Looking Ahead

By Ian Wyatt, Big Idea Investor | END | Jan 03, 2006 | comment

Looking Ahead 

By Ian Wyatt, Editor-in-Chief, Rising Star Stocks

2005 proved to be anything but a spectacular year for the markets.  While the large caps posted small gains or slight losses (S&P 500 +3.0%, DJIA down 0.6%), small and micro caps didn't fare any better with the small cap Russell 2000 index shedding 0.7%. 

While I won't spend the time rehashing 2005 in this column, there are certainly some emerging trends from the past year that are likely to continue into 2006.  To that end, I think it is worthwhile to touch upon some of the big issues and opportunities that will likely affect individual stocks in the coming year and create opportunities for individual investors. 
 

Housing on the Ropes

The housing slowdown is currently underway, as we reported in the December 7th issue of Big Idea Investor (click here to view the article, no registration required).  Real estate appreciation has been a big driver of growth over the course of the last five years.  Unfortunately, all good things come to an end at some time, and it looks like now may be the day of reckoning for real estate.   

Real estate appreciations have meant not only paper profits for homeowners, but many have actually pulled money out of their homes by refinancing.  Goldman Sachs' chief U.S. economist Jan Hatzius estimates that consumers withdrew $887 billion from residential real estate in 2005.  While he expects the trend to continue in 2006, he anticipates this number to decline to $552 billlion.  Some economists argue that the economic growth of the last few years has been driven largely as a result of real estate gains. 

According to a Wall Street Journal survey of 56 economists, GDP should grow at an annual rate of 3.5% in the first half of 2006 and 3.1% in the second half of 2006, below the 4.1% average of the last 2.5 years.  A slowing real estate market is partially to blame for the expected slowdown in the coming year.  As we noted in our December 7th article, real estate price growth is slowing or in some cases even turning negative, inventories are increasing, and houses are spending more time on the market once they are listed.  
 

Commodities Remain Important: Oil & Gold 

After years of being considered non-growth opportunities, commodities returned to the forefront of investors concerns in 2005 with Hurricanes in the U.S. showing consumers nationwide just what an oil shock really is, sending the cost of a barrel of oil as high as $70.85 in August, and the price of a gallon of unleaded gasoline to a record $3.057 nationally in September.   

While oil has settled in at roughly $62 per barrel at the start of 2006, a significant decline from these levels is largely unlikely.  The prospects for $20 - $30 per barrel oil is something we are unlikely to see anytime soon, if ever again.   

High oil prices are likely to further squeeze the already leveraged American consumer, and contribute to slower GDP growth in 2006 as businesses begin passing the additional cost of transport on to the end consumer.   

With oil prices unlikely to decline in a big way anytime soon, I believe gold is an outstanding opportunity for investors.  As I wrote in the December 14th  issue of Big Idea Investor (click here to view the article, no registration required), there is a historic correlation between the prices of oil and gold.  The discrepancy today indicates that gold needs to rise to $760 per ounce, oil needs to fall by roughly 50%, or the two will converge.   

I'm betting on gold, which is now easier than ever to buy as an ETF through StreetTracks Gold Trust (NYSE: GLD). 
 

Micro Caps Hot Again 

Interest in micro cap stocks heated up in 2005, evidenced by the launch of the Russell Microcap Index in June.  Russell produces equity indices designed to track the performance of the markets and act as a benchmark for money managers, with the company's Russell 2000 Index being the benchmark for small cap equity performance.   

Russell launched its new Microcap Index in order to track the smallest class of U.S. equities, with the index comprising the smallest 1,000 members of the Russell 2000 index and the next smallest 1,000 companies in terms of market cap.  According to the firm, between July 1, 2000 and March 31, 2005 the Microcap Index would have posted a cumulative return of 50.8% versus 26.5% for the Russell 2000 Index.  The firm also commented, "It is also interesting that on a monthly basis, the Microcap and the Russell 2000 Index have each led essentially an equal number of time periods.  The large level of overall out performance by the Microcap Index is indicative of the return potential this space may be able to provide over a very short period of time."   

We have long been bulls on micro cap stocks, and in June 2004 launched Rising Star Stocks as a newsletter focused on emerging micro cap stocks.  This newsletter was designed to compliment our small cap growth newsletter, Growth Report.  Our micro cap investment strategies have performed well, delivering returns of 62.1% in 2004, followed by returns of 20.6% in 2005.  

We are bullish on micro caps for 2006, and see many continued individual investment opportunities created due to a lack of coverage and available information on companies with very bright prospects.  We expect this trend to continue in the coming years.  For more on micro cap stocks, including our favorite stocks, visit RisingStarStocks.com today for a 30 day free trial subscription.
 

IPO Market Ends Year Strong

2005 was not the year of the IPO, despite much hope from venture capitalists and investment bankers following Google's (Nasdaq: GOOG) August 2004 IPO success (click here to read Growth Report columnist Peter Henig's article on the 2006 IPO market in this issue of Big Idea Investor).

Deals coming public through IPO's are being better scrutinized by bankers, institutions, and retail investors alike.  And with performance of IPO's anything but certain, there has been a slowdown in the number of companies seeking this type of exit strategy. 

However, two late 2005 IPO's perhaps give some investors hope.   

First, iRobot (Nasdaq: IRBT), a robotics company with military contracts and its consumer line of Roomba home cleaning robots.  The company's IPO was priced at $24 in November, and shares soared to $37 for gains of 54%.  While the stock has pulled back to $33, investors are still sitting on gains of 38% in two months.  

Second, Under Armour (Nasdaq: UARM), a maker of performance and sports apparel for men and women.  The company came public at an IPO price of $13, and closed its first day of trading at $25, a 95% gain which amounted to the best IPO performance for an American company since 2000.  Shares have since jumped to $35, providing early investors big gains and leaving the company with a market cap of $1.6 billion.   

So will 2006 be the year that IPO's return to popularity?  It's probably unlikely, in spite of the fact the venture capitalists continue to pump big investments into private companies and will seek some sort of exit sooner rather than later.  Valuations of investment in private companies by VC funds is increasing, likely a result of too much money chasing too few deals.    

M&A is likely to remain the preferred exit strategy for VCs.  Why no return to the IPO craze?  Equity markets have been largely unexciting and unexcitable to date, meaning the opportunities for huge premiums in the open market is unlikely.  Plus, for smaller companies that might have previously sought a Wall Street IPO, the costs and obligations of being a public company are quite burdensome as a result of Sarbanes-Oxley legislation.
 

Share your thoughts with us on these and any other issues you see on the horizon for 2006.  We love to hear from our readers!  Email us by clicking here now.



A Better Richer IPO

By Peter D. Henig, Market Columnist, Growth Report

IPOs in 2006 should be more solid than ever before.

The IPO market has come full circle. In 2005, the percentage of profitable companies going public held at a steadfast and important 70 percent; a very high number, and a data nugget representing a true solidification of the IPO market for profitable companies over the last three years. There's now a no-nonsense approach as to what is good enough to pass muster as a public company, and it's a far cry from 1999 and 2000, when the percentage of profitable companies going public stood at less than 30 percent.

The results are almost counterintuitive, however, given that in 1999 and 2000, the number of IPOs stood at a record 486 and 406, respectively - among the highest in decades despite their lack of profits. Far higher, in fact, than the 194 deals that went public in 2005 of which roughly 140 were profitable.

The selectivity is showing, and in some ways perhaps Darwinian. December was a trim month for Wall Street public offerings, with just 22 deals getting priced, raising $3.47 billion - roughly 60 percent of the capital raised versus last December when 33 deals went public. The fourth quarter overall was even a bit worse, with 59 deals going public in Q4 2005 raising $8.95 billion - or just 50 percent of the capital raised versus the 86 public offerings in Q4 last year. Still, it's profitability and sustainability that are now the watchwords among IPO watchers - even if that means fewer or smaller deals.


Building strength

We were reminded of the solidification of the IPO market recently when it was revealed that Google (Nasdaq: GOOG) now has the right (as part of its $1 billion equity investment in AOL) to request an AOL public offering by July 2008. If Time Warner (NYSE: TWX) chooses not to pursue such an IPO, it will then have to buy back Google's shares for cash or stock at fair market value. Does Google know something the rest of us don't? Probably. Or at least it's making a fair bet that not only will AOL be strong and profitable enough to execute its own IPO in two and a half years, but that the IPO market itself will be equally accommodating.

In fact, if anyone has credibility in the IPO market it's Google. Since its IPO in August 2004, Google's stock has increased five-fold, from a market cap of roughly $23 billion to $125 billion today. And though the trend appears to be one of slipping IPO returns -averaging 17 percent returns in 2005, versus 34 percent in 2004 and 28 percent in 2003 -- returns still remain solidly positive and clearly ahead of the S&P 500 and other major indices (on a first day of trading, rather than an aftermarket, basis.)

According to many IPO analysts, the trends for 2006 will remain much the same, with continued underlying strength across the board as a result of profitable track record requirements among companies filing to go public. Healthcare, financial services, and technology will likely make up the bulk of future deals as they, combined, made up 50 percent of all 2005 IPOs. Tech will continue to produce the strongest returns - following the 33 percent returns among all tech IPOs this year; and energy (particularly alternative energy) should be equally fruitful. (Energy IPOs averaged 20 percent returns in 2005.)

Though there are few, if any, Google-sized blockbuster deals on the horizon for 2006 (MasterCard is being cited as the one possible exception), investors should look to the IPO market with a certain baseline level of confidence that even small to medium sized deals are now far more solid than many deals in the past; and that such deals have been far more scrubbed for sustainability and profitability than ever before. This might not mean huge returns right out of the gate, but it should give those investors with an inclination towards betting on new issues a renewed sense of optimism that companies going public in 2006 will arguably have far better legs to stand on long term.

Peter D. Henig is the market columnist for the Growth Report, an independent investment newsletter dedicated to uncovering undervalued small cap growth stocks. 

Get Peter's weekly columns by email when you sign up for a 30 day free trial to the Growth Report today.  Plus, get our recently released 41-page Special Report "Oil Rush of 2006: Top 6 Oil & Gas Stocks" as a special bonus just for signing up! Click here now - it's free.



Investment Idea: Endeavor International 

By Ian Wyatt, Editor-in-Chief, Rising Star Stocks 

For our first investment idea of the New Year we look to a sector that, due to rising commodity prices, rightfully garnered a lot of investor attention in 2005.  We expect that this trend will continue into 2006 and that there are several intriguing opportunities within the oil and gas sector. 

Endeavor International (AMEX: END) is an oil and gas exploration and production company with extensive drilling rights in the North Sea and production in Norway.  Why the North Sea you ask?

Major oil companies are in the process of shifting their portfolios out of the North Sea, which they believe to be a mature area where production will begin to level off or decline slightly before eventually going dry.  This is very similar to what occurred in the Gulf of Mexico in the 1980's.  As larger energy companies begin to vacate the North Sea, as with the Gulf of Mexico, development opportunities for smaller oil and gas players open up.   

Major oil companies need big targets to influence overall revenues so they are always looking for areas with massive amounts of proven and probable reserves.  As soon as an area starts to mature or decline in production, they need to look for other areas to deploy their massive resources.  Smaller companies like Endeavor, however, can experience rapid revenue growth with a relatively small find that a major wouldn't consider worthwhile.  The mature fields that have been left for dead by the majors are often a good opportunity for the smaller players such as Endeavor.  Endeavor believes that it can, through the application of seismic technology take advantage of the opportunity in the North Sea area.   

The Endeavor portfolio currently includes 1.1 million acres of licenses in the North Sea.  The plan for 2005 was to drill four exploration test wells in the UK sector of the North Sea.  The first was unsuccessful, but management is confident that the 2 year campaign to drill 10 wells will be largely successful.   

The executive management team brings years of experience to the table.  One co-CEO recently was an Executive Vice President and CFO of Ocean Energy, prior to its merger with Devon Energy (NYSE: DVN).  The other was CEO, COO, and President of Anadarko (NYSE: APC), a major player in the E&P realm.  Several Executive Vice Presidents also joined Endeavor after leaving senior positions at Anadarko.   

Insider ownership is high relative to other exploration and production companies.  The co-CEO's each own about 8 million shares of Endeavor, and total insider ownership stands at 23% of shares outstanding.  This high level of ownership indicates that management is willing to take on the risk of ownership, and that their financial interests are clearly aligned with those of shareholders.  

Well financed to the tune of nearly $100 million with an outstanding management team, we believe Endeavor is well positioned as an emerging leader in the oil and gas exploration.   

In our opinion, Endeavor has an attractive risk-reward profile.  With assets in the North Sea and a top-notch management team, the risk is at a controllable level.  The potential reward remains significant because of the area's proven reserves and management's commitment to the process.     

Why We Like Endeavor

• Attractive assets in the North Sea
• Seasoned management team with years of exploration experience
• Small size with large North Sea acreage provides tremendous possibility for gains in a "hit-or-miss" exploration play
• 2,000 Boe/day current production provides the company with constant revenues and cash flow

Risks

• North Sea prospects may not hold reserves that can offset cost of wells
• Re-structuring of majors' portfolios may mean the North Sea is not only mature, but drying up

Investment Catalysts

• North Sea acreage holds potential for sustainable exploration and production growth
• Successful drill program in the North Sea in 2006

Endeavor International was added to the Rising Star Stocks portfolio of micro cap stocks in December 2005.  The Rising Star Stocks portfolio closed 2005 with a gain of 18.8%, building on its stellar 64.1% return in 2004.  Is Endeavor the next Rising Star stock?

Take a free 30 day trial to Rising Star Stocks today and read the complete report on Endeavor today.  Click here now - it's free!

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