This edition of HRVA finds us, once again, none too thrilled about living through a moment of historic import. We are not referring to what some are calling 11/4, when the “the seas stopped rising” and all that, although that does play into this morning’s funk in an indirect sort of way. No, this past week took the Market indices to depths that will rank this Bear Market somewhere between “73-74” and The Big One in the 1930s. (Apparently, there were at least three distinct Bear Markets in that era, a 48% drop in just over two months in the fall of 1929, a similar drop over a one year period starting in 1937, and the Granddaddy of them all, the 86% drop between April 1930 and July 1932.) As of the morning of November 21, no Bear Market except the 1930 debacle has been worse than what we have now gone through (Those who were long the Tech Bubble going into 2000 and didn’t get out might beg to differ.) The spirited rally that marked the last hour on Friday might have lifted our spirits a bit. It was the media explanation that this time-worn observer of human folly found exasperating.
There are two explanations for why the media informed us that the Market broke loose from a pattern of meandering uncertainty and ripped about 6% in an hour or so. The one I would prefer to believe is that, as always, certain peoples’ meal tickets are dependent on coming up with reasons why inscrutable activities happen. Apparently consumers of information and insight expect an explanation for whatever is happening in the moment, and if one wants to keep their snout in the trough from whence investment insight is generated, they sure better come up with an answer. So like when the sun comes up its because the geese just flew by (or in another time and place, that first born male child got passed through the fire), the fact that the name of the likely Treasury Secretary was leaked around the time the Market took off was a slam dunk in the great game of spurious cause & effect. Never mind that having been crumbling the way it had all week it was as oversold as it ever gets. The media and the Street do this all the time, as if there was a possibility that if just once they did not have a glib answer for the day’s fluctuation, we might tune them out and not come back.
A less palatable explanation might be that the news media is still smitten with our newly arrived Savior and eager to do their part in helping Him make history. The announcement of the name of a likely Cabinet member does clear up a bit of uncertainty, but only a small bit. How much might this glimmer of clarification account for, say, the 12% rise in the value of Microsoft that afternoon? As a conservative (one who is squeamish about the prospect of squandering what the Founders bequeathed to us) it has been disconcerting to watch the institutions that have are supposed to hold the political class accountable show such abject adoration for any public figure, let alone one who has shown strong sympathy toward the thoroughly discredited ideologies that brought so much human misery to the Twentieth Century. It will not be a good thing if even the financial media is in the tank for the Anointed One and his crew of nice folks from Chicago. One is left to hope and pray that the opposition can buy time, rebuild and rise again as voters recognize life starting to resemble the aftermath of the Great Society again. In the very near term, though, there could be a silver lining in this. To the extent that the Market is very over ripe for some kind of rally, and “needs an excuse to go up”, this sort of cheerleading could prove helpful in weeks and months just ahead.
Most likely, what transpired Friday was that the Market got a just good enough “excuse to go up”. Any excuse would have done. The Nasdaq had traded down nearly 55% from its year earlier peak as of Friday, the S&P 500 about 52%, the DJIA just shy of 50%. The whole week had been disheartening, the final hours of the two preceding days in particular. The economy, which has been slowing for quite some time (the global purchasing managers index peaked over two years ago), got pole-axed by the shock waves emanating from financial markets in September. It might not start to recover until well into next year, and when it does start to recover it could be a very tepid recovery for quite some time. That said, it is important to never lose sight of how short term pricing activity almost invariably exaggerates what is actually going on in the world of commerce. And we have got the illustration of a lifetime of this from the recent price of petroleum.
Recently, when called upon to try and be helpful to younger colleagues, I find myself encouraging them to think of investing as the reconciliation of two distinct realities. There is the reality of the enterprise that underlies the stock, which I call Commercial reality. We need to devote most of our time, effort and thought to understanding this reality; to being assured that the enterprise we are investing in has a strong commercial position and can hang on to it. It works itself out in intrinsic value, which can be quantified, but only approximately so. The other reality is what I call Price Reality. It is about fear and greed, momentum and sponsorship, and while it can be precisely measured in whatever the price is in a moment of time, it can only understood for what it is, a manifestation of the mood of an ill-informed and emotional crowd. I try to encourage colleagues to view what they do this way, as an alternative to succumbing to the Analysis Delusion. This is a tendency to build models and then treat those models as somehow real in a way that exists outside the mind of the person who made the model. Models are useful tools, but not much more, and in the hands of someone who disregards what really real, they become implements of destruction.
With this in mind, consider what has happened over the last year or so to the price of something that is much more a part of how nearly everyone on the planet goes about their daily business than those abstractions that, figuratively speaking, change hands every day on the NYSE. It is hard to remember just where a barrel of oil was priced a year ago, but $60 in 2007 would not be off the mark. Indeed, I have dim recollections of $60 seeming kind of “out there” no more than two years ago. Somehow, it found its way up to $147. Then, perhaps ninety days later, it’s breaking through $50. Somehow, the stuff that makes the trucks run and the planes fly and puts the ester in your polyester, among about a zillion other things we don’t want to think about living without, lost two-thirds of its value in about a dozen weeks. It is true that many of us have found ways to drive a bit less, and likely that economic activity will continue to slow to an extent that some price retrenchment might be in order. Any fool could tell you as much. Many of us “knew” there was something in the realm between fishy and ridiculous about it going to $147, that the “speculative interest” was acting in a way that was contrary to the interest of the rest of us. Studies were made and experts hauled before committees, but the outcome was the familiar “I didn’t do it, nobody saw me, you can’t prove anything!”
Thus it will always be. Markets are peculiar things. People want explanations, as if they were as forthcoming as what the research of the past 200 years has rendered in fields like chemistry or astronomy. Such answers about why stock prices do what they do are not forthcoming, and never will be. Part of the reason is that most people seem to so prefer answers that merely seem substantive and they reject answers that leave that matter in the realm of mystery. (Mystery in the sense of how so much else, like weather or the workings of the body remained mysterious, until science provided a bit of illumination. Despite being much more understood, these matters also retain a bit of mystery.) Markets act the way they do because humans are, to varying degrees, speculative creatures, endued with an impulse to better their lot in life by making guesses about an inscrutable future. Speculation is always with us (as long as there is freedom, and even in oppressive states there will be covert markets). Most of the time, it is benign, even useful activity. Occasionally it takes on a life of its own and becomes a raging beast. We have just lived through such a time. This will be remembered as one of those times when speculation became the “tail wagging the dog”. Actually, this is the time when the natural consequence of that abnormal state, a painful unwinding of excess, takes place. Hopefully, this unwinding has found impetus from the rapidly approaching New Year. If it is things like tax loss selling and client redemptions that have kept the selling interest so much greater than the buying interest, we are now only a couple dozen trading days away from when that is no longer the case. Let us hope so.
Saturday, November 22, 2008
Saturday, November 8, 2008
Fish In a Barrel Time
This first week in November finds us taking exception with one of our oldest journalistic rules. Since the beginning of “ruminations on things that matter for thinking investors”, I have assiduously avoided “naming names”, i.e., writing about the specific investment merits of a particular stock. One does not want to degenerate into a “tout sheet”, and on among the safeguards against degeneracy, as with many other of life’s hazards, is remember that there are not only lines one does not want to cross, there are lines one does well to not even go near. This exception is being made because it is the best way to illustrate something that has become almost too obvious too see: stocks are ridiculous, stinkin’ cheap right now, the kind of bet against the end of the world one only gets once or twice in a lifetime (if it happens twice in your life, you were probably too young and didn’t have the proverbial two-nickels- to-rub-together the first time, or too old and world weary the second time.) So I am going to include a few thoughts about some (but not all) of my favorite (most beat up?) stocks.
This past week shook my conviction, but just a bit. No one should have been surprised that the Market needed to pull back after ripping about 18% in just six or so days. The first -5% day (Wednesday) had the feel of a normal pullback, with a concentration on the stuff in the indices. It had a nice orderly feel to it. Thursday was another matter, likewise down about 5%, but had all the gentility of Hutus meeting Tutsis on a moonlit road. That day’s carnage brought the indices down to within about 6% of their 10/10 lows, and sent us home wondering if Friday might not end up being the day “the center did not hold”. Friday brought wretched news (GM running out of money, unemployment up more than expected, hedge funds still have lots to liquidate, President-elect Obama appointing some memorably loutish alumni of the Clinton Administration). The Market popped up like a prairie dog with a tail full of fire ants anyway. This is a healthy sign. The urge to purge is still there, but not nearly as urgent. The hedge funds are still there, but their ranks are thinning. The unwinding of the 2 and 20 business model has been painful even for those of us who got nowhere near it, but it is most decidedly a finite process. The bad news will keep coming, but Big Dump I wrote about on 10/19 is likely getting down to the late innings. It matters much less to investors that GM might go through a reorganization (unless of course they are owners of GM securities) than that of a class of investors, apparently bereft of the humility that was considered virtuous before the self-esteem movement ran amok in the education system, thought they were immune to the ill effects of leverage gone bad and now are reaping the consequences. This liquidation will probably keep the Market moving sideways for a few more weeks or even months, but it will run its course.
We are at a point much like late 1987 or 1990 or 2002, only more so. I can’t speak for 1974 or 1932, but you would think it was 1932 to listen to some people. Heck, if you are working in “the business” and living in a money center, where most the people you know are contemplating big time life style changes, it is 1932, in the same way it was in Seattle in 1972 when Boeing was said to be down for the count. The Street is a scary and depressed place right now. That does not mean that the challenges are not real. What it does mean is that the messengers are traumatized, a herd a scalded cats ready to bolt up a tree any time anyone reaches for anything resembling a pasta pot. The events of the past year have been unsettling to a degree that nothing we went through in 1987 or 1990 prepared us for them. However, I do believe we have reached the point where one has to make the same bet I did back then, the Bet Against the End of the World. Valuations are such that for a bet on the stocks of reasonably secure enterprises to not work out much better than money market rates, we would have to be at something akin to the end of the world. It would be an outcome so bad that however much money you have would be the least of your worries. I would not recommend that anyone put all their money into stocks. Some kind of rainy day (or year) cash reserve is still in order, but there will not likely be another opportunity like the one that is at hand for another couple of decades at least.
I would encourage readers to look at that dismal time that was the 1970s, the (as my Company Commander at the time put it) “peanut poppin’ redneck” in the White House, the Ayatollah, the gas lines, disco, Whitewater, double-knit pant suits and double digit inflation. The Market had a swoon of similar magnitude to what we just endured in 1973 and for most of 1974. It, too, was the worst downturn since the Depression. Then a funny thing happened. From its nadir in late 1974, the S&P rose 54% in a year. If you look at the records of value investors, as lousy as the second half of the 1970s were for the rest of us, well-situated investors had a splendid four years. You can look it up! But they had to be there, and not wait for a theme (like energy, which worked great until about 1980 and then gave it all back and then some) to appear to them on the pages of USA Today.
The bargains are everywhere, even among the some of the most stellar of “blue chips”, stocks that haven’t been cheap in decades, if ever. A good example would be Intel. (INTC - $14.63 ) At less than 12 times current year EPS, with a couple of dollars per share more cash than debt and a franchise (leadership in the advance of microprocessor power & functionality) that will never be matched, it has been the sort of a “no-brainer” that I don’t mind recommending to strangers I meet at parties who want to talk about the Market (another rule being bent for the first time). I have spent the last couple of years studying Intel and its place in the world and have concluded that “the end of the line” for Moore’s Law is well beyond the far edge of my three to five year investment horizon. I reckon the appreciation potential to be something on the order 20 times EPS of $2+, well within that timeframe. Earnings might flatten out or even decline a bit in the year ahead if the global economy slows enough, but it would little more than a speed bump considering all of the life changing innovation that Intel’s own innovation is still unleashing around the world.
That said, if you forced me to make a short list of “best ideas”, INTC would not be on it. As compelling as two points of downside and 20+ points of upside, with a decent dividend yield (Yes, INTC has a well covered 3.5% yield!) no less, there are plenty of situations offering significantly more appreciation potential without significantly more risk. While I presently own more INTC than I ever would have imagined owning even a few years ago, I would be more focused on other stocks with much more upside that are arguably riskier (based on comparison of attributes) but as practical matter the downside is not all that different (they’ve all been crushed to valuations that could not have been imagined a year ago). So without further ado, here are five stocks that I am particularly pleased to suggest and to go “on the record” with”:
Seagate Technology (STX: 485MM shares @$6.60) As the world’s leading and low-cost producer of hard disk drives (HDD), STX has both facilitated and benefited from the burgeoning (40%+) growth in demand for data storage. It has also played a hand in the consolidation of what for most of its three decade history had been a frightfully competitive market. Seagate will probably earn about $1 this (June) FY. In a more normal period, FY 04 to FY 08, grew EPS from $1.41 to $2.63). Based on $1 EPS, gross CF will be just under $3: Free Cash Flow will be $1.45. The company has net debt of a little under $1B, or less than two (trough) years of FCF. With $0.48/year in dividends, the stock has an attractive yield. Unless the “growth in data storage” thesis has run its course, STX has earnings power well above $3 per share. I still expect the Market to accord a low teen multiple once this downturn proves that the HDD business is less cyclical (doesn’t give it all back in the downturn) than in the past. $40 within three to five years would not surprise me.
USEC (USU:110MM @ $4.05) is one of four companies in the world that enrich uranium for electric power production and the only one that is US based. As a provider, under long term contracts, of the fuel that provides 20% of what keeps the lights on, it is in a stable and low risk business. They will likely earn something like 30c this year and 70c next year while spending close to $1 per share developing a next generation technology. The reason the stock trades at a huge discount to a $12 book value, which consists largely of very fungible inventory, is lingering uncertainties about the funding and construction of a new plant, the American Centrifuge Project. The funding issue was signed into law earlier this year in the form of a loan guarantee by the Department of Energy (which used to own USEC and has a royalty interest in the production of ACP). Once the DOE loan guarantee is finalized sometime before the present Administration departs, the only remaining “issue” will be their ability to construct the American Centrifuge Program on time and on budget. This is not without risk (it is similar to the risk in a new aircraft engine program, but my estimation more contained, as if the new engine had millions of hours on it already, which the ACP does), but it is out there in time, as in two or so years from now. Once the financing question that goes away (they will be borrowing on an as needed basis through the Federal Finance Bank) there will be no good reason for the stock to trade at a discount to book value. I believe the earnings power from the ACP is such that USU could be $30+ in the next five years.
Hutchinson Technology (HTCH: 22MM @ $5.08) the world’s leading (of three) producer of suspension assemblies for hard disk drives. The stock traded off the map because they have been losing money on a GAAP (but not cash) basis. Earnings will recover as volume builds in the “additive” plant they started up last summer (to support the next step-change in suspension design; having this plant makes HTCH the only fully integrated provider to a customer base that needs rapid design, prototype and delivery) and they rebuild their share in the biggest the Seagate desktop. This is by far the largest SKU in the industry, went to zero for HTCH last year and is programmed to grow over the next several quarters. They have also been generating an operating loss on their BioMeasurement startup, to the tune of $5MM+/Q, or nearly $1 per share pre tax. This start-up has developed InSpectra, a device that non-invasively measures tissue oxygenation (StO2), a drop in which is a precursor to “going into shock” (is there an ancillary market putting these in brokerage offices?). It was approved by the FDA last year and continues to progress well ahead of expectations in terms of getting into hospitals, protocols and additional indications. Given what they have going for them, worst case I see the stock narrowing the discount with tangible book value (about $19). Alternatively, with a moderately profitable BioMeasurement division and the suspension business reaping the benefits of that investment in “additive” technology, it is no stretch at all to get to $5/share and, considering the potential of the StO2, which is already being regarded in some quarters as a standard vital sign, a P/E of 20+.
Mohawk Industries (MHK 68MM @ $39) is a leading producer of floor coverings, including carpet, tile, wood and laminate. The company earned $6+ per share in both 2006 and 2007, a period of declining housing activity and rising energy and raw material costs. These pressures got even worse in 2008, especially in H2. MHK will only earn about $3.60 this year and will probably see weak demand in the few months of next year. However, raw material and energy costs will be lower, and the company has been working very hard to otherwise reduce cost and emerge from the downturn an even stronger company. They should be able to continue to generate free cash flow and reduce the borrowings that funded their acquisition of Unilin in late 2005. (They paid down $128MM in Q3, and $1.4B since the acquisition.) This has been a splendidly well run company, a low cost provider of a basic need (predominately replacement). It is presently selling for less than eight times trough free cash flow and five times a more normal year’s free cash flow. I anticipate EPS of $10+ within the next five years and decent, mid-teen multiple on that.
The Dixie Group (DXYN 12.2MM @ $4.15) is another, albeit much smaller producer of floor coverings. In 2003, DXYN transformed itself by selling its commodity operations and using the proceeds to pay down debt, focus of it high-end brands (Masland and Fabrica) and develop Dixie Home, a new better-priced brand. Reaping the fruits of this transformation has been postponed by the housing downturn, but the company has remained profitable and continues to develop new product. This recent extension of its lending agreement to May 2013 put to rest any concerns about financial flexibility. The stock is trading well below its tangible book value of roughly $12. I believe DXYN has earnings power a couple of years into a recovery of something closer to $2 than to $1 per share.
Obviously there are many other bargains to be had, some of which are no doubt even more compelling. Only time will tell. These are but a few of the stocks that I expect future investors to say “Dang! Did it really get that cheap?” when they pick up a Value Line. The important thing is not to pick “the best of the best of the best”, but to heed the maxim, attributed to Woody Allen, that 90% of success is just showing up. It’s been hard enough just to show up lately, especially if showing up means stepping up and buying. So show up, and try not to throw up. We’ve lived through worse.
This past week shook my conviction, but just a bit. No one should have been surprised that the Market needed to pull back after ripping about 18% in just six or so days. The first -5% day (Wednesday) had the feel of a normal pullback, with a concentration on the stuff in the indices. It had a nice orderly feel to it. Thursday was another matter, likewise down about 5%, but had all the gentility of Hutus meeting Tutsis on a moonlit road. That day’s carnage brought the indices down to within about 6% of their 10/10 lows, and sent us home wondering if Friday might not end up being the day “the center did not hold”. Friday brought wretched news (GM running out of money, unemployment up more than expected, hedge funds still have lots to liquidate, President-elect Obama appointing some memorably loutish alumni of the Clinton Administration). The Market popped up like a prairie dog with a tail full of fire ants anyway. This is a healthy sign. The urge to purge is still there, but not nearly as urgent. The hedge funds are still there, but their ranks are thinning. The unwinding of the 2 and 20 business model has been painful even for those of us who got nowhere near it, but it is most decidedly a finite process. The bad news will keep coming, but Big Dump I wrote about on 10/19 is likely getting down to the late innings. It matters much less to investors that GM might go through a reorganization (unless of course they are owners of GM securities) than that of a class of investors, apparently bereft of the humility that was considered virtuous before the self-esteem movement ran amok in the education system, thought they were immune to the ill effects of leverage gone bad and now are reaping the consequences. This liquidation will probably keep the Market moving sideways for a few more weeks or even months, but it will run its course.
We are at a point much like late 1987 or 1990 or 2002, only more so. I can’t speak for 1974 or 1932, but you would think it was 1932 to listen to some people. Heck, if you are working in “the business” and living in a money center, where most the people you know are contemplating big time life style changes, it is 1932, in the same way it was in Seattle in 1972 when Boeing was said to be down for the count. The Street is a scary and depressed place right now. That does not mean that the challenges are not real. What it does mean is that the messengers are traumatized, a herd a scalded cats ready to bolt up a tree any time anyone reaches for anything resembling a pasta pot. The events of the past year have been unsettling to a degree that nothing we went through in 1987 or 1990 prepared us for them. However, I do believe we have reached the point where one has to make the same bet I did back then, the Bet Against the End of the World. Valuations are such that for a bet on the stocks of reasonably secure enterprises to not work out much better than money market rates, we would have to be at something akin to the end of the world. It would be an outcome so bad that however much money you have would be the least of your worries. I would not recommend that anyone put all their money into stocks. Some kind of rainy day (or year) cash reserve is still in order, but there will not likely be another opportunity like the one that is at hand for another couple of decades at least.
I would encourage readers to look at that dismal time that was the 1970s, the (as my Company Commander at the time put it) “peanut poppin’ redneck” in the White House, the Ayatollah, the gas lines, disco, Whitewater, double-knit pant suits and double digit inflation. The Market had a swoon of similar magnitude to what we just endured in 1973 and for most of 1974. It, too, was the worst downturn since the Depression. Then a funny thing happened. From its nadir in late 1974, the S&P rose 54% in a year. If you look at the records of value investors, as lousy as the second half of the 1970s were for the rest of us, well-situated investors had a splendid four years. You can look it up! But they had to be there, and not wait for a theme (like energy, which worked great until about 1980 and then gave it all back and then some) to appear to them on the pages of USA Today.
The bargains are everywhere, even among the some of the most stellar of “blue chips”, stocks that haven’t been cheap in decades, if ever. A good example would be Intel. (INTC - $14.63 ) At less than 12 times current year EPS, with a couple of dollars per share more cash than debt and a franchise (leadership in the advance of microprocessor power & functionality) that will never be matched, it has been the sort of a “no-brainer” that I don’t mind recommending to strangers I meet at parties who want to talk about the Market (another rule being bent for the first time). I have spent the last couple of years studying Intel and its place in the world and have concluded that “the end of the line” for Moore’s Law is well beyond the far edge of my three to five year investment horizon. I reckon the appreciation potential to be something on the order 20 times EPS of $2+, well within that timeframe. Earnings might flatten out or even decline a bit in the year ahead if the global economy slows enough, but it would little more than a speed bump considering all of the life changing innovation that Intel’s own innovation is still unleashing around the world.
That said, if you forced me to make a short list of “best ideas”, INTC would not be on it. As compelling as two points of downside and 20+ points of upside, with a decent dividend yield (Yes, INTC has a well covered 3.5% yield!) no less, there are plenty of situations offering significantly more appreciation potential without significantly more risk. While I presently own more INTC than I ever would have imagined owning even a few years ago, I would be more focused on other stocks with much more upside that are arguably riskier (based on comparison of attributes) but as practical matter the downside is not all that different (they’ve all been crushed to valuations that could not have been imagined a year ago). So without further ado, here are five stocks that I am particularly pleased to suggest and to go “on the record” with”:
Seagate Technology (STX: 485MM shares @$6.60) As the world’s leading and low-cost producer of hard disk drives (HDD), STX has both facilitated and benefited from the burgeoning (40%+) growth in demand for data storage. It has also played a hand in the consolidation of what for most of its three decade history had been a frightfully competitive market. Seagate will probably earn about $1 this (June) FY. In a more normal period, FY 04 to FY 08, grew EPS from $1.41 to $2.63). Based on $1 EPS, gross CF will be just under $3: Free Cash Flow will be $1.45. The company has net debt of a little under $1B, or less than two (trough) years of FCF. With $0.48/year in dividends, the stock has an attractive yield. Unless the “growth in data storage” thesis has run its course, STX has earnings power well above $3 per share. I still expect the Market to accord a low teen multiple once this downturn proves that the HDD business is less cyclical (doesn’t give it all back in the downturn) than in the past. $40 within three to five years would not surprise me.
USEC (USU:110MM @ $4.05) is one of four companies in the world that enrich uranium for electric power production and the only one that is US based. As a provider, under long term contracts, of the fuel that provides 20% of what keeps the lights on, it is in a stable and low risk business. They will likely earn something like 30c this year and 70c next year while spending close to $1 per share developing a next generation technology. The reason the stock trades at a huge discount to a $12 book value, which consists largely of very fungible inventory, is lingering uncertainties about the funding and construction of a new plant, the American Centrifuge Project. The funding issue was signed into law earlier this year in the form of a loan guarantee by the Department of Energy (which used to own USEC and has a royalty interest in the production of ACP). Once the DOE loan guarantee is finalized sometime before the present Administration departs, the only remaining “issue” will be their ability to construct the American Centrifuge Program on time and on budget. This is not without risk (it is similar to the risk in a new aircraft engine program, but my estimation more contained, as if the new engine had millions of hours on it already, which the ACP does), but it is out there in time, as in two or so years from now. Once the financing question that goes away (they will be borrowing on an as needed basis through the Federal Finance Bank) there will be no good reason for the stock to trade at a discount to book value. I believe the earnings power from the ACP is such that USU could be $30+ in the next five years.
Hutchinson Technology (HTCH: 22MM @ $5.08) the world’s leading (of three) producer of suspension assemblies for hard disk drives. The stock traded off the map because they have been losing money on a GAAP (but not cash) basis. Earnings will recover as volume builds in the “additive” plant they started up last summer (to support the next step-change in suspension design; having this plant makes HTCH the only fully integrated provider to a customer base that needs rapid design, prototype and delivery) and they rebuild their share in the biggest the Seagate desktop. This is by far the largest SKU in the industry, went to zero for HTCH last year and is programmed to grow over the next several quarters. They have also been generating an operating loss on their BioMeasurement startup, to the tune of $5MM+/Q, or nearly $1 per share pre tax. This start-up has developed InSpectra, a device that non-invasively measures tissue oxygenation (StO2), a drop in which is a precursor to “going into shock” (is there an ancillary market putting these in brokerage offices?). It was approved by the FDA last year and continues to progress well ahead of expectations in terms of getting into hospitals, protocols and additional indications. Given what they have going for them, worst case I see the stock narrowing the discount with tangible book value (about $19). Alternatively, with a moderately profitable BioMeasurement division and the suspension business reaping the benefits of that investment in “additive” technology, it is no stretch at all to get to $5/share and, considering the potential of the StO2, which is already being regarded in some quarters as a standard vital sign, a P/E of 20+.
Mohawk Industries (MHK 68MM @ $39) is a leading producer of floor coverings, including carpet, tile, wood and laminate. The company earned $6+ per share in both 2006 and 2007, a period of declining housing activity and rising energy and raw material costs. These pressures got even worse in 2008, especially in H2. MHK will only earn about $3.60 this year and will probably see weak demand in the few months of next year. However, raw material and energy costs will be lower, and the company has been working very hard to otherwise reduce cost and emerge from the downturn an even stronger company. They should be able to continue to generate free cash flow and reduce the borrowings that funded their acquisition of Unilin in late 2005. (They paid down $128MM in Q3, and $1.4B since the acquisition.) This has been a splendidly well run company, a low cost provider of a basic need (predominately replacement). It is presently selling for less than eight times trough free cash flow and five times a more normal year’s free cash flow. I anticipate EPS of $10+ within the next five years and decent, mid-teen multiple on that.
The Dixie Group (DXYN 12.2MM @ $4.15) is another, albeit much smaller producer of floor coverings. In 2003, DXYN transformed itself by selling its commodity operations and using the proceeds to pay down debt, focus of it high-end brands (Masland and Fabrica) and develop Dixie Home, a new better-priced brand. Reaping the fruits of this transformation has been postponed by the housing downturn, but the company has remained profitable and continues to develop new product. This recent extension of its lending agreement to May 2013 put to rest any concerns about financial flexibility. The stock is trading well below its tangible book value of roughly $12. I believe DXYN has earnings power a couple of years into a recovery of something closer to $2 than to $1 per share.
Obviously there are many other bargains to be had, some of which are no doubt even more compelling. Only time will tell. These are but a few of the stocks that I expect future investors to say “Dang! Did it really get that cheap?” when they pick up a Value Line. The important thing is not to pick “the best of the best of the best”, but to heed the maxim, attributed to Woody Allen, that 90% of success is just showing up. It’s been hard enough just to show up lately, especially if showing up means stepping up and buying. So show up, and try not to throw up. We’ve lived through worse.
Saturday, November 1, 2008
The Evil Eye, Virtual Crowds & The One
Halloween finds us contemplating a ghoulish spectacle: the smoldering ruins of a portfolio laid low by Bear Market forces of once-in-a-generation magnitude, and an electorate seemingly determined to plunge the nation into a two to four year bout with that retrograde conceit that calls itself Progressivism. These two developments have something in common, something besides making some of us want to curl up in a safe corner and wait for the dry heaves to subside. They were helped along by what seems to have become the Ubiquitous Evil Eye.
Actually, as painful as it is to see how far some of our stocks have fallen from where we thought they were really, really cheap and so doubled (or tripled) down, the way the Market has been acting these past few days is quite encouraging. I am seeing the return of at least a modicum of confidence on the part of bargain hunters, and a diminution of the “get me out!!” liquidation that has taken so many stocks to such unbelievable discounts to their intrinsic worth. It was encouraging to see the Dow Industrials and the S&P 500 test the 10/10/08 intraday lows so successfully on Monday, trading to within 3.3% and 0.8% of the major low before commencing a rally of nearly 11% through Thursday. Whereas the weeks leading up to this “test” have been characterized by waves of liquidation selling being interrupted by feeble recoveries, and dramatic losses of heart (as in last minutes-of-the-day meltdowns), whatever ongoing selling that has continued is now being met with buying interest of at least equal vigor. It also matters that the short side is proving to be a much more perilous place to place one’s bets, and that the vast herd of hedge hogs, which grew so fat feasting on easy money, is well along in the process of being thinned out down to a level the range can actually support. The Market is acting as if the “urge to purge” has spent its fury. I can see the possibility of another test of the low, which is now defined by 10/10 and 10/27, if the election ends up being close and contested enough to unleash another wave of uncertainty, but otherwise I strongly suspect that prevailing bias is in the process of turning upward.
It has been my experience that election outcomes tend to get discounted well in advance, and that there is not much value in trying to handicap likely Market trends based on them. Elections, or rather, the campaigns leading up to them, are quirky things. It is best to keep in mind the fortunes of war. As in war, unpredictable things happen. As the loss of a nail caused the horse to lose its shoe, and so on, tiny, quirky events can change things dramatically, shifting the final score the way an aberrant bounce of a football late in close game might. That said, I have a distinct recollection of the Market figuring it out last time, in 2004. The trend shifted from a weak drift to a distinct upward bias on the morning after the Democratic Convention tried to pass their man off as a war hero. I remember thinking that this charade, so unlike the demeanor of any other warrior I have ever known or met, was simply not going to fly. The Market did a very good job of discounting a victory by the incumbent, completely neutralizing what we as individuals saw as a great source of uncertainty. The remainder of 2004 was very much a validation of the maxim “Buy the rumor, sell the news”.
As I ponder the questions of why this Market got as whacked out as it did, why 2008 turned into the downturn of a lifetime, and why we are facing an election outcome favoring vague promises about “hope” and “change” over proven leadership in facing the world’s evils for what they are, I find a common thread of understanding. It is the ubiquity of that Evil Eye, that flat panel of light that shouts out at us everywhere we go unless we take deliberate steps to avoid it. It seems that most people have become overwhelmingly dependent on visual stimuli, unable to suffer more than a few minutes without soaking up a dose of whatever it is that comes to us out of a big screen TV or a monitor. I, for one, have chosen to be an exception. For the last decade or so, the television in my home has been used as a monitor to play tapes, and more recently, DVDs from Netflix. Consequently, not being as inured to the bombardment as I imagine most people to be, I find TV to be unbearably shrill, an annoying and obtrusive absurdity. One of the marks of being a mature person is recognizing that there are some people whose demeanor or character has some negative aspect that we do well to avoid, lest something “rub off”. It is a recognition that we are more malleable than we would like to think, and that attitude is contagious. Can nonstop interaction with digital personages, especially given the “amplification” that seems to be intended for dramatic effect (watch the faces with the sound off, as I have founded myself doing on many an airplane, to see what I mean) be any better for you? I think not!
When I am asked about how this Market downturn differs from 1987, one of the first things that comes to mind is that back then, we only had a handful of channels to choose from. People who owned stocks were plenty scared, but the fear mongers could not ply the multitudinous digital channels to seek them out and agitate them even further. You would find it instructive to compare the Wall Street Week episode from that week in October 1987, which included the reflections of Sir John Templeton, (available on You Tube) with what we are subjected to today if we find ourselves in the presence of a TV tuned to a financial or “news” channel. And how unlikely is that? Go to a tennis club to burn off some stress by whacking away at some fuzzy balls, and there’s the Evil Eye, filling the lobby with its prognostications of doom. Head out for an offbeat lunch, ethnic fare tucked away in a strip mall, and that same eye is staring at you, with its inducements to try a new kind of birth control or asthma relief or the services of some pit bull of an ambulance chaser. In the mall, in the airport, in the doctor’s office, it is as if it simply has to be there for us. But it doesn’t, really.
The blessings of technical progress are not unalloyed with invidious consequences. Besides facilitating a bombardment of information that if allowed to will overwhelm one’s capacity for critical thought (or is just me, with my underwhelming-to-begin-with capacity?), the tsunami of digital content, however it is delivered, also seems to have the ability to create virtual crowds. It was instructive to read Fouad Ajami’s 10/30 editorial in the WSJ about the role of crowds in this election. He spoke to literal masses of people in close physical proximity, but thanks to big screen TV, wall-to-wall coverage by far too many “news” channels, and Web communities where like-minded individuals can go and reinforce each other into a frenzy, we seem to have arrived in the Age of the Digital Crowd. That the idea of Crowd has taken on a new and more pervasive meaning is not the only reason that this Market downturn got so out of hand , but it is a big part of the equation. Likewise, the candidate leading in the polls, despite many lingering questions about who he really is, where he actually came from, who is putting up all that money for him and what he really believes, is perfect for the part if one is trying to cast the One who will lead a Digital Crowd.
My guess is that while some fear as to the outcome of the election is in order, the worst fears are all but certainly overblown. (They usually are, but good grief, we have been watching Worst Case go to Even Worse for months now already!) Le Bon commented that crowds lose their heads as one, and then men regain their senses one at a time. The crowd whose members have been allowing their fears to add fury to the forced selling of others is already starting to thin out. Let’s assume for a moment that the polls, though persistently problematic, are “close enough” this time and the front runner wins. The Crowd that has projected their hopes for nebulous change onto the cipher that is BO will inevitably dissipate as each individual comes to the realization that The One is not who or what they allowed themselves to believe he was. Scandal will linger past Election Day, much like Whitewater did twelve years ago, like so much sand poured into the gas tank of the Engine of Change. Bereft of a promising abstraction, as opposed to a very human leader, to focus them, the litany of grievances that defines the Democratic Party will succumb to centrifugal forces and start to come asunder. Meanwhile, that 40%+ of the electorate that is not on board with Progressive ideology has gotten its wake up call. A Progressive president will find himself between the rock of multifarious ideologues for whom he cannot move fast enough and the hard place of tens of millions who will be agitated by all but the most subtle moves down the Progressive path. And these are the people who are much more likely than those on the other side of the cultural divide to reproduce, to volunteer their time and money, to serve in the military or to own guns and know how to use them. Some of them, when faced with dire enough circumstances, have even been known to call on aid of the Almighty, the One who not only made them all but has also seen it all, and who answers such calls in ways that are sometimes later than we would wish, often beyond our understanding, but always to suit His good purposes.
I see a slowly clearing financial storm, followed by economic recovery in fits and starts, helped along by the same sort of political gridlock that made the last years of the Twentieth Century a relatively benign era for investors. The years ahead might see a quickening of the entropic forces that send all human edifices down the way of all flesh, but then again, they might not. In any case, it looks like 2009 will be a great year to have owned stocks.
Actually, as painful as it is to see how far some of our stocks have fallen from where we thought they were really, really cheap and so doubled (or tripled) down, the way the Market has been acting these past few days is quite encouraging. I am seeing the return of at least a modicum of confidence on the part of bargain hunters, and a diminution of the “get me out!!” liquidation that has taken so many stocks to such unbelievable discounts to their intrinsic worth. It was encouraging to see the Dow Industrials and the S&P 500 test the 10/10/08 intraday lows so successfully on Monday, trading to within 3.3% and 0.8% of the major low before commencing a rally of nearly 11% through Thursday. Whereas the weeks leading up to this “test” have been characterized by waves of liquidation selling being interrupted by feeble recoveries, and dramatic losses of heart (as in last minutes-of-the-day meltdowns), whatever ongoing selling that has continued is now being met with buying interest of at least equal vigor. It also matters that the short side is proving to be a much more perilous place to place one’s bets, and that the vast herd of hedge hogs, which grew so fat feasting on easy money, is well along in the process of being thinned out down to a level the range can actually support. The Market is acting as if the “urge to purge” has spent its fury. I can see the possibility of another test of the low, which is now defined by 10/10 and 10/27, if the election ends up being close and contested enough to unleash another wave of uncertainty, but otherwise I strongly suspect that prevailing bias is in the process of turning upward.
It has been my experience that election outcomes tend to get discounted well in advance, and that there is not much value in trying to handicap likely Market trends based on them. Elections, or rather, the campaigns leading up to them, are quirky things. It is best to keep in mind the fortunes of war. As in war, unpredictable things happen. As the loss of a nail caused the horse to lose its shoe, and so on, tiny, quirky events can change things dramatically, shifting the final score the way an aberrant bounce of a football late in close game might. That said, I have a distinct recollection of the Market figuring it out last time, in 2004. The trend shifted from a weak drift to a distinct upward bias on the morning after the Democratic Convention tried to pass their man off as a war hero. I remember thinking that this charade, so unlike the demeanor of any other warrior I have ever known or met, was simply not going to fly. The Market did a very good job of discounting a victory by the incumbent, completely neutralizing what we as individuals saw as a great source of uncertainty. The remainder of 2004 was very much a validation of the maxim “Buy the rumor, sell the news”.
As I ponder the questions of why this Market got as whacked out as it did, why 2008 turned into the downturn of a lifetime, and why we are facing an election outcome favoring vague promises about “hope” and “change” over proven leadership in facing the world’s evils for what they are, I find a common thread of understanding. It is the ubiquity of that Evil Eye, that flat panel of light that shouts out at us everywhere we go unless we take deliberate steps to avoid it. It seems that most people have become overwhelmingly dependent on visual stimuli, unable to suffer more than a few minutes without soaking up a dose of whatever it is that comes to us out of a big screen TV or a monitor. I, for one, have chosen to be an exception. For the last decade or so, the television in my home has been used as a monitor to play tapes, and more recently, DVDs from Netflix. Consequently, not being as inured to the bombardment as I imagine most people to be, I find TV to be unbearably shrill, an annoying and obtrusive absurdity. One of the marks of being a mature person is recognizing that there are some people whose demeanor or character has some negative aspect that we do well to avoid, lest something “rub off”. It is a recognition that we are more malleable than we would like to think, and that attitude is contagious. Can nonstop interaction with digital personages, especially given the “amplification” that seems to be intended for dramatic effect (watch the faces with the sound off, as I have founded myself doing on many an airplane, to see what I mean) be any better for you? I think not!
When I am asked about how this Market downturn differs from 1987, one of the first things that comes to mind is that back then, we only had a handful of channels to choose from. People who owned stocks were plenty scared, but the fear mongers could not ply the multitudinous digital channels to seek them out and agitate them even further. You would find it instructive to compare the Wall Street Week episode from that week in October 1987, which included the reflections of Sir John Templeton, (available on You Tube) with what we are subjected to today if we find ourselves in the presence of a TV tuned to a financial or “news” channel. And how unlikely is that? Go to a tennis club to burn off some stress by whacking away at some fuzzy balls, and there’s the Evil Eye, filling the lobby with its prognostications of doom. Head out for an offbeat lunch, ethnic fare tucked away in a strip mall, and that same eye is staring at you, with its inducements to try a new kind of birth control or asthma relief or the services of some pit bull of an ambulance chaser. In the mall, in the airport, in the doctor’s office, it is as if it simply has to be there for us. But it doesn’t, really.
The blessings of technical progress are not unalloyed with invidious consequences. Besides facilitating a bombardment of information that if allowed to will overwhelm one’s capacity for critical thought (or is just me, with my underwhelming-to-begin-with capacity?), the tsunami of digital content, however it is delivered, also seems to have the ability to create virtual crowds. It was instructive to read Fouad Ajami’s 10/30 editorial in the WSJ about the role of crowds in this election. He spoke to literal masses of people in close physical proximity, but thanks to big screen TV, wall-to-wall coverage by far too many “news” channels, and Web communities where like-minded individuals can go and reinforce each other into a frenzy, we seem to have arrived in the Age of the Digital Crowd. That the idea of Crowd has taken on a new and more pervasive meaning is not the only reason that this Market downturn got so out of hand , but it is a big part of the equation. Likewise, the candidate leading in the polls, despite many lingering questions about who he really is, where he actually came from, who is putting up all that money for him and what he really believes, is perfect for the part if one is trying to cast the One who will lead a Digital Crowd.
My guess is that while some fear as to the outcome of the election is in order, the worst fears are all but certainly overblown. (They usually are, but good grief, we have been watching Worst Case go to Even Worse for months now already!) Le Bon commented that crowds lose their heads as one, and then men regain their senses one at a time. The crowd whose members have been allowing their fears to add fury to the forced selling of others is already starting to thin out. Let’s assume for a moment that the polls, though persistently problematic, are “close enough” this time and the front runner wins. The Crowd that has projected their hopes for nebulous change onto the cipher that is BO will inevitably dissipate as each individual comes to the realization that The One is not who or what they allowed themselves to believe he was. Scandal will linger past Election Day, much like Whitewater did twelve years ago, like so much sand poured into the gas tank of the Engine of Change. Bereft of a promising abstraction, as opposed to a very human leader, to focus them, the litany of grievances that defines the Democratic Party will succumb to centrifugal forces and start to come asunder. Meanwhile, that 40%+ of the electorate that is not on board with Progressive ideology has gotten its wake up call. A Progressive president will find himself between the rock of multifarious ideologues for whom he cannot move fast enough and the hard place of tens of millions who will be agitated by all but the most subtle moves down the Progressive path. And these are the people who are much more likely than those on the other side of the cultural divide to reproduce, to volunteer their time and money, to serve in the military or to own guns and know how to use them. Some of them, when faced with dire enough circumstances, have even been known to call on aid of the Almighty, the One who not only made them all but has also seen it all, and who answers such calls in ways that are sometimes later than we would wish, often beyond our understanding, but always to suit His good purposes.
I see a slowly clearing financial storm, followed by economic recovery in fits and starts, helped along by the same sort of political gridlock that made the last years of the Twentieth Century a relatively benign era for investors. The years ahead might see a quickening of the entropic forces that send all human edifices down the way of all flesh, but then again, they might not. In any case, it looks like 2009 will be a great year to have owned stocks.
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