You may recall where we left off yesterday – with the realization that investors pay for the entertainment of owning fashionable stocks. The inverse proposition – that investors should be rewarded for owning unfashionable ones – is the point of departure for today’s letter.
If there is any justice in the market, investors who own the most hip, fashionable and cool stocks should pay the highest price. Quepaso.com is probably one such stock. So is Dreamlife. In both cases, investors who bought the stocks at their peaks of coolness will probably lose almost all their money.
I can sense you are getting ahead of me, dear reader… rushing me to pose the question: which are the stocks that are not at their nadirs of coolness…stocks so unappealing that you don’t want to have anything to do with them… stocks so un-fetching that you want your proxy statements sent in plain brown wrappers?
If you wanted to find such a company where would you look? Among the smokers…the polluters…the pornographers… the companies doing the least cool thing, at the least cool time, in the least cool way.
Barron’s mentions one candidate – a company whose chairman is such an out-of-the-box thinker he needs to invent his own verbs. “We continue to sell nonstrategic assets and to highgrade our reserve base.” The company is Cabot Oil and Gas.
Cabot, says Scott Black, Barron’s Roundtable panelist, “is ridiculously cheap.” Since ridiculous is what we’re looking for, we will look further: Cabot is in the ridiculously old fashioned business of drilling natural gas wells in such ridiculously unfashionable areas as the Green River Basin of Wyoming and the Cajun backwaters of Louisiana.
But Cabot was even more ridiculous before people began to notice oil and gas in 1999. Then, it traded as low as $12. Now, it’s $20. But Black thinks the breakup value of the company is $26 a share – conservatively valuing its oil and gas holdings. “In other words,” says Barron’s, “you can buy Cabot’s assets for 75 cents on the dollar.” Black thinks the stock will go up 50% in a year or so.
Another ugly mutt you might want to adopt is International Aluminum – mentioned in the same Barron’s article. The company earned $3.18 a share of profit in 1995. In fiscal 2000, it managed to cut its earnings down 29 cents a share. IAL is not a growth company, in other words, it is a shrink company. But the shares are selling for less than half of their price in 1998 – about $15. And has turned down an offer to sell all the shares for $18 a share.
IAL makes things such replacement windows, patio doors and tub enclosures. Not very cool. No bandwidth plenty…no cosmic dimension…no media stars among the shareholders. Indeed, the leading shareholder is the 85-year-old chairman, Cornelius Vanderstar, who still comes to work every day. An investor might be inclined to take more than a casual interest in Mr. Vanderstar’s health – since it is quite possible that the company could benefit from the Carnahan Effect, should something happen to him. That is, investors – like Missouri voters – might find Mr. Vanderstar’s stock more appealing once its owner is no longer at the controls of the enterprise.
The stock is not attractive. But, our hypothesis is that the market pays you to hold ugly stocks and charges you to hold pretty ones. IAL pays well – an annual dividend of $1.20 – about 8%. Getting 8% on your money – while waiting for the stock price to shape up – is not a bad deal.
But there are degrees of ugliness, just as there are degrees of pulchritude. We are familiar with beauty pageants – and the staple of the financial press: 10 Best Stocks for the New Millenium — but what about the 10 worst stocks? What about the real mirror-crackers?
As so often, the Grants team has done the screen tests – and discovered some stocks that are at least worthy of being County Fair Queens of unsightliness.
Armstrong Holdings, for example, has had its credit rating reduced (on October 25), and its line of credit at the bank was not renewed. Armstrong is one of a handful of companies that make up a kind of very dirty dozen in what might be properly termed the asbestos litigation defense business. WR Grace, Federal Mogul, and Kaiser Aluminum are also mentioned in the Grant’s article. WR Grace, for example, ended 1999 facing 105,670 asbestos cases, each one representing, potentially, millions of dollars of extra costs.
Similar businesses have already cracked under the strain – Owens Corning went bankrupt on October 5, Celotex went belly up in 1997; National Gypsum rolled over in 1990 and Johns Mansville began the trend back in 1982 when it sought the protection offered by the U.S. bankruptcy courts.
So, here we have bag-over-the-head scale hideousness – the crooked nose of pollution, the warts and open sores of lawyers… What could be better?
At Grace, says Grants, we have “a large, but probably not devastating, legal liability. The stock trades like an option – a very cheap option.”
How cheap? “At less than $4 a share,” Grant’s figures, “the specialty chemicals and materials company is valued at about two times net income.”
Kaiser Aluminum, meanwhile, is perhaps the Miss America of Ugliness. Not only does it face the lawyers, environmentalists, and bankers…it has also had to contend with a protracted labor strike and an explosion at one of its main plants in Gramercy, La.
Just as a man who courts an ugly woman must get a reward of some sort, Mr. Market cannot expect investors to line up for the hand of this particular daughter without a significant dowry. Thus, investors who act quickly have an opportunity to buy senior debentures from Kaiser priced to yield 24%.
The shares might also be a good deal – they are certainly not as attractive as Cisco.
Your correspondent, obeying the Law of Perverse Outcomes… and searching for the ugliest investments in the world…
Paris, France November 17, 2000
*** Earnings were back in the news yesterday. Applied Materials told investors that chip sales to mobile telephone makers are weakening. This, along with the Fed’s failure to move to a neutral stance, was all it took to put stocks into a funk.
*** Applied Materials fell 14%. Broadcom dropped $25. American Greetings was the biggest loser for the day – down 42%. Sun Microsystems lost 7%.
*** At the end of the day the Nasdaq was almost back down to the 3,000 level – it settled off 133 points at 3,031. The Nasdaq 100 lost almost 6%.
*** The Dow did better – it fell only 51 points.
*** 1218 stocks advanced; 1650 declined. 78 hit new highs; 103 dropped to new lows.
*** The BLS said U.S. consumer prices rose only 0.2% in the latest period. This low figure could be taken in one of three ways: 1) that it is another meaningless number from the Bureau of Labored Statistics; 2) that New Era technology really is lowering costs, thus offsetting inflation or 3) that prices are falling because we are entering a period of recession and deflation
*** The evidence is mixed, but #3 seems increasingly likely. Bonds rose yesterday. And “Credit trends are clearly deteriorating,” said a Merrill Lynch bank analyst, adding, “We think that is very deflationary.”
*** The FDIC warned earlier this week that U.S. banks face a rising risk of real estate loan defaults.
*** And just as investors rushed to buy shares in dot.coms, tech and telecom stocks – banks rushed to lend them money. The loans piled up like manure…and must age a little more before they really begin to stink.
*** In Canada, where lending to telecoms became very fashionable, loans to phone companies now equal 47% of bank equity. And Merrill Lynch says its bridge loans to struggling telecoms rose 300% in the 3rd quarter.
*** Tech and telecom bond funds have lost 14% of their value since January, reports Morningstar. And junk bond funds, generally, are being hit by defaults, averaging a 1.2% loss for each of the last 3 years. Paine Webber’s High Income fund is off 28% for the year.
*** Reaching for yield has turned out to be expensive. The worst 5 performing bond funds had more than 80% of their assets in bonds rated B or lower. In the top 5 funds, by contrast, only 58% of bonds were B-rated or lower.
*** Meanwhile, natural gas rose 4% on Wednesday to a new record. Supplies are about 10% below last year. Heating oil supplies are more than 30% below a year ago.
*** And people still seem to be building homes. Lynn Carpenter reports that she has done very well with her builder, Centex: “It was under-priced, going for a P/E of 5.6 last spring,” she writes. “But as the market has fallen this year, that boring old construction company began to look good by comparison; then people discovered it really was good and picked up the buying even more. The price rose accordingly. Centex is up 47% since we bought it in April. It hasn’t even reached full valuation yet; it’s only up to a P/E of 8 even with this big rise.”
*** That seems to be a trend in what she terms the market’s secret sweet spot: “When the floor fell out of the market in October,” says Lynn, “mid-caps still held on to a 9% gain – compared to a 10% loss for the S&P 500 and a 24% loss on Nasdaq. You could say that 2000 has been the year of the mid-caps.”
*** The euro fell to 85.17 yesterday. If ever there were a point of consensus in the investment world, it seems to be centered on the euro. “People may be bewildered by the politics,” said a currency analyst, “but they know exactly what they think about the euro. They hate it.”
*** The euro is so ugly to so many investors’ eyes… shouldn’t buyers be rewarded for owning it? We will see, dear reader, we will see.
*** Investors no longer care about dividends. But maybe they should. Steve Leuthold figured – reported by Richard Russell – that over the last 100 years dividends added more than $29 million to an investor’s return. If your great grandfather had put $1,000 into stocks in 1900, the total return without dividends would have been an average of 5.9% per year – or $319,694. With average dividends over the period, the total return rose to 10.8% each year, giving you, are you ready for this, $29,471,614.
*** Einstein called it the 8th wonder of the world; he was talking about compounding. Over a very long period, compounding an extra 4.9% annually makes a very big difference. But you can’t compound zero. In 1978, 66% of stocks paid dividends. Today, fewer than 20% do.
*** Leuthold also, this time via Barron’s, sees tech, “which still enjoys a 27% weighting, shrinking to as small as a 17% weighting” in the S&P 500 within the next 18 months. Why? Leuthold: “The big cap tech stocks, like Cisco, Sun and EMC are cruising for a bruising as fund holders try to salvage something from the year…”
*** “If this were Nigeria or Kosovo, there would almost certainly be accusations of impropriety,” writes Marshall Auerback about the US election, “investors would already be rushing for the exits… so the question legitimately arises as to whether, in such circumstances, a higher risk premium ought to be factored into US dollar based assets.”
*** Perhaps, the most honest and accurate picture of the American economy, in the year 2000, can be had by looking at the Port of Los Angeles. The month of October saw a new peak in the number of containers handled by the stevedores and forklift operators there. 251,000 containers came in – mostly from the Far East, full of consumer items. 230,000 went out. But 136,000 of those leaving L.A. were empty. Foreigners send us valuable goods. We return the containers empty…and send them dollars.
*** Que pasa? Another milestone in the collapse of dot.coms – the Hispanic site, quepasa.com, announced that it is laying off 2/3rds of its workforce. The company went public in June of ’99…the stock shot up to $16. The CEO says the company has “been achieving growth in its metrics” whatever that means, but what counts is that it lost $7.9 million on sales of less than half that much.
*** Elizabeth seems drawn to crusty, Old Money conservatism the way some women are drawn to hats or Tupperware. We dined last night with a group of right-wing politicians and their wives, one of whom rides horses with Elizabeth in the Bois de Boulogne.
*** But the right wing is at least as feathery in France as in America. There are the monarchists of various stripes (since there are rival claims to France’s throne, if it had one)…there are even a few of what they call “Liberals” – people who prefer the persuasion of the market to the force of politics. But the biggest group is probably the Buchanan-style nationalists led by Jean-Marie Le Pen. Le Pen’s finest moment came several years ago when, annoyed by reporters, he pulled down his pants on TV and told the assembled journalists that they could kiss his derriere.
*** The host of the dinner, Jean Charles, was an interesting man who had worked his way up from humble beginnings. He was not ‘old money’ at all – but shared many of the attitudes of the Catholic traditionalists. He had recently been asked by the government to figure out what it should do in response to the information revolution. France’s Minitel was the world leader in information technology two decades ago. Now, the Minitel is a quaint anachronism. Jean Charles’ panel studied the issue and gave its answer: nothing. “The government cannot do anything,” he told us. “The centralized administration set up by Colbert in the 17th century is just not suited to the new technology. Something is going to give…and no one knows what.”
*** “Anyone who has survived his childhood,” said Flannery O’Connor, “has enough information about life to last him the rest of his days.” Yesterday marked the anniversary of the debut of Marcel Proust’s “Remembrance of Things Past.” At the age of 35, Proust confined himself to his apartment in Paris and devoted himself to the 16 volumes of his oeuvre.