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Profiting From The Mortgage Mess

Ideally, you want to invest in industries where the dominant factors are positive, where booming demand for products and services means revenue growth is rapid and profit margins are high. Trouble is, in the current market climate, the best growth stocks, which have enjoyed great advances earlier this year, are in retreat. Buying them is a high-risk proposition. But there is one exception, and it’s interesting enough to discuss here.

Last week a federal appeals court, siding with five environmental groups and eleven states, rejected the federal government’s proposed new fuel-economy standards. The court cited two major grounds.

First, the court said the government had failed to take pollution issues into account. And second, the court asked the government to explain why it set lower fuel-economy standards for light trucks, minivans and SUVs than it did for cars.

The first is a point that would not have been made five years ago, but the ascendancy of global warming to the foreground of our national consciousness makes it a natural today. And the failure of the administration to address it looks pretty stupid (a word, admittedly, that my kids were taught in elementary school to never use).

The second point is the one I want to address here. The fact that there are separate fuel economy standards for different types of vehicles is a relic of the original Corporate Average Fuel Economy (CAFE) legislation of 1975, which exempted light trucks on the grounds that higher standards would make those vehicles more expensive or less productive and thus pose a burden to the “working men” who drove them.

And what did we get as a result? We got the death of the traditional station wagon, and in its place we got a generation of minivans and sport utility vehicles (SUVs) that were designed to be classified as light trucks and thus duck under the CAFE requirements. Thanks to the law of unintended consequences, by 2002, nearly half of all vehicles sold in the U.S. were SUVs and light trucks!

So now, in an era of increasingly expensive gasoline and attention to automobile emissions, the administration goes back to the drawing board, trying to appease the court but also satisfy the demands of the auto industry lobbyists who have worked so hard to impress it with their own point of view.

Eventually, they’ll come out with new standards that will be accepted, and then the automakers will adapt once again, searching out the loopholes that will enable them to build vehicles that people want to buy.

It’s a messy business.

Personally, I think we’d have better results if we gave the market a chance to work by giving people a real incentive to shop for vehicles that burned less fuel and emitted fewer pollutants.

And what would those incentives be? The classic incentive to burn less gas is a higher fuel tax; it’s common practice in European countries. Trouble is, such a tax is regressive, hurting the poor more than the rich ... but that shortcoming could be overcome by the application of tax credits.

The second incentive, to choose a car with lower emissions, would require still more government involvement, perhaps in the form of a penalty/credit calculated at tax time based on the emissions rating of the vehicle. That’s not something I’m crazy about, but I do fear that the problems created by CAFE will only get worse.

In short, I fear that the whole concept of CAFE is now taking us farther away from the world where people get to choose the vehicles they want to drive. And I fear that our first halting steps toward alternative-fuel vehicles will be both directed and constrained by government-created standards whose unintended consequences - like the SUV - are unforeseen today.

For example, in many places, it’s now common to allow hybrid vehicles into express vehicle lanes that have typically been reserved for cars with two or more occupants. But today one of those hybrid vehicles includes the Chevy Silverado, a full-size truck that gets 19 or 20 miles per gallon on the highway ... not exactly Prius territory.

In the years ahead, as vehicles powered by hybrids, diesel fuel, ethanol, batteries, fuel cells and more are developed, I’d hate to see government policies unintentionally restrict development in any promising avenue. But I fear that’s what will happen.

As an investor, I embrace the fact that change brings opportunity. I’m truly excited that high gas prices and global warming are combining to accelerate development of more efficient vehicles. But I’d prefer this development without the government’s heavy hand on the scale ... and that’s just one reason why the auto industry today is not an attractive place to invest.



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Ideally, you want to invest in industries where the dominant factors are positive, where booming demand for products and services means revenue growth is rapid and profit margins are high. Trouble is, in the current market climate, the best growth stocks, which have enjoyed great advances earlier this year, are in retreat. Buying them is a high-risk proposition.

But there is one exception, and it’s interesting enough to discuss here.

It’s FTI Consulting (FCN), and it excels in helping businesses pick up the pieces after they’ve been hit by devastating events.

Originally, the company’s name was Forensic Technology Inc, which gave a clear indication of the company’s expertise, and to tell the truth, I liked that name better. But the company has grown its sphere of expertise over the years, and the old name was rather limiting. So the name has been reduced to initials, which, of course, don’t match its ticker symbol.

In any event, FTI today provides a wide variety of expert services to assist companies with litigation, corporate finance, restructuring, media relations, and mergers and acquisitions.

Historically, the company has been an important player in a number of high-profile corporate events.

For example, it was instrumental in the AT&T/BellSouth merger, presenting its findings to the DOJ, FCC and a variety of state regulatory commissions.

Its forensic accountants and forensic computer consultants analyzed Refco’s money trails to tell the board where the money went.

It used over 40 employees over an eight-month period to analyze and evaluate over 150 million Freddie Mac documents.

It assisted TYCO in responding to the SEC’s request for documents.

And it was instrumental in the restructuring of American Home Mortgage, Calpine, Dana, Delphi, Northwest Airlines, Tower Automotive and Winn Dixie.

Today, FTI has clients in a wide variety of industries, including automotive, chemical, communications, construction, energy, financial services, healthcare, insurance, pharmaceutical, real estate and retail.

And business is booming. In the third quarter, revenues grew 56% to $253 million, while earnings jumped 46% to $0.60 per share. The profit margin for the quarter was 10.8%. Following the report, analysts adjusted their estimates of future earnings upward.

And with good reason! All you’ve got to do is look at all the failures in the mortgage industry and the related credit-dependent industries ... and the housing industry ... to conclude there’s a lot of forensic work to be done and that FTI will be one of the major beneficiaries of this trend.

Since that report was issued, the stock has climbed from 53 to last week’s high of 60, totally ignoring the broad market’s weakness. Since then it’s pulled back just slightly toward its 25-day moving average at 56.

So should you buy?

An aggressive investor might jump on board here with a tight stop loss, and it might work out well. But more prudent investors might wait until the stock’s next major correction to step on board ... keeping in mind that the broad market is not supportive today.


Editor’s Note:

FTI Consulting was first recommended in Cabot Top Ten Report on August 20, when it was trading at 52, and if you’d followed the advice in that issue, you could have bought below 50 in the weeks that followed. Today it’s still followed in every issue of Cabot Top Ten, and it will be as long as it keeps performing well. If you’d like updates on this great stock, as well as on other market leaders, I highly recommend a no-risk trial subscription.

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Yours in pursuit of wisdom and wealth,

Timothy Lutts
Cabot Wealth Advisory

Timothy Lutts is Chairman Emeritus of Cabot Wealth Network, leading a dedicated team of professionals who serve individual investors with high-quality investment advice based on time-tested Cabot systems.