly competent spend all their time worrying about what they did wrong, what may go wrong, and how they will recover should they fail. These thoughts are distracting and obscure the flow of immediate experience, and the ability to read current market activity with unfailing accuracy. In other words, by kicking yourself for not being perfect, you feel bad about yourself and make even more mistakes.

A more adaptive approach is to realize that it's impossible as a trader to be thoroughly competent, adequate, and achieving all the time. Certainly, you should develop an extremely detailed trading plan and try to account for all adverse events that may go against your plan, but there are limits to what you can do. For your long term enduring success, it is vital that you learn to ease up. You don't have to be perfect. You are bound to make mistakes occasionally, and if you are consumed with avoiding them, you'll be so anxious and fearful that you will make even more mistakes. Besides extreme perfection doesn't always pay off in the trading business. Trading isn't exactly a science. Even when you think a trading plan through carefully, you can't account for every possibility. An unexpected event may ruin your plan and there is nothing you could have done about it, but manage your risk and chalk up it to fate. Sure, you don't want to make too many mistakes, but you can make a few occasionally with little repercussions. Striving for perfectionism is an important ideal to hold, but don't forget that it is just an ideal. You might try to reach for it, but don't beat yourself up when you don't get there. Mistakes happen. Let it go. You'll feel better and take home more profits.

A line in the sand

[click on image to enlarge]
Once resistance, now support. A breach of the rising trend line, now at ~$370-368 (but rising), would change materially the intermediate term trend dynamics for Google/GOOG. But I suspect the shares will hold the line -- if GOOG were even to decline that low.
-- David M Gordon / The Deipnosophist

20 July 2006

Q2 2006

Google's 2nd quarter 2006 earnings report and conference call webcast occurs today at 1:30pm pdt. Go here to listen in, if interested.
-- David M Gordon / The Deipnosophist

18 July 2006

Relative strength

I use often the term, relative strength. It is a concept that typically is mis-applied but remains crucial to identifying leaders. Hand-in-hand with relative strength is the notion that these very same leaders will out-perform the market averages:
• The market advances, these leaders scream higher;
• The market declines, these leaders retreat only to a new base, at worst.

Thanks to reader, Ray Seakan, I have an example to share with you. What follows is only an analysis of a chart and not a fundamental or valuation recommendation. (Although I admit the shares appear poised to go higher.)

[click image to enlarge]

You could characterize the recent area pattern of 8-10 weeks (area 1 in chart above) for Trico Marine Services/TRMA as a short term double bottom ("W" pattern), a base atop another base (within a continuing uptrend), or a cup & handle (the most consistently mis-perceived pattern of them all). Note the data points:
• Point #2 is the new high that also coincides with its correction, slightly ahead of the general market (leaders lead!);
• Points 3 and 4 are the double bottom;
• Point 5 is the interim high between the double bottom. A trade above #5 both confirms the double bottom and changes the dynamics of this chart to up from down;
• Point #6 is the handle portion of the pattern that follows the successful breakout (not identified, but seen easily at the end of June) above the cup or double bottom;
• Point #7 is the low trade of the handle. Note how the shares not only reverse and close on the highs for that day, but how the reversal itself comes as a bounce off the (red) line of former resistance now proved as support;
• Point 8 is the high volume breakout above the handle.

Yesterday's seeming reversal is only that: seeming. If you trade solely on a technical basis, that reversal affords you the opportunity to enter your position near the most recent short term pivot price of $35.5-36.

The most important recognition, and why I share this chart and analysis, is that
TRMA led down the general market averages,
• Held crucial support,
• Aborted its decline ahead of the market's decline,
• Its decline was exceedingly shallow,
• It emerges to new highs, with explosive volume, while the market itself continues its meandering ways.

New leaders are not those stocks that have been in prolonged and now obvious to all up trends. Does this notion then include Trico Marine Services/TRMA as a new leader? Only time will tell. But the first step from here (after identifying the stock) is to investigate the group and sector -- do they out-perform? Do they lead? If yes, then and only then find the leaders in the group/sector, investigate further the company's (companies') fundamentals and valuations, find the best chart pattern that speaks to your needs... and then purchase the shares.

What more than that do you require? Certainly not the certainty of a rising market. Leaders lead.
-- David M Gordon / The Deipnosophist

17 July 2006

"on a darkling plain I met 'weltschmerz'"

I received via private email message the cleverest poem. Okay, perhaps I am fond of it because it is about me... well, kindasorta. I only wish I know who wrote and sent it; it arrives with only a subject header ("a wiser man might have slept last night...") and the poem. Nothing more to identify its author or sender.

I hope the poet speaks up for him or herself...

-- David M Gordon / The Deipnosophist

Hours ago I sat to read of charts and trend
for my net worth years idle badly hurts
but thoughts of finance came to sudden end
when on a darkling plain I met "weltschmerz"

Oy vey! I cannot abide fruitless depression
no submissive leaps needed, and this I can show
you've simply been asking yourself the wrong question
So I say to your Moses "let my David go"

Reason and faith themselves get along
its the humans who trump up all the disputes
and you well know why they keep getting this wrong
their heads are stuck way up their own absolutes

The border where thinking crosses over to knowing
will vary for each, and that's no great surprise
its where one decides further just ain't worth going
so you stop calculating and make compromise

"Will the sun rise tomorrow?" I may ask of your powers
to model with maths or perform computations
but if this "proof" ain't finished in twenty-four hours
you're useless, I'll go with some approximations

Now I'm not the person to ask for a savior
you follow your bliss and choose to your taste
but I'll say that for humans all's betting behavior
seek "truth" when you've infinite resource to waste

"Call it a feeling, or...I just knew" -Mr. Gloom
from the one without faith...what's the name of that guy?
leave Golgotha for others, for you, Googlebensraum!
Oh yeah, by the way... when do I buy?

14 July 2006

How I proceed on a day like today...

First, I acknowledge the obvious:
That recent market action is a resumption of the decline that began 11 May.
• That the charts look sh**ty. (Does anyone NOT know what that word is? Why the need for placeholders to mask it?)

Then I look at favored opportunities:
• Those that breach identified support are cast aside.
• Those that have yet to breach support, I zoom in on.

Specifically, I monitor the intra-day charts in the quest for reversals. These reversals manifest as a comination of factors:
• A specific pattern for the price bars;
• A specific price:volume relationship;
• A specific relationship of the price bars and the moving averages. (NB the periodicity of your movings averages, as they will carry into the intra-day chart their default settings).

Who, in his or her right mind, would buy such market action? And who would do so in the face of such ugly geo-political news? And who would do so in front of a weekend, allowing the opportunity to absorb the potential 70 hours of bad news before redistributing any shocks to their portfolios come Monday AM? ("SELL!")

Professional investors is who. They -- we -- are paid explicity to assume risk. Not [to] avoid it. There is only one deterministic item in this entire shebang: Whether you will do the right thing, the hard thing, when conditions change. Professional investors neither "predict" nor even "expect"; they do, however, anticipate. Given any set of circumstances, a stock (or the tradable you prefer) either abides by the rules of its setup, or it is gone. Poof! Next...!

So Rackable Systems/RACK has declined to its 200 day sma. This moment, then, tells its immediate future; it either holds... or fails to hold. Buying at $32.75 with a closing stop 75¢ lower is my notion of a good risk:reward ratio. Of course, I could wait to be certain, but certainty assesses its own costs:

Less certainty = less risk + increased reward
More certainty = more risk + decreased reward.

Hmm, I wonder which option I would (should) select...? (Of course, I am a trifle distracted today, of all days.)
-- David M Gordon / The Deipnosophist

13 July 2006

Brief update re RACK

So RACK declines again towards $32. Is it too silly to suggest I expect(ed) this type of action? (Recall the limned double bottom intermediate term base.) In fact, the closer it nears to crucial support at $32 (the 200-day sma now is ~$32.65), the more likely it becomes I will purchase another lot. I prefer the shares wash out towards that level today -- and soon (meaning, early on) -- so that the likelihood of a bounce from that low would increase.

But $32 also is my stop out level. A failure to hold that price level, especially on a close, changes materially the picture. And my interest.
-- David M Gordon / The Deipnosophist

This is how it begins...

Age-Activated Attention Deficit Disorder

... I decide to water my garden. As I turn on the hose in the driveway, I look over at my GMC and decide it needs washing. As I start toward the garage, I notice that there is mail on the porch table that I brought up from the mailbox earlier.

I decide to go through the mail before I wash the GMC. I lay the car keys down on the table, put the junk mail in the garbage can under the table, and notice that the can is full. So, I decide to put the bills back on the table and take out the garbage first. But then I think, since I'm going to be near the mailbox when I take out the garbage anyway, I may as well pay the bills first.

I take my checkbook off the table and see that only one check remains. My extra checks are in my desk in the study, so I go inside the house to my desk where I find the can of Coke that I had been drinking. I'm going to look for my checks, but first I need to push the Coke aside so that I don't accidentally knock it over. I notice that the Coke is getting warm, and I decide I should put it in the refrigerator to keep it cold.

As I head toward the kitchen with the Coke, a vase of flowers on the counter catches my eye -- they need to be watered. I set the Coke down on the counter, where I discover my reading glasses that I had been searching for all morning. I decide I'd better put them back on my desk, but first I'm going to water the flowers. I set the glasses back down on the counter, fill a container with water and suddenly I spot the TV remote. Someone left it on the kitchen table. I realize that tonight when we go to watch TV, I will be looking for the remote, but I won't remember that it's on the kitchen table, so I decide to put it back in the den where it belongs. But first I'll water the flowers.

I pour some water in the flowers, but quite a bit of it spills on the floor. So, I set the remote back down on the table, get some towels and wipe up the spill. Then I head down the hall trying to remember what I was planning to do.

At the end of the day:
the GMC isn't washed
• the bills aren't paid
• there is a warm can of Coke sitting on the counter
• the flowers don't have enough water
• there is still only one check in my check book
• I can't find the remote
• I can't find my glasses
• I don't remember what I did with the car keys.

Then when I try to figure out why nothing got done today, I'm really baffled because I know I was busy all day long, and I'm really tired. I realize this is a serious problem, and I'll try to get some help for it.

But first I'll water my garden...

(The story above is from a forwarded email.)
-- David M Gordon / The Deipnosophist

12 July 2006

Can there exist...?

Say, what? Does an albino peacock truly exist...? Or is this image massaged with PhotoShop?

[click image to enlarge]

-- David M Gordon / The Deipnosophist

10 July 2006

One reader points a hot light at RACK

A shrewd investor, Deipnosophist reader, and friend who signs his posts as Anatole K. (skinowski), writes the following commentary re Rackable Systems/RACK...
Good morning, David!

I did not buy RACK at 32, but I did buy it under 34, on the morning weakness on June 23. Enjoyed a nice few point swing, and got out. Thanks for the idea! I think this will not be my last encounter with RACK. I am considering buying it at 36 - a nice support level, and a 50% retracement level of the recent rally. Now, the issue I have with this stock is the classical 5 wave descent which it traced out since the top in April; from an Elliottian pont of view, this suggests increased odds for another (matching) decline. In fact, I think that an impulsive decline in an important (and imo sensitive) stock like RACK may be in its own right a bearish indicator for the markets.

[click on image to enlarge]

From an Elliot Wave perspective, this down fiver suggests potential bearishness in the future... At least another impulse move down to complete an "ABC" correction...
Well, I must admit I do not disagree with Anatole. I agree there is important support at $36-35, and crucial support at $32. In fact, a failure to hold at $32 changes materially the picture for the stock picture, and thus my interest. I suppose, however, the crucial difference between Anatole's and my outlook is time frame. Anatole seemingly prefers to trade the short term price oscillations whereas I prefer to expect those very same price oscillations and instead accumulate more shares. The lower the price the better, although as just mentioned a failure at ~$32 would change my investment interest.

Continuing to watch closely the ongoing inter-market dynamics and assuming the bullish resolution for Rackable Systems/RACK, it would not surprise me that, come October 2006, the shares would make a sneak attack on $50. But that possibility remains dependent on the market's future and the successful breach of multiple levels of resistance for RACK. That first level of resistance lies dead ahead at $41-42, the level that confirms the past 3 months of decline as an intermediate term base prefatory to higher highs. Rather than a top, as some observers believe, including Anatole.

What do you think...?
David M Gordon / The Deipnosphist

09 July 2006

Left brain, right brain

When I moved to Europe in 2001, and then did not return to southern California, I lost touch with many people. Time passed; connections frayed and good friends disappeared what with changing snail mail addresses, e-addresses, telephone numbers, and my inherent laziness. One of the better items that comes about due to the WSJ interview is the opportunity to re-establish connections with long-lost friends.

Bryan Gindoff is one. Bryan is the epitome of bleshing the brain's two hemispheres; the hemisphere lateralization of its logical and creative halves. An accomplished and highly-regarded screenwriter and novelist, Bryan also is as shrewd and savvy as they come with re to the world of business, but especially investing. Bryan 'gets' it; in fact, the quality of his insights convinced Bob Koppel and Howard Abell to interview Bryan for their book, Bulls, Bears, and Millionaires. (See sidebar for link.) I, too, am included among the interviewees albeit only for my handsome mien. The best part of it all? Bryan is a friend.

I recall one day at Tim Slater's long-gone and lamented TAG (Technical Analysis Group) seminars. These annual meetings were for market professionals -- its stellar list of participants, its interactivity, and non-fawning atmosphere led to some fantastic and informative discussions and conversations. On this particular day, Tom Bulkowski (see sidebar, "Chart patterns") discovered Bryan was the screen writer of the movie, Hard Times.

Tom's excited comment was that the movie was his perfect metaphor for being a successful stock trader. The way the Charles Bronson character would wait and wait and wait, and then POW! land the perfectly-timed and perfectly-placed knockout blow. Also was the deprivation -- almost Zen in its austerity -- the Bronson character imposed upon himself. Etc. So Bryan immediately phoned the studio and requested it rush a copy of the video to the conference. Bryan inscribed it for Tom, and then Tom wandered off, happy as a clam.

From the website,
"Walter Hill's colorful directorial debut has quite a cult following for its toughness and violence; it may well be his best film, in fact. Charles Bronson plays a silent street fighter in New Orleans in the '30s managed by the cool James Coburn. Jill Ireland, Strother Martin, and Michael McGuire costar in this spare existential Depression dirge. It owes a lot to its noir origins that Hill adores so much, yet there's something very fresh and vital about its subject and approach. That's really what made so many of these films from the '70s so endearing. An added bonus is the love and affection displayed by the real-life husband and wife team of Bronson and Ireland."
Walter Hill? How about Bryan Gindoff? Although Bryan, in full humility mode says,
"So you'll know the facts, I wrote the original screenplay with my then writing partner Bruce Henstell. Walter Hill then rewrote the script and directed the movie. It was his first major film. He shares story and screenplay credit with Bruce and me. And I suppose it would be fair to say that I made Charles Bronson's career, just as it would also be fair to say that I made Tom Cruise what he is today."
(The Tom Cruise comment refers to Bryan's casting of Tom in Tom's first movie role.) I agree with Tom Bulkowski: This movie not only is good, but a fine metaphor for investing success. Moreover, I like the movie; in fact, I always have, even before I knew Bryan.

I also like Bryan. Perhaps he will habituate this blog, and grace it, and us, with his many fine insights on a bevy of topics.

-- David M Gordon / The Deipnosophist

08 July 2006

The Futurist

While reading The Futurist, I used words such as clever, hilarious, and insightful to describe the experience of reading such a fun and intelligent novel. The truth is those words do this book little justice...

"Oh, shit. I've given back tens of millions. Some of these guys, these billionaires, make me sick. They think that now they're rich, they can satisfy their egos, alleviate their guilt, by thinking their accidental windfall somehow means they are geniuses, cosmically ordained and therefore eminently qualified to solve the world's problems -- AIDS, loose nukes, illiteracy. They're delusional enough to think that they matter more than others in a larger sense. They think, Now that I've made billions on a seach engine that can locate highly specialized subgenres of kiddy porn at thrice the speed of light, I'm going to teach the world to read. When in truth they're rewriting history to say that their original business models, the ones that made them obscenely rich, were driven not by greed and hubris but by some larger calling to transform the world."
William Faulkner once instructed that good fiction is "about the human heart in conflict with itself." Author James P Othmer seemingly knows this writerly commandment especially well. Othmer conflates the personal and professional conflicts that rage in the heart of his protagonist, Yates (the eponymous Futurist) with his, and our, attempt at understanding "why they hate us (Americans)."

The Futurist

It has been a long, long while since I devoured a novel as voraciously as I did The Futurist. Its sheer exuberance, its epigrammatic style, and its wit and irreverence are a hoot! More to the point, however: I believe you would enjoy this novel every bit as much as I did. And still do. Yes, it is that memorable.

Check it out!
-- David M Gordon / The Deipnosophist

Google, the Wall Street Journal, and dmg

March 2, 2006 2:35 a.m. EST; page A1

URL for this article:

Engine Knocks
As Google Matures, Investors Take Closer Look at Its Risks
Mixed Signals on Growth
Create Tug of War on Stock Among Skeptics, Believers
A Tale of Two Shareholders

There is one thing about Google Inc. that investors seem to agree on: Its stock has entered a new era, in which shareholders are looking beyond the Web-search giant's stunning growth and raising questions about its business risks and tight-lipped approach to strategy and earnings.

But that is where the agreement ends, as the divergent bets placed by investors like Chad Brand and David M Gordon show. Mr. Brand and Mr. Gordon each bought Google shares in the months after the company went public in 2004. They both saw wild increases in the value of their stock. But after Google reported on Jan. 31 that fourth-quarter earnings were short of expectations, the two investors came to sharply different conclusions about the prospects for the 21st century's hottest stock.

Mr. Brand, who manages money in St. Louis at his one-man Peridot Capital Management LLC, sold all of his clients' remaining Google holdings early last month for about $400,000, or $400 a share, after the company reported the disappointing earnings. After analyzing the earnings, he decided that "it's a dicey situation in the short term," says the 26-year-old manager.

Mr. Gordon, creator of and writer for, the blog site, The Deipnosophist, placed the opposite bet after examining Google's numbers. Two weeks after Mr. Brand bailed, Mr. Gordon bought 1,000 shares at around $339 a share, adding nearly $340,000 to the few-million dollars of Google stock he already held. "The stock will give Wall Street fits," says the 50-year-old Mr. Gordon, a Las Vegas-based former stock broker who now invests his own money full time. But, he says, "months from now, it will be at $600 to $800 a share and people will say, 'My God, why didn't I buy it back then?' "

The competing forces of investors like these have helped whipsaw Google -- a stock that evokes the wild hopes of the dot-com boom. Even amid Google's current hiccups, few are predicting a dot-com-style bust. Unlike many of the Web upstarts that flamed out starting in 2000, Google has built a real business that generates significant profits.

Still, skeptics are concerned that as the company gets bigger, it can't keep up its torrid growth since going public less than two years ago. The true believers, while acknowledging that growth may slow, think Google has yet to fully realize its potential and have acted as a safety net, swooping in when the price falls and keeping the stock afloat.

As the two camps place their bets, the stock gyrates. It fell sharply early last month after disappointing earnings, and then crept back up. Tuesday brought another selloff, when Chief Financial Officer George Reyes said Google's growth is slowing due to the "law of large numbers" and it will need to find new ways to boost revenue. He added, "I think we have a lot of growth ahead of us. The question is at what rate." Google's stock fell about 13%, then quickly rose, finishing the day down 7%.

Yesterday, the stock edged up $2.18 to $364.80 in composite trading on the Nasdaq Stock Market. A big meeting with analysts today could generate more volatility.

The company declines to comment on the stock moves. "Our primary focus is on making Google more beneficial for users and customers, and on building a world-class company," said a Google spokeswoman. "As a policy, we have no comment on Google's stock performance."

The divide between buyers and sellers is particularly pronounced with Google because the Mountain View, Calif., company has been growing so quickly -- and because its business model and the risks to it remain largely uncharted.

Also adding to investor uncertainty is the company's reluctance to give guidance to analysts seeking to hone revenue and profit forecasts. Google executives say their goal is to manage for the long term and not to attempt to smooth out any quarter-to-quarter bumps in financial results.

Investors largely took that approach in stride until recently. The stock rose from its August 2004 initial public offering price of $85 to above $471 by January. With revenue increasing about 100% each quarter from the year-earlier period, many investors were willing to look past concerns and keep the faith in the stock. Fueling their excitement was the company's clever model for selling ads alongside Web-search results and other online content, which alone generated about $6 billion in revenue for Google last year. Profits also were stellar, with net income of $1.5 billion representing 24% of revenue in 2005.

Messrs. Brand and Gordon, like many investors, hadn't started out with that faith: Each had decided against buying stock in Google's IPO. Mr. Brand, the money manager, was wary about the projected price, which he believed was too high. Mr. Gordon, the individual investor, sat out the IPO because of its unusual online-auction-style format, a factor that also deterred many other investors.

Mr. Gordon jumped in first. He bought shares within a few weeks of the stock's launch, on the belief that Google was a "generational, singular opportunity," he says, to benefit from a "convergence of many once-divergent political, social, cultural and financial trends." Those trends include the rapid digitalization of vast tracts of human knowledge, including detailed information about the human body. Google was trading between $100 and $110 at the time of his purchases. About a month later, Google announced third-quarter 2004 earnings and revenue that far exceeded analysts' consensus forecasts, and investors pushed its price sharply higher, to above $190 by the end of October 2004.

Temporary Swoon

Mr. Brand bought Google shares for his clients in January 2005, when he saw what he viewed as a temporary price swoon. Google's stock had dipped below $180 on fears that selling by employees would damp its rise. Mr. Brand, who started investing his family's money as a teenager and now manages about $10 million from roughly 30 clients through Peridot, believed investors had lost sight of Google's strong growth prospects. The stock looked cheap compared with other Internet companies, he decided, on the basis of price-to-earnings ratios and other valuation measurements.

It proved a good time to buy. The company's fourth-quarter 2004 earnings were another blowout, with profit rising almost eightfold as more advertisers bought Google ads. Big institutions were snapping up the stock, spurring interest by other investors. One key buyer: Lone Pine Capital, an influential hedge fund run by Steve Mandel, which began buying on a large scale in early 2005 and became one of Google's biggest holders. Mr. Mandel's enthusiasm was a green light for other hedge funds to buy Google shares, helping to send them past $200 in early 2005.

Mutual fund giants Fidelity Investments and Capital Research & Management Co. added huge helpings of Google shares to their portfolios in the first half of 2005, helping lift the stock to $300.

By the second half of 2005, a new group of investors joined the party: "momentum" investors, including hedge funds and individual investors, who hoped to catch the wave. Momentum investors try to ride updrafts in stock movements -- sometimes betting less on the fundamentals of a company and more on an extrapolation of possible price increases. Ever sensitive to changes in direction, these investors can exaggerate a stock's volatility.

A buying frenzy developed from September to mid-November, as Google's stock jumped above $400. In January, some of the last skeptics threw in the towel, and the stock hit a peak of $475.11. On Jan. 4, Bear Stearns Cos. analyst Robert Peck increased his rating for Google to "Outperform" from a less enthusiastic "Peer Perform" and raised his 2006 price target for its shares to $550 from $360. "We believe that we have been too conservative in our original models," he and colleagues wrote in a report.

Around this time, Mr. Brand, who had accumulated about $600,000 in Google holdings, began to worry about Google's price. At $467, Google traded at 21 times 2006 sales estimates, Mr. Brand says, which he saw as unsustainable. He sold roughly a quarter of Peridot's holdings in early January at above $460. Mr. Brand wanted to lock in some of his gains, but believed Google still could move higher in the short-term.

Even with the shares touching $475, Mr. Gordon remained a believer. He was convinced most investors didn't understand Google's potential. He compared the search company to a black hole, sucking in the best employee talent and the most advertising dollars, while maintaining lower costs than those of competitors.

Then Google dropped a bombshell. On Jan. 31, it reported fourth-quarter 2005 per-share earnings of $1.54, far short of analysts' consensus estimate of $1.76 when factors such as stock-based compensation are excluded. Google blamed complicated tax-related reasons. "We are very pleased with these results," Chief Executive Eric Schmidt told analysts during a conference call, reminding them that "we take a long-term view of business."

Many investors didn't buy it. Clearly, Google's stock wasn't the sure-fire momentum play it had appeared. Some investors were counting on 30% or more revenue growth from the third quarter, when certain marketing expenses are factored out; Google reported growth of 23% on that basis.

Google's shares plunged more than 16% in after-hours trading to around $360 from $432.66 following the earnings announcement. Suddenly, the company's business prospects -- not the momentum of its stock -- were on investors' minds. International growth was weaker than many anticipated, led by disappointing sales in the United Kingdom. Google had misjudged its annual tax burden, raising doubts about its internal financial forecasting.

Perhaps most importantly, the company had failed to beat analysts' consensus forecast, as it had done each quarter since its IPO. One factor was an increase in sales and marketing expenses, which rose 47% in the fourth quarter of 2005, compared with the third quarter. Some analysts pointed out that interest income on Google's $8 billion cash pile contributed to profits, prompting questions about growth in its core business.

Nothing New

Such concerns hadn't mattered much before. In fact, none were really new. But investors, both skeptics and believers, suddenly began looking at everything. "The old 'In Google We Trust' mentality has dissipated," says Bear Stearns's Mr. Peck. "People are taking a closer look at numbers."

Sitting in Peridot's headquarters, Mr. Brand's home office, the fund manager listened to Google's management discuss earnings. As Google executives talked, he became concerned that short-term profits would be damped by Google investments in new staff and international expansion. His heightened awareness of those concerns led Mr. Brand to cash out of Google entirely. "It just seems there's a lot more risk to banking on all of these other things they're doing," he says.

More investors began to worry about the increasing number of restricted shares and options that Google is handing out to employees. A bearish Feb. 13 article in Barron's added to the dark cloud over the company, asserting that factors such as online fraud and competition would weigh on Google. Barron's and The Wall Street Journal are both published by Dow Jones & Co.

Some began drawing parallels to what happened with other growth stocks, such as Microsoft Corp. and eBay Inc. Those companies also had gone through periods of phenomenal profit growth and could do no wrong in many investors' eyes, before scrutiny grew. Meanwhile, Google and other Internet companies have come under fire in Washington for complying with government censorship in China. And telecommunications carriers are pushing regulators to allow them to charge Internet companies to carry data traffic to consumers.

By Feb. 15, Google shares had fallen to $342.38, 27% off their high. Then, suddenly, the plunge stopped. On Feb. 16, the stock jumped 7% to $366.46. It jumped another 3% to $390.50 on Feb. 27.

While acknowledging new concerns about expenses and other business risks, Google bulls like Mr. Gordon saw reasons to buy more. At their recent low on Feb. 15, he snapped up the additional 1,000 shares. Worries about such factors as competition and growing expenses that others have raised about Google "are all valid risks," Mr. Gordon says. He says he is particularly baffled by Google's misjudging of its 2005 tax rate. "How could they not know that?" asks Mr. Gordon.

Still, after analyzing those concerns, he has concluded that Google shares will continue going up, whatever the short-term fluctuations. Mr. Gordon says he learned to focus on a company's long-term prospects after missing out on big rises in other growth stocks such as Microsoft and Cisco. He believes Google will be a principal beneficiary of shifts in advertising spending and will likely generate other major revenue sources along the way.

The plunge in Google's stock price this week didn't change Mr. Gordon's analysis. Mr. Gordon called the sharp intraday drop in Google shares to $338.51 from $397.54 "incredibly horrifying." But reiterating his long-term view, he says, "I haven't lost my bullishness -- this is Wall Street doing its typical dance."

Like Mr. Gordon, other investors have decided to hold on or buy more. Bill Miller, who runs the big Legg Mason Value Trust mutual fund, bought more than four million Google shares in the IPO, becoming one of the largest shareholders in the company. Yesterday, Mr. Miller said he remained positive on Google's future, saying the company "will grow substantially for many years to come." People close to the matter say Lone Pine remains a big holder.

When Google shares hit $450, some hedge-fund managers, such as Thomas Vincent of New York-based Acero Capital Management LLC, started selling. Mr. Vincent says he sold most of his Google holdings in January. In recent days, he was among those inching back into Google shares.

Mr. Vincent says the market overreacted to the financial chief's comments on Tuesday and that his firm is looking to buy even more shares. All the same, "it's clearly a different environment for the stock," he says. "Ever since the negative reaction to their earnings, anything that comes out of the company will be scrutinized more than ever."

07 July 2006

Some humor for the weekend

Several centuries ago, the Pope decreed that all the Jews had to convert to Catholicism or leave Italy . There was a huge outcry from the Jewish community, so the Pope offered a deal. He would have a religious debate with the leader of the Jewish community.

If the Jews won, they could stay in Italy. If the Pope won, they would have to leave or convert. The Jewish people met and picked an aged, but wise, Rabbi Moshe to represent them in the debate.

However, as Rabbi Moshe spoke no Italian and the Pope spoke no Hebrew, they all agreed that it would be a "silent" debate. On the chosen day, the Pope and Rabbi Moshe sat opposite each other.
• The Pope raised his hand and showed three fingers. Rabbi Moshe looked back and raised one finger.
• The Pope waved his finger around his head. Rabbi Moshe pointed to the ground where he sat.
The Pope then brought out a communion wafer and a chalice of wine.Rabbi Moshe pulled out an apple.

With that, the Pope stood up and declared that he was beaten; that Rabbi Moshe was too clever and that the Jews could stay in Italy.

Later, the Cardinals met with the Pope, asking what had happened. The Pope said,"First, I held up three fingers to represent the Trinity. He responded by holding up one finger to remind me that there is still only one God common to both our beliefs.
Then, I waved my finger around my head to show him that God was all around us. He responded by pointing to the ground to show that God was also right here with us. I pulled out the wine and wafer to show that God absolves us of all our sins. He pulled out an apple to remind me of the original sin. He had me beaten at my every move and I could not continue."

Meanwhile, the Jewish community was gathered around Rabbi Moshe. "How did you win the debate?" they asked.

"I haven't a clue," said Rabbi Moshe. "First he said to me that we had three days to get out of Italy, so I gave him the finger! Then he tells me that the whole country would be cleared of Jews and I told him we're staying right here."

"And then what?" asked a woman.

"Who knows?" said Moshe, "He took out his lunch, so I took out mine.

What?! Again with Google...?

Well, yes and no.

Yes, this Washington Post article, "Shake-Up, Competition Raise Doubts About EBay" is about how Google/GOOG assumedly will eat eBay's lunch via the just released Google Checkout. But no, not really, because my goal is to show you that Wall Street -- i.e., investors -- are a forward-thinking gaggle of characters.

"A management shake-up at eBay Inc. and a new threat posed by an online payment system from Google Inc. have caused analysts to question the outlook for the world's largest online auction site. The San Jose-based company announced yesterday that Jeff Jordan, a longtime eBay executive and the dynamic heir apparent to current chief executive Meg Whitman, would leave the company to spend more time with his family. Jordan was president of PayPal Inc., the popular payment processing system owned by eBay. At the same time, eBay said it would not accept Google Checkout -- the rival online payment system unveiled last week by Google Inc. -- on its site, angering many buyers and sellers who want alternatives to PayPal and who claim eBay is using its market share to squeeze out competitors..."
The thing of it is is that PayPal owns this market. Google Checkout is merely and only the newest entrant in the field. And for all that, about the size of a gnat on an elephant's butt.
"... the emergence of Checkout signaled turmoil for eBay, which in the first quarter this year got nearly a fourth of its $1.39 billion in revenue from fees collected through PayPal... Google Checkout is limited to holding credit card information so that users can buy items on any participating Web site with a single click, but the company will probably expand its scope, which would encroach more on PayPal's business of serving individual merchants and buyers. Google is also offering the service at a lower rate, which means merchants would flock to it..."
So, really, where is the feared competition? PayPal has the brand name, PayPal invests a lot of money, time, and effort into establishing trust... and yet, investors believe Google Checkout will emerge triumphant in a battle of the two. So eBay/EBAY shares are sold and Google/GOOG shares instead are purchased.

And precisely as I told you, lo these many months ago.
-- David M Gordon / The Deipnosophist

05 July 2006

"Great book!"

One reader, Scott Browning, shares a book recommendation with this blog's community of readers...
-- David M Gordon / The Deipnosophist

David, All,

Over the years I've felt the frustration in many of you when trying to understand the writings of David (particularly on how he finds his stocks).

Well believe it or not I've found a little gem of a book that's easy,humorous, and fast to read, written by Joel Greenblatt, a hedge fund manager who supposedly has had 40%+ returns FOR OVER TWENTY YEARS. The book is called, appropriately, "The Little Book That Beats The Market". He believes that if you find stocks that have a high return on capital (like GOOG) and buy them AT THE LOWS FOR THE YEAR (sound familiar?) you will do as well as he has. He even has a website that list stocks that meet these criteria.

Check it out.
Scott Browning

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