The Value of Garbage

Wall Street fraught with fraud, criminals and miscreants? "So what!" says Extreme Values’ Dan Ferris. Sometimes there’s money to be made in the wreckage…

It certainly pays to invest in quality businesses.

The S&P 500 index includes some of the greatest business enterprises ever created: Microsoft, ExxonMobil, Wal-Mart. All the big names are there.

Those 500 big names earned investors an average of 28.7% in 2003, an excellent one-year return. Many 401(k) plans invest in the S&P 500 index. So a vast number of investors did well investing in those companies that most people agree are the safest places for your money…

The Feds Index: Invest in the Crooks

…but you could have made twice as much money last year simply by focusing on those companies that failed miserably. Some of them actually turned out to be staffed by criminals!

That’s not a typo error. I just said that the worst failures, the companies run by the most devious managers, made investors twice as much money in 2003 as the most successful businesses, run by the most capable managers. If you break out the top 10, 20, or 30 stocks in the S&P 500, the results are similar. The worst businesses made more money for investors than the most successful businesses.

The stocks I’m talking about are the components of an index called the Feds Index. The equity investment department at Guardian Life Insurance Company created the Feds Index. It’s a list of several companies that are under investigation by the federal government and/or the Securities Exchange Commission for possible wrongdoing.

The Feds Index contains stocks like Tyco, formerly headed by the now infamous Dennis Kozlowski. Also in the Fed Index are El Paso, HealthSouth, Qwest, Symbol Technologies and Computer Associates.

HealthSouth, for example, was down 98% while under investigation for accounting fraud. But it staged a miraculous 5,365% comeback. It’s still rising, even though the size of its fraud has been raised from $2.7 billion to as high as $4.6 billion.

The Feds Index doesn’t have a monopoly on these stocks. There were plenty of companies that did lousy last year and made plenty of money for investors. Williams Cos. fell as low as 78 cents a share in the post-Enron energy meltdown. It had to sell billions of dollars worth of valuable natural gas assets to survive. Within a year, it had climbed as high as $9.

AmeriCredit Corporation, the company that buys sub-prime car loans, fell as low as $1.55. Management got its act together and it’s now at around $19.

The Feds Index: Cheaper Shares

The reason why lousy companies bring you great returns is simple. Since nobody wants to own them, their share prices get far cheaper than those of the popular, successful companies most investors want to buy.

Right now is an especially good time to focus on the losers. A year-long rally has pushed many stocks up so that they’re either overvalued or simply no longer cheap. There isn’t much worth buying today, except the failures and criminals.

To find the next Gateway, HealthSouth or Williams Cos., set your favorite stock screener to find "meltdowns." Look for companies trading at huge discounts to book value. There are a several insurance companies out there that fit this bill. Insurance premiums have been up the past two years, after falling for two decades. I found one that has taken its share of licks in Hurricane Andrew and again on 9/11. It’s still below my maximum buy price today.

Besides big discounts to book value, you can usually set a stock screener to show you all the stocks that have fallen by a given amount during the last 52 weeks. Look for those that have fallen at least 50%. Remember, you want the worst, not the best.

One caveat: You’ll want to be careful once you start looking for companies that have failed in some way. You’ll find some real garbage, including companies that have declared bankruptcy. They have a letter ‘Q’ on the end of their trading symbol. Oglebay Norton, for example, now trades under the symbol OGLEQ. Gadzooks is now GADZQ. Ignore the bankruptcies and move on.

Focus your efforts on finding the beaten down companies that have enough money and/or net assets to survive. If you do that, I think you’ll do much better over the next year or so than the vast majority of investors.


Dan Ferris
for The Daily Reckoning
March 11, 2004

Editor’s Note: If you’re interested in safe, value-oriented investments, you’ll be interested in Dan Ferris’ research service, Extreme Value. Dan models his investing theories after some of the most successful investors of all time, Benjamin Graham and Warren Buffet. Following their example, Dan has filled his portfolio with profitable plays. To date, not one of Dan’s recommendations has lost money…and his winners have made gains as high as 124%.

It is still snowing…odd, this late in the year. A bad omen…winter hanging on when spring should be here.

When we left Bonn last night, it was snowing. As we make our way to London, the snow is still swirling about here and there. To the right of the tracks, somewhere in Pas de Calais, a small cemetery appears, looking ghostly in the early-morning light.

The tombstones are dusted white…and a row of trees along one side is pruned in the odd French manner. The trunks rises thick and solid, but only about as high as a farmer’s shears can reach…and then the limbs spread out all at once into a dozen wispy branches…all bent towards the graves like a row of spectral chorus girls waving to the dead.

In the train, the business travelers hunch over their work, making notes, reading the paper, or tapping away on their laptop computers. Not one bothers to look out the window. The train could pass a squadron of space ships from Jupiter sitting in a cow pasture…no one would be the wiser.

Not noticing things is one of the great talents of modern times. We have our TV and Internet connections…our endless talk radio and newspapers. From these sources we know that America is on track for a full ‘recovery.’ Europe, as usual, lags behind. Old Europe is said to have a slower growth rate…lower standards of living…lower earnings per capital.

Americans innovate, we are told, Europeans and Asians emulate. Europe…say the pundits…is on its way to becoming a vast museum. But if you merely look out the window from the Thalys going down the Rhine valley or from the Eurostar on its way to London, you realize that these notions are one part misinformation, one part misapprehension, and one part pure humbug.

You do not see consumer-led development in Europe the way you do in America. You do not see acres of new condos and strip malls. But you do see what appears to be solid construction…new office buildings, new apartment buildings, and even new industrial plants. Everywhere, people go about their work in nice clothes and nice cars. Restaurants are bright and expensive. The women are attractive, the food is good and the newspapers are unreadable. What else matters?

While GDP growth numbers are lower in Europe, the old world numbers seem to measure real growth…not the phony progress of debt-fed consumption. In terms of output per hour and output per capita, European nations are doing as well or better than America. And what the Europeans are putting out brings them a positive balance of trade with the rest of the world. Unlike America, they are producing more than they consume, in other words.

"U.S. deficit in trade hits a record," says today’s Associated Press report. "The trade imbalance widened to $43.1 billion in the first month of 2004," continues the article. "For all of 2003, the trade deficit posted an annual all-time high of $489.9 billion."

The U.S. deficit on the trade account has been growing at about 28% per year for more than 10 years. As a percentage of GDP, the deficit has recently been rising five times faster than the economy as a whole. This puts America in the category of "banana republics," writes Peter Bernstein.

No major currency has ever had current account deficits of 5% of GDP, he points out: "The hole Americans and our trading partners have dug for this country is now so deep that the road back to sustainable conditions appears to be not only long, but paved with risks."

Bernstein says the U.S. may be setting itself up for a full blown "currency crisis." We cannot know for sure, he points out, but investors should probably approach it as philosopher Blaise Pascal nudged into Christianity. Hell may not exist, said he, but the consequences of being wrong about it – roasting in the infernal fires for all eternity – are so bad, you’re better off being a believer, even if it turns out you’re wrong.

A dollar crisis would be Hell on earth for most Americans. The U.S. has reserves of only $137 billion, of which $90 billion is in gold. The Japanese spent more than that last year alone – trying to hold up the dollar. In a few weeks, U.S. reserves could be wiped out and the dollar could collapse like…well, the Argentine austral.

We have nothing against banana republics, but America doesn’t have the weather for it.

When the crisis hits, our guess is that Americans will both shiver and sweat. Barely able to afford oil from Araby…and sweating their mortgage payments…they’ll wish they’d taken Pascal’s wager, and set a few euros and gold aside…just in case. [Ed note: For seven ways to prepare your own portfolio for the crisis, see:

Bonfire of the Currencies ]

Here’s more news, from Eric…


Eric Fry on the scene in New York…

– Happy Birthday, Bubble! Four years ago yesterday, the Nasdaq Composite Index kissed its all-time high of 5,132.52 – a mere 158% above its current level…Four years ago yesterday, stocks were absurdly expensive, yet most folks could think of absolutely no reason NOT to buy them. "Haven’t stocks been rising for years?" they asked themselves. "Don’t stocks always go up over the long run?" they reasoned.

– Indeed, in March of 2000 the stock market had been rising – more or less – for the previous 18 years. And, yes, stocks do tend to go up over the long run. But over the short run, the stock market – like the wind – "blows where it pleases."

– "You hear [the wind’s] sound," Jesus observed 2000 years ago, "but you don’t know where it comes from or where it is going. So is everyone who is born of the spirit." Life in the domain of "filthy mammon" is not so different. We may observe the effects of the stock market’s movements, but still have no idea where it will blow next.

– For three years, Hurricane Nasdaq buffeted the complacent capital, destroying much of the capital that stood helplessly in its path. The Nasdaq’s gale force winds toppled many icons of the era, like Cisco Systems and Lucent Technologies, which both fell more than 90%. The Nasdaq itself dropped nearly 80%.

– Mercifully, the winds of destruction died down about one year ago. And the balmy breezes of capital appreciation have been blowing ever since. Investors have become relaxed and complacent once again, which is just about the time that gale force winds usually start kicking up on Wall Street…Did you feel a gust yesterday, dear reader?

– The Dow Jones Industrial Average opened Wednesday’s session with small gains, but quickly reversed direction and cascaded 160 points to 10,297. The Nasdaq Composite Index also forfeited its early gains. After bouncing back above the psychologically rewarding 2,000-level early on, the tech-heavy index tumbled to a 31-point loss at 1,964. The stock market’s steep losses dropped the Dow and the Nasdaq into the red for 2004. The S&P 500 still clings to a 1% gain for the year…

– Mother was right; you can’t judge a book – or a trade report – by its cover. America’s trade deficit ballooned to $43.1 billion in January. Judging from the report’s cover, a $43 billion trade deficit would seem to be a bad thing, especially since the Federal Reserve and Treasury have been destroying the dollar for the express purpose of NARROWING the trade deficit.

– Therefore, on the surface of things, the ballooning trade deficit would seem to be a scathing indictment of the Bush Administration’s de facto "weak dollar" policy. After all, didn’t President Bush, Alan Greenspan and Treasury Secretary Snow all assure us that the road to an improving trade deficit could be paved with devalued dollars? And have they not been trying to pave such a road by dumping so many newly minted dollars on the foreign exchange markets that the U.S. currency has lost a third of its value over the last two years?

– And still, the U.S. trade gap widened nearly 1% in January to $43.1 billion – a new all-time record. Taking a peak inside the report, we find that exports and imports both fell in January, but exports fell more. Specifically, January exports dropped 1.2% – the biggest decline since last August. Curiously, the August edition U.S. dollar was about 15% stronger than the January edition…and still the trade gap worsened. [Ed note: Strategic Investment’s Dan Denning sheds further light on the Commerce Dept. report on the Daily Reckoning website.

– Yesterday’s news of the embarrassingly large trade deficit would seem, on the surface of things, to have presented an ideal occasion for investors to unload dollars and to buy gold. (After all, if a weak dollar has not yet wrought its intended magic, won’t the Administration try to engineer even more weakness?) Instead, investors scurried to do the exact opposite.

– Presumably, the most motivated of yesterday’s dollar-buyers were those foreign central banks that have a multi-billion dollar axe to grind. The Japanese Central Bank, for example, in an effort to weaken the yen, has sold ¥10.5 trillion, or $95.3 billion, during the first two months of the year. That’s more than half of the annual record amount spent last year to weaken the yen. Perhaps the Japanese Central Bank was busily scooping up unwanted dollars again yesterday.

– On the surface of things, a 30% devaluation of the dollar over 24 months would seem sufficient to BEGIN correcting our nettlesome trade imbalances. But the evidence-to-date argues to the contrary. Nevertheless, up on Capitol Hill, overt policy failure is never reason enough to discontinue a failing policy. In fact, the dollar devaluation campaign is twice a failure.

– Isn’t the weak dollar supposed to boost job growth here at home, while narrowing our trade deficit overseas? But neither one is happening. In February, the average length of joblessness rose to 20.3 weeks, the longest since January 1984.

– As Sen. John Kerry quipped after last week’s dismal jobs report, "At this rate the Bush administration won’t create its first job for more than 10 years." We suspect a Kerry Administration would not have any better luck creating jobs, unless it encouraged the kinds of economic behavior that lead to long-term prosperity.

– Here’s a thought: Maybe devaluing the dollar isn’t such a great idea after all. And here’s a related thought: If we wish to boost exports and add jobs, maybe we should make more of the things that the rest of the world wants to buy…

– Just a thought.


Bill Bonner back, now, in London…

*** Oh là là…the top seems to be in. The great bear market rally of 2003-2004 seems have run its course. The Dow fell sharply yesterday and now is in losing territory for the year…along with the Nasdaq.

*** GDP numbers seem to mislead everyone. The numbers themselves are silent. They do not say whether they measure production or consumption…that is, the rate at which one gets rich or the pace at which he races to the poorhouse. But the world loves humbug…and no people love it more than Americans. They think they are getting rich…and rush to spend their new fortunes before they’ve even been created.

*** Here comes news of suspected coup attempt in Equatorial Guinea – a country so Godforsaken that that even God himself has probably forgotten where He put it. But we turn to our handy Atlas and find that it is in a particularly dark corner of the Dark Continent. Until recently, that is…when the country began pumping oil in large quantities.

Apparently, a group of mercenaries from South Africa were on their way to take over the country when their plane was delayed by the gendarmes of Zimbabwe. African dictators look out for each other, so the one now in charge of Zimbabwe put the cuffs on the South Africans and signaled his indignation that anyone would have the bad taste to try to knock off one of his buddies, who had staged his own coup back in 1979 and has been torturing people ever since.

There’s something so refreshing about seizing power by force. It is the old-fashioned politics – simple and pure, with neither the conceits of ideology nor the props of the ballot box, just honest, naked government with its corruptions out in the open for all to see.

*** Are you codependent, dear reader? Do you have repressed memories? Does the Rorschach inkblot test show you hate your mother? Are you the victim of sexual addiction…caused, perhaps, by some critical incident? Or maybe you are plagued by multiple personalities?

Well, get over it. You’re nothing but a cringing, weak-minded, self-absorbed psycho-hypochondriac, trying to explain away your slimy shortcomings in clinical terms. At least, that’s what we make of an article in the New York Times. Most of these syndromes are just faddish poppycock, say a group of academic psychologists.

The Daily Reckoning