Desert Island Stocks
MicroStrategy, mentioned above, is priced as though something wonderful were about to happen. Somehow a small company with a mediocre business may hit upon a really nifty business. Its CEO may have a bright idea that will somehow rev up profits by 100 times — enough to justify the current stock price.
On the other hand, Tenneco, Fleetwood, Philip Morris and a growing host of other companies are priced as though something terrible has already happened.
And in many cases, it has. Bad things happen to good companies. Philip Morris, for example, has been the subject of litigation all over the world. Shareholders now believe that any profits the company may make will find their way into the pockets of tort lawyers rather than shareholders. In this, of course, they may be correct. Terrible can get worse.
But we cannot know the future. At best we can only know the present — and then, only feebly, partially and tentatively. Still, we have to do our best. And when good companies become cheap enough, the best thing to do is often to buy them — realizing that may become even cheaper as time goes by. But who knows, maybe something wonderful will happen.
The bad thing that has happened to Tenneco, as noted in Grant’s “Interest Rate Observer,” is that the automakers — to whom Tenneco is a major supplier — got together and set up an Internet system for ordering parts. This, it is presumed, will make it easier for other companies to move in on Tenneco’s territory.
The new technology could do to Tenneco what juries are doing to Philip Morris. All we know is that the price of Tenneco is low enough that a value investor cannot help but take an interest. The stock recently traded at only 2.8 times last year’s earnings and only 4.5 times forecast earnings. Unlike MicroStrategy, which trades at a multiple of sales that exceeds room temperature, Tenneco’s multiple of sales is almost a negative number — .075, to be exact.
I don’t know if Tenneco is a good company or not. But if you were going away to a desert island for a long time, Tenneco might be a good company to own.
Buy `em and forget `em. That was the motto of the “Nifty Fifty” investors back in the 1960s. It was believed that there were some companies that had such strong management and such important positions in the marketplace that they would be able to survive and prosper indefinitely.
Investors did not mind paying a premium for these stocks. Because they had already demonstrated that they would outperform the rest of the market. And because there was no reason to think that this spectacular performance wouldn’t continue.
America was on top of the world back then…and stocks were at their highest level, by almost any measure, since 1929.
It was at this point that Warren Buffett, the bumpkin from Omaha (not yet the Sage of Omaha), took a fateful decision. He decided to sell. In 1969, he dissolved his investment partnership, explaining that stock prices at that level just didn’t make sense to him.
In 1970, the Nifty Fifty started to fall — and continued falling for the next three years. “By the end,” writes Lynn Carpenter in our current “FSL” issue, “companies such as Avon and Xerox were worth only 10% of what investors had paid for them in 1969.”
Three decades later, Buffett seems to have passed through his “sage” phase. Now, according to “Barron’s,” he has run out of ideas. And his stock is selling for half of what it was a year ago.
But Buffett’s ideas are still the same. It is the market that has changed. And our task has been to try to figure out whether this change is cyclical…or permanent. As I have argued consistently, and perhaps tediously, I believe the change is cyclical, not permanent…that what goes up still comes down…and that Buffett’s approach is still correct.
Buffett believes you can find great companies at decent prices, hold them for a long time and make more money than the average investor. He believes in stocks you can buy…and then go off to a desert island for five years…and find yourself richer when you come back.
Those stocks are not the Nifty Fifty-type high-flyers at the top of the cycle. But the undiscovered, unnoticed or neglected stocks you find at the bottom of the cycle.
John Dorfman, writing in Bloomberg, recently selected a number of these stocks. He cites the work of two professors at Cornell who studied approximately 2,000 stocks back in 1986. They found that the stocks followed by fewer than 10 analysts did better than those followed by more than 10 analysts. The neglected stocks performed from 6.5% to 24.8% better.
Another study by Prudential Securities discovered that the effect did not apply to growth stocks. “Value stocks,” writes Dorfman, “with no analysts covering them rose an average of 20.1% per year. Those with more than 10 analysts produced only an 8.7% return. For growth stocks, however, [researchers] generally found that the more coverage, the better.”
Makes sense. Value stocks get to be values because no one is looking. Once they start moving…people notice. The more people notice, the more they move.
Dorfman goes on to list 10 stocks that meet his neglected value criteria:
American Woodmark: the company makes cabinets and other wood products — it sells for 7.7 times earnings, 1.5 times book value, or 40 cents for every dollar of sales.
Banco Latinoamericano is located in Panama City, Panama. I don’t know what it does, but you can buy it for 5 times earnings.
Another bank you can get at a P/E of 5 is in Santa Ana, CA — First American Financial. It’s the nation’s largest title insurance company. But, as Dorfman puts it, “you’d think it was America’s largest skunk.” Is the company threatened by the Internet? Maybe.
And here’s a company DR readers may remember — Fleetwood. It’s the maker of manufactured housing and motor homes that I mentioned several months ago. You could have picked up shares in 1998 for $47. Now you can get them at half that price. It sells for only six times earnings. Lynn Carpenter, however, has found another neglected company in the same industry. She thinks hers is better (http://www.fleetstreetletter.com).
Dorfmann’s other selections:
Hamphire Group makes sweaters in Anderson, SC, and trades at five times earnings. No analyst has written a report on the company in the last two years. The stock sold for $24 in April ’98. Now it’s at $9, when you can find a buyer — which isn’t always the case.
Kaman is a quirky company that makes helicopters and guitars. It sells for seven times earnings.
Lincoln Electric makes arc welding equipment. Everybody is paid on performance — which hasn’t been bad. It sells for 10 times earnings.
OEA,Inc. — Dorfman went to school with the CEO. It makes aircraft ejection seats and sells for five times earnings.
Powell Industries in Houston makes large-scale electrical equipment. It sells for 11 times earnings.
Scientific Games Holdings is in the business of servicing lotteries. Dorfman thinks the lottery business is in a long-term secular uptrend. You can buy the company at nine times earnings.
It seems to be getting easier to find these neglected, cheap companies. And as the bear market continues, they are likely to become even cheaper and more neglected.
But in a bear market, he who loses less wins. Thus these loser stocks may turn into winners anyway — because they have less left to lose. And coming back from a desert island five years from now, an investor might be pleased to discover that not only are these companies still in business, but something wonderful has happened — their prices have risen. Your contrary correspondent,
March 9, 2000 Paris, France
*** Again the Buy-the-Dips crowd showed up Wednesday morning with their mortgage and unpaid tax money. These people serve the same purpose to the bear as the “useful idiots” in the West did for Stalin. They keep the world from noticing the terrible things that are going on. They are optimistic. They are positive. They are sure that things will work out. Stocks always go up in the long run, don’t they?
*** Well, generally…yes. Along with corporate profits, GDP and inflation. But a downtrend can last a long time. Stocks in Japan, to recall a current example, are still about 50% cheaper than they were at the end of the `80s. Plus, any particular stock may disappear forever. And, guess what, in the long run — all of them will!
*** So the Dow rose 60 points yesterday. The S&P was up 11 points. And the Nasdaq slid in the morning but came back to close up 49 points for the day.
*** Don’t confuse yesterday’s action with a bull market…or even a rally. For the Dow, it was barely a bounce. The number of stocks advancing was 1,431. But 1,532 declined. There were 49 new highs on the NYSE against 263 new lows.
*** Have we seen the top in the Nasdaq? I don’t think so. I think the light-headed brigade will charge through the 5,000 mark before they are taken out by the bear.
*** But it’s impossible to tell. This is a “greater fool” market. And it will continue until the supply of fools — which has been bountiful — runs out. No one knows when that will be, but if you buy now, you run the risk of buying at the very tippy-top…that is, being the greatest fool of all.
*** But who am I do make fun of the Nasdaq speculators? They’ve gotten rich. That’s the goal, isn’t it? Nothing else really matters, does it?
*** If I had been smart, I would have holed up for a weekend or two developing a business plan for an Internet start-up. Entrepreneurship doesn’t involve the hardships it used to. It’s “not about taking a leap of faith anymore,” says a venture capital investor, quoted in “Vanity Fair,” “unless you consider a leap of faith to be some idea you work on for seven days before someone gives you $20 million to develop.”
*** Well, the whole spectacle is entertaining. It’s the greatest show on earth. I just enjoy watching. It’s a comedy with new punch lines every day, clowns on every corner and grotesque sideshows down every alley.
*** Lynn Carpenter parodies one of the grotesqueries in the current issue of FSL. MicroStrategy made a trifling $12 million profit last year “helping its customers make information a valuable source of strategic insight…[and providing} enterprise decision support.”
Lynn translates this babble as, “Honey, we’re out of corn flakes [a strategic insight]; pick up some while you’re out [an enterprise decision].” MicroStrategy is hardly a company with a defensible brand or a near- monopoly. Yet it is valued at 585 times earnings…125 times book value.
*** Semiconductors collapsed, as the price for DRAMs fell a buck.
*** Oil slipped back $2.87. Transportation stocks loved it — they rose 88 points. But Gordon Bethune, CEO of Continental, warned that the high oil price “could destroy weak airlines.”
*** Gold skid along with oil — down $3.30. I’m repeating myself — but I think gold could be reacting to the deflation in the capital markets…and anticipating both greater deflation and a recession.
*** “[T]here has been a moral rebirth,” says Jack Wheeler in the current issue of “Strategic Investment.” “The death of left-wing anti-capitalism is a moral triumph of enormous proportions.” Wheeler believes that this “moral dimension of Information Age Capitalism” is the key difference with previous new eras. This time, it really is different, he believes. Hmmm…
*** Maybe it is a new era. A Prozac era. That’s the hypothesis of Professor of Psychiatry Randolph M. Nesse of the University of Michigan. Professor Nesse notes that the U.S. stock market may now be driven by a “prozac effect,” in which drugs help people ignore risk. Prescriptions for psychoactive drugs have risen from 131 million in 1988 to 233 million in 1998. If this is true, says Professor Nesse, it could have “potentially catastrophic economic and political consequences.”
*** The situation in China is really worse than people realize. Willy Wo-lap Lam, writing in the “South China Morning Post,” refers to an internal communist party document that cites more than 2,000 violent demonstrations in the countryside last year and millions of peaceful protests. There are as many as 200 million people without jobs in rural areas, says Wo-lap, who describes the situation as “a time bomb.”
*** Springtime has come to Paris. People seem to be flinging off the winter garments of repentance. They’re sitting outside at sidewalk cafes again, for the first time since October. You can smell the grass growing in the parks. And lovers seem to be embracing on the streets just as they did in the classic photo by Robert Doisneau. Some things are not different — thank God.
*** One DR reader and WWII vet recently wrote to cancel his subscription. Even though DR is free, he said, he didn’t want it. He was wounded by my comments on Jorge Haider. In the event that he is still reading — I will take this opportunity to rub salt in the wound. Haider is no neo-Nazi. His politics are no different from those of, say, Pat Buchanan. Stupid? Yes. Nazi? No.
*** But the reason I keep bringing up the issue is to highlight the galactic hypocrisy of the European governments involved. They are indignant that voters in Austria elected Haider — who has never had any connection to the Nazis. Yet almost every one of these governments includes people who have had plenty of connections to the communists and socialists whose crimes surpassed even the Nazis.