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A New Year

Elliott Gue
Elliott Gue
Who are the surprise winners and losers in today's market reality? Click here to find out!

With the New Year fast approaching, it's time to take stock of your holdings, making any changes that might be necessary. But, for now, we're happy with our positioning in the Advantage Portfolio.

By holding a mix of long and short positions, we're well placed to take advantage of any volatility the New Year may bring. Here's a review.

The Short Story

We currently hold two short positions, Sepracor and Regal Cinemas. Specialty pharmaceutical Sepracor has been in a tailspin lately, dropping from its fall highs near $60 to the low $50s by mid December.

This weak action is particularly remarkable given what's been a fairly positive news backdrop for the stock and a benign market environment. Since October, the Nasdaq has seen an impressive run; Sepracor, however, hasn't participated.

And the company reported decent earnings in late October, getting an initial pop on the news. But despite these positives, the stock has been unable to make any headway. Whenever stocks sell off on what's perceived to be good news, it's time to sit up and take notice.

Sepracor's hottest drug is Lunesta, a sleep aid. The insomnia market is one of the largest and most profitable markets a drug company can target, and Lunesta is perhaps the most promising drug in this space right now.

The problem for Sepracor is competition. The market is already pricing in some impressive growth trends for Lunesta despite several looming competitive threats. Specifically, Sanofi-Aventis recently gained Food and Drug Administration approval for and started selling Ambien CR, a controlled-release sleep aid with a similar profile to Lunesta.

Two other drugs loom on the horizon for 2006—first up is Takeda's Rozerem sleep aid; and by the middle of 2006, an even more promising drug, Indiplon, is scheduled for launch.

Typically, when a drugmaker is faced with competition, the response is to step up marketing and sales initiatives. Sepracor has a well-regarded marketing and sales team, but so do its competitors—big-name pharmaceuticals like Sanofi.

Even if Lunesta does become the treatment of choice, it's likely that Sepracor will have to spend big to fend off the competitive threat. That would clearly cut into Lunesta margins.

With the stock trading at nearly 9 times sales, there's little room for error or any, even comparatively minor, Lunesta shortfall. Sepracor remains a short with a stop at 62.

Our other short recommendation is Regal Cinemas. The story here really hasn't changed during the past few months.

While there have been a few cinema hits recently, such as the Johnny Cash biography film Walk The Line, Hollywood has had a terrible 2005. Theatre attendance is also way down this year, a trend we don't see reversing anytime soon. Regal rates a short.

Going Long

The consensus opinion on retail sales a few months ago was that higher gas prices would result in a terrible holiday shopping season. But the worst of those fears simply aren't panning out.

Discount retailer Target remains our top play on the trend. Target is a buy with a stop at 48.95.

We're also continuing to profit from the bull market in Japanese stocks this year—the Nikkei 225 in now up more than 30 percent for 2005. Automaker Toyota Motor is capitalizing on most other US manufacturers' weak sales trends.

It's rapidly gaining market share. Toyota remains a buy with a stop at 85.

And while we recommend avoiding General Motors' common stock like the plague, value remains in its bonds. Our recommended GM bonds are trading at a marked discount to their par value of $100 yet have only roughly 2 years until maturity.

The chances of GM going bankrupt before these bonds mature is small; the bonds are likely to be paid off in full, meaning that investors would receive the full par value on maturity.

A measure known as yield to maturity indicates the annual returns on the bonds if they're paid off in full and all interest payments are made on time. Currently the yield stands at far more than 12 percent. Buy the GM bonds.

Elliott Gue will be available to take your questions until Monday, December 27. Please use the form below to submit your questions.

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