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Stock Ideas Investors Daily Edge Speaking of Destruction—Cheap and Good versus Cheap and Gone
Stock Ideas Investors Daily Edge Speaking of Destruction—Cheap and Good versus Cheap and Gone 
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| A few years ago my friend made about $4 million dollars by investing in the video game company Midway. Midway at the time ran from about $3 to over $20!! | |
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| Speaking of Destruction—Cheap and Good versus Cheap and Gone |
| Friday, 07 November 2008 | ||||||||
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In a sidebar last week I mentioned that newspapers were falling rapidly to Internet dominion at last—the work of creative destruction. It caught the eye of a veteran of the process. From Bob K… Sometimes it takes years for creative destruction, and many false starts. In the early 80's, I worked for a subsidiary of the Knight-Ridder newspaper chain in South Florida. The company was called Viewtron and was an electronic newspaper. In many ways, it was similar to today's Internet. It was based on a packet switch network and used a graphic display language. The LA Times was also testing a similar system. They called this technology videotex and it never succeeded. Part of the problem was that the technology was too expensive at that time. But I think the major problem was that the business model was wrong. The model was an electronic newspaper. It was local and generated income from both subscription and advertising fees. Another major problem was the cost of the data transmission. This was occurring at the time of the break of the telephone system. Knight-Ridder saw the future as electronic newspapers rather than the national printed paper that their competition was launching, USA Today. Twenty-five years later Knight-Ridder and videotex are dead, but their fear of electronics replacing printed news has come true. It is hard to imagine where technology will take us. About midway through this face off between new and old media, I liked Tribune Co (TRB) because it seemed to be tackling the problem straight on. One of its projects was “electronic paper.” It promised that a newspaper could update itself. Must have been too early, my Tribune investment didn’t work out too well. But the idea did progress. Today, Amazon’s got it. It’s called Kindle, and I hope I get one in my stocking for Christmas. On the subject of the current market and how cheap it is when measured by valuations like price to earnings ratios and price to sales, a couple of readers added some insights of their own that are worth looking at. First from Grant J.... Lynn Carpenter nailed that one. I'm going to print it and save a copy. I might even extract some of the data; the historic average P/E, price to book, price to cash flow, etc., and put them in poster for my office wall.
She convinced me stocks are cheap. Unfortunately, all the capital Bernanke and Paulson dumped into the system has primed the inflation pump. It has already started, a trickle of little price increases hidden in the tug of war between deflation and inflation. However, once the fear induced deflationary suction stops counteracting the increased money supply we will have full-blown, 1970s style, inflation. My question is, "Do we have a Paul Volcker?" Even better, do we have a way to stop it before we need a Volker in the Fed? I don't want to go there again. [Late breaking note: The Wall Street Journal reports that Paul Volcker is one of the people President-Elect Obama is considering for Secretary of Treasury.] If you missed the last round of double-digit inflation as the economy sunk—stagflation-- in the 1970s, Paul Volcker was the hit man. President Jimmy Carter appointed him to head the Federal Reserve board in 1979. Reagan inherited Volker, but kept him on and reappointed him in 1983. Volker did a hard, impossible job bringing inflation down from over 13% a year by sharply controlling money supply. It worked on inflation, but it didn’t help the economy, and in the early 1980s, we had a big recession with unemployment rates reaching 10.8% at their peak. That’s the pain Grant is talking about. As to having a Volker, I don’t expect that in Bernanke. On the other hand, a few more months like this, and inflation will be less likely, as consumers resistance to price increases seems to be getting stronger every day. And here is a good letter from Ray on the treacheries of “cheap stocks”: Hi Lynn, I enjoy your columns. You are intelligent and thoughtful. The stats you expressed in this column would be very impressive during normal times. I believe these are far from normal times. I am a student of the market and history. I have been investing for 45 years. In the past century we have had two serious secular bear markets. We are now halfway through our third. In these markets the bottom is typically down 80 to 90 percent in constant dollars. The tech bust was only the start. I even got fooled (shame on me). When the NASDAQ dropped 50% I said FIRE SALE and invested some hard earned money in great companies. The market then proceeded to drop another 50 %. These great companies have yet to recover because we are still in the secular bear. I know it is tempting to get sucked into what appear to be great bargains but history has something else to tell. I wish it were easier but this is the real world. It's rarely easy. If it appears so- look out! Keep up the good work. Be very careful. Your readers are common folk who have worked very hard for the bucks they have saved. You know the bottom line-NEVER LOSE PRINCIPAL. Stay tuned-leave happy tracks and spread the word, I agree completely with you Ray. Just because a stock is down 50% does not mean it’s safe. It can fall farther. I agree, too, that we are in a secular (long-term) bear market. So let me carry on from there. It’s good to recognize a bear market for what it is. I personally prefer to buy in bear markets given a choice. That’s when you get the best prices. But you also must brace for your stocks to go lower. When I say “invest,” I ONLY mean long-term horizons based on expected future profits and cash flows. I am not talking about making money the next day or even the next month—though I like it when it goes that way, for sure! And despite what the colleges teach about efficient markets, the only efficiency you can count on in the stock market is that information is rapidly processed. But very often, it’s neither correctly nor intelligently processed. So in a bear market, you can get a good, fair price—one that makes perfect business sense—and still watch the stock drop as investors go into a frenzy of selling. That’s why being 50% off is no reassurance to me that a stock is a good deal. Instead, I like to use a combination of outlook (is the company going to grow 4% a year or 15% a year? Will its profit margins improve? Are its competitors closing in? And so on) along with valuations. The only reasonably reassuring way to know you got a good price is to know what the “right price” should be. That would be based on the company’s normal valuations—what investors are typically glad to pay for it—and its outlook. A stock that normally commands a P/E ratio of 18 on sale for a P/E of 9 is a good deal, provided its future looks good. It’s a bad deal if it’s bleeding cash, losing customers and watching growth slip. A stock that is 50% off in price may even be a very bad deal—because it might have been 200% overvalued to start with. So, I will settle for a good outlook at a fair value, add time, and watch for progress the right way. That’s it for this week. Thanks for writing, folks. P.S. To let me know what you thought of today's article, send an e-mail to: This e-mail address is being protected from spam bots, you need JavaScript enabled to view it
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