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Focusing On Revenue Is A Great Idea! But Do Not Forget About Stabilized Profit

I was feeling a bit sick this morning, so I stayed in bed and turned on CNBC. I NEVER watch CNBC, unless I am at home in bed sick. And it usually makes me feel worse. They were interviewing Reed Hastings, the CEO of Netflix (NASDAQ: NFLX ), who has clearly done a great job guiding that company. In 2005, Netflix did $682 million in revenue, and this past year, it did $5.5 billion in revenue. Quite an accomplishment. Yes, there are a lot of competitors out there, but he has clearly done a great job. So he was talking about how having negative free cash flow and very low profit is proof that the company is in this for the long run, and he is 100% correct. We are actually starting to operate our business the same way, as I said in a previous post about Dell’s new approach to growth. And this is exactly what you would want to see as an investor. HOWEVER, the problem with this is that most investors are not smart enough to do the trickle-down analysis of what this means. Amazon (NASDAQ: AMZN ) has the same issue, and it’s something I have lamented about over and over. What a good investor SHOULD do is analyze what the company would have made had it not reinvested. What would there profit be if the company stopped reinvesting and just operated normally for normal growth? That is exactly what you need to do to analyze the value of a business. Because at the end of the day, what is happening now is that with no profit and negative free cash flow, an investor’s eyes are growing wider and wider saying “The profit potential is infinite!” Clearly, it’s not infinite. Clearly, a company with $100 billion in revenue can’t make more than $100 billion in profit, which is also impossible. If Netflix, on a normalized basis, has 15% in profit, its $5.5 billion in revenue would lead to around $825 million in bottom line profit, and at 20 times earnings – which is high based on history, but we will give it that due to just me being overly optimistic – that’s a valuation of $16.5 billion. Now, I am not saying that its profit margin is 15%, because I know it to be. I am purely speculating. But Netflix is currently selling for a valuation of $47 billion. Hmmm. So, based on 20 times earnings, that’s a bottom line profit of $2.35 billion, which is over 42% margin. Not likely. The same goes with Amazon. In the company’s best year ever, it did 3.5% or so in bottom line profit margin. This last quarter, it made $75 million after making $500 million on its cloud-based AWS business, and that was on total revenue of over $25 billion. Not exactly something that I deem to be worth more than Wal-Mart (NYSE: WMT ), which has almost $500 billion revenue per year. Either way, the point is that valuing something today for future potential is fine, but you also have to be realistic about it and realize that you have to let things grow into what you hope them to be, without overpaying today for that. Make realistic assumptions about their profit margins based on other businesses in their markets and their gross margins. It’s too easy to get stuck in a market like this assuming the best will happen, since it has for the last 6 years. It is a game of musical chairs, and when the music stops – which it will – don’t be caught looking for a seat.

Aerospace And Defense ETFs Flying High On Strong Earnings

The U.S. bourses saw the majority of Q3 earnings releases getting over last week with headwinds from Q2 still at play. A combination of Energy sector weakness, dollar strength and global growth uncertainties weighed on the results. 341 S&P 500 members, accounting for 75.5% of the index’s total market capitalization, have so far reported results. Total earnings for these companies are down 1% on 4.9% lower revenues, with 71.3% beating earnings estimates and 42.7% coming in ahead of revenue estimates. Companies struggled to beat lowered top-line expectations, with the ratio of companies beating revenue estimates being the lowest in the recent past. However, instead of ‘extremely weak’, the Q3 earnings picture is shaping up to be about in line with the preceding quarter, which was by itself a weak reporting season. Despite the headwinds, aerospace & defense, a relatively smaller sector within the S&P 500, held up well this past quarter. They have not only reported better-than-expected results but also lifted their views in the past two weeks. The earnings beat ratio of the entire aerospace and defense companies unfolding their Q3 results is a stellar 77.8%. The U.S. defense sector performed well given the elevated geopolitical risk, a recovering U.S. economy and strong commercial sales. Escalating geo-political tensions in Eastern Europe, the Middle East, North Korea and Syria boosted demand for defense products. Further, nations such as India, Japan and South Korea are raising their budgets in order to make their defense platforms up to date. Below we have highlighted in greater detail the earnings of some of the major aerospace and defense companies which really drive this sector’s outlook. Quarterly Earnings in Focus The Pentagon’s prime contractor, Lockheed Martin Corp. (NYSE: LMT ), opened this earnings season with robust third-quarter profits. It reported better-than-expected earnings along with higher revenues, solid margins, and strong cash flows, buoyed by robust sales of its F-35 Joint Strike Fighter. The solid quarterly results have enabled it to lift its 2015 guidance for sales, operating profit, and EPS. Aerospace giant, The Boeing Company (NYSE: BA ), delivered third-quarter 2015 adjusted earnings of $2.52 per share, confidently beating the Zacks Consensus Estimate by 13.5%. Earnings also increased 18% year over year on the back of strong operational performance. Revenues came in at $25.85 billion for the quarter, exceeding the Zacks Consensus Estimate by 4.5% and improving 9% from the year-ago level on solid commercial aircraft deliveries. Boeing raised its full-year earnings outlook to the range of $7.95-8.15 per share from the prior guidance of $7.70-7.90 per share. The company also lifted its revenue guidance for the year to the range of $95-97 billion from $94.5-96.5 billion expected earlier driven by increased commercial delivery outlook. Just after winning a multibillion-dollar contract to build a new U.S. bomber, Northrop Grumman Corp. (NYSE: NOC ) reported solid third-quarter 2015 results with revenue and earnings beating the Zacks Consensus Estimate by 6% and 2.4%, respectively. The maker of the current B-2 bomber and Global Hawk unmanned planes has also increased its profit outlook for the full year. General Dynamics Corp.’s (NYSE: GD ) third-quarter earnings from continuing operations of $2.28 per share topped the Zacks Consensus Estimate by 8.6% and also increased 11.2% from the year-ago period on the back of higher defense orders and solid demand for its Gulfstream airplanes. Revenues of $7.99 billion surpassed the Zacks Consensus Estimate by 3.1%. The company raised its 2015 profit outlook based on Q3 results, higher deliveries of Gulfstream business jets and surging sales at the submarine-building unit. Earnings are expected to be between $8.90 and $9.00 per share for 2015, up from $8.70 to $8.80 projected earlier. United Technologies Corporation (NYSE: UTX ) reported third-quarter adjusted earnings of $1.67 per share, down 2% year over year. However, the figure surpassed the Zacks Consensus Estimate of $1.54. Total revenue decreased 6.0% year over year to $13,788 million owing to the impact of adverse foreign exchange and a decline in organic sales. Revenues also missed the Zacks Consensus Estimate of $14,593 million. The company reaffirmed its 2015 guidance. ETFs to Play All these major aerospace and defense companies and their ETFs have been experiencing a surge in share prices, since their solid third-quarter earnings results and improved outlook. For investors who want to play the sector in order to capture the impressive trend, there are a few aerospace and defense ETFs available. Below, we have highlighted some of the key points regarding them. iShares U.S. Aerospace & Defense ETF (NYSEARCA: ITA ) The fund, tracking the Dow Jones U.S. Select Aerospace & Defense Index, holds 39 securities in its basket with Boeing, United Technologies, Lockheed Martin, General Dynamics and Northrop Grumman being the top five stocks. All of them account for more than one-third of the fund assets. With an asset base of nearly $523 million, ITA is the largest player in this space. The fund trades in moderate volumes of roughly 42,000 shares a day and charges an annual fee of 43 bps per year. The fund was up 4.9% in the last two weeks and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook. PowerShares Aerospace & Defense Portfolio (NYSEARCA: PPA ) PPA follows the SPADE Defense Index, with 53 companies involved in the development, manufacturing, operations and support of U.S. defense, homeland security and aerospace operations. Lockheed Martin, Boeing, United Technologies, General Dynamic and Northrop Grumman are among the top 10 holdings and together occupy 30% of total fund assets. The product has managed to garner nearly $238 million in assets so far and trades in an average volume of 36,000 shares per day. It charges 66 bps in annual fees and returned 6.8% in the past two weeks. It currently carries a Zacks ETF Rank #3 with a Medium risk outlook. SPDR S&P Aerospace & Defense ETF (NYSEARCA: XAR ) XAR tracks the S&P Aerospace and Defense Select Industry index, holding a basket of 35 stocks. Boeing, United Technologies, Lockheed Martin, General Dynamics and Northrop Grumman score among the top 10 holdings, with a combined share of 18.6%. This product has attracted an AUM of nearly $147 million and exchanges nearly 35,000 shares in hand per day. It charges 35 bps in fees per year and gained 4.6% in the last two weeks. The fund has a Zacks ETF Rank #3 with a Medium risk outlook. Original Post

EZR: Is This A Useful ETF Or Symptom Of Wall Street Excess?

WisdomTree just introduced a new exchange traded fund. The Europe Local Recovery Fund sounds great, but is it? My gut tells me it’s another sign of an overextended ETF industry. Exchange traded funds, or ETFs, are amazing products in many ways. In fact, used properly, ETFs can be the basis for a solid portfolio. However, if you don’t pay close enough attention or make aggressive fund choices, ETFs can be very dangerous. WisdomTree’s (NASDAQ: WETF ) new Europe Local Recovery Fund (BATS: EZR ) falls into the riskier category in my book and is another sign that ETFs are, perhaps, too hot a product. The new fund EZR, WisdomTree’s new fund , is designed to, “…maximize exposure to European companies that may benefit from Europe’s economic recovery…” It goes about this by focusing on companies that generate 50% or more of their revenues from within Europe. According to the fund’s fact sheet, the portfolio gets about 70% of its revenues from this region. So an investment in EZR really does get you focused on Europe. There’s more to it than that, though. EZR’s portfolio excludes telecom, utilities, consumer staples, and health care, which aren’t as impacted by economic recoveries. Instead, it focuses on the industrial, materials, consumer discretionary, IT, finance, and energy sectors. All of which WisdomTree expects to benefit more from a regional upturn. But wait, there’s still more… EZR’s holdings: …are weighted by their correlation to the [European Commission’s Economic Sentiment Indicator]. Those whose returns show higher correlations to monthly changes in the indicator will be tilted toward higher weights-and vice versa. So the most economically sensitive stocks have the highest weight. Is EZR good, bad, or indifferent? Here’s the thing. EZR isn’t exactly a bad ETF. But it is a risky one. If Europe is doing well economically, the fund should perform well. If Europe isn’t doing well economically, EZR is likely to be a dog. Don’t overlook this simple fact. By its basic design, EZR is leveraged to Europe’s economic performance up and down. It’s not your typical European stock fund. You need to understand that very clearly when you buy it, otherwise you could be getting something you didn’t expect. If EZR is exactly what you’re looking for, great. But I consider this a pretty esoteric investment product. It’s highly focused around just one positive outcome. WisdomTree has other European funds, so I’m not sure why this one was needed. Except, perhaps, to bring out a new product so the fund sponsor could bring in more assets. Which is the first thing I thought about when I saw the news release on this ETF. Maybe there are a few highly sophisticated investors out there for which this product would make complete sense. But for most, it’s way too targeted. While WisdomTree suggests pairing it with its more broadly diversified Europe Hedged Equity Fund (NYSEARCA: HEDJ ), EZR is really meant for a trader. Someone who thinks the European economy is going to pick up. But that same investor needs to be savvy enough to sell EZR when he or she thinks the European economy is going to head south. If you aren’t that type of investor than owning EZR is far more likely to be dangerous to your financial health than helpful. Got to make a living This isn’t to suggest that WisdomTree is doing anything bad or wrong. If there’s a market for a niche product like EZR they have every right to fill it. In fact, if they want to keep growing, they pretty much have to find unique products to bring in more and more assets under management because the ETF market is pretty saturated with product at this point. And that’s what worries me. ETFs are a huge business and a relatively new one. We’ve quickly moved past the basics, like broad-based index funds, to increasingly focused and sometimes highly unique investment options. To give you a sense of where we’ve come from and where we are going, the Investment Company Institute’s data shows that there was about $45 billion of ETF issuance in 2002. That number was over $240 billion in 2014. So nearly six times as much money went into ETFs in 2014 as went in in 2002. If you are like me, you like to see new ideas for no other reason than they are interesting. They make you think about things in a different way. And to that extent, EZR is very interesting. But it’s also a product that isn’t appropriate for most investors. It’s also a product that’s taking such a specialized focus that it makes me question if ETFs have grown too far (I’ve long felt this, so it’s really just a symptom of an issue I’ve already been concerned about). It makes me think that ETFs are increasingly more about marketing than creating low-cost, freely traded, and broadly useful investment products. Which is what the goal was when ETFs were first created. The Global X Yieldco Index ETF (NASDAQ: YLCO ) is another fund I’d throw up as questionable so you don’t think I’m picking on WisdomTree. EZR is just a new fund that highlights my concern about increasingly esoteric ETFs. The sad truth is that it wouldn’t take me long to create a substantive list of ETFs that might be more dangerous than they are helpful. (Throw in most of the 2X and 3X ETFs on that score.) If you are an ETF investor you don’t have to run for the hills. But you do need to think carefully about what you own and why. Make sure you understand the ETFs in your portfolio and all of the implications you face from owning them-good and bad. My gut says that ETFs are a product where simple is better, particularly as ETFs get more and more complicated. As for EZR, most investors should avoid it.