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Jubak's Journal
Recent articles:
• It's good news when good stocks fall, 8/1/2002
• Putting a value on hapless AOL, 7/30/2002
• Big step toward a bottom comes Aug. 14, 7/26/2002
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| | Jubak's Journal
Are you ready to bottom fish with Buffett?
A not-so-random walk through the minds of bottom fishers reveals a deep strain of pessimism. That said, Ive found three sunken companies worth a hard look.
By Jim Jubak
Warren Buffetts doing it. So are William Miller, Martin Whitman and the buyout team at Hicks, Muse, Tate & Furst.
Yep, even before the impressive rally of the last few days, the deep value investors were out snapping up the busted, the distressed and the despised. Theyve bought wholesale phone service providers, natural gas pipelines and telecommunications equipment makers.
Itching to follow their example? This is the point in a long bear market where the impulse to go bottom fishing can get downright overpowering. Prices are low. No, check that. Prices are ridiculously low in comparison to where they stood not just two years ago but even at the beginning of 2002. We all know the case histories of investors who made a killing by buying a despised stock at the bottom. Didnt that Saudi prince make a gazillion dollars buying Citibank -- now Citigroup (C, news, msgs) -- when everybody thought it was going bust? What would be sweeter than making up some of the losses of the last two-and-a-half years with profits from the battered shares of the very companies that produced those losses in the first place?
And finally, if Buffett and the others are buying, doesnt that mean weve hit the bottom in this long bear market. And isnt the smart thing to do to go bottom fishing yourself?
Asking for disappointment
Unfortunately, I dont think most investors are pessimistic enough to be successful bottom fishers. Going bottom fishing with an ounce of optimism in your soul is asking for disappointment. And nothing about bottom fishing is more misleading than the idea that the busy deal-making of these investors is calling a market bottom.
So heres how to answer the question, Are you ready to be a bottom fisher? -- plus suggestions for how to invest if you can summon the requisite patience and pessimism.
Bottom fishers are the most pessimistic of all investors who are long stocks. I know that description goes against the conventional wisdom, but I think its the essential point to grasp if you want to understand what bottom fishing signals and how to profit from it.
Now, of course, bottom fishers are at some level optimists, like all investors who buy stocks on the long side of the market. Everyone who invests long -- as opposed to going short -- does so in the belief that stock purchased today will be worth more tomorrow.
But within that optimistic framework, bottom fishers are deeply pessimistic, especially in their reading of human abilities and human nature.
Real bottom fishers cant see the bottom
Bottom fishers, for example, are deeply skeptical of anyones ability to call a bottom in the market. Scan the writings of articulate bottom fishers like Buffett or Third Avenue Funds' Martin Whitman and youll find the repeated refrain of fallibility: I cannot predict the short-term movement of stock prices or pick the bottom of any market, these very successful investors say. In his most recent semiannual report to shareholders of his mutual funds, Whitman put it this way: As far as I can tell, near-term prices for common stocks in non-arbitrage situations will continue to be a random walk.
Burton Gordon Malkiel, the author of "A Random Walk Down Wall Street," about the unpredictability of stock prices, couldnt have put it any better himself.
But I think the bottom fishers pessimism about the ability of anyone to pick stocks profitably goes well beyond this traditional doubt. Bottom fishers emphasize the likelihood that any investor will make mistakes in evaluating a stock. Its human nature to get it wrong -- with great frequency.
Thats why bottom fishers emphasize buying assets at extremely low prices. Getting a dollar of assets for 25 cents certainly minimizes the damage that will result if the investor gets it wrong. And buying at such a deep discount means that an investor can get a lot about any stock wrong and still make a profit. Whitman roughly managed to break even in his investment in Exodus Communications, something Id certainly like to be able to say. The gambit worked because he bought the senior debt so cheaply that even the companys bankruptcy filing and eventual liquidation didnt hurt much.
Bottom fishers are equally as pessimistic about the ability of other investors -- the stock market in general -- to recognize value in a stock or asset until it slaps them in the face. In this, theyre at the opposite pole from those optimistic investors who buy Microsoft (MSFT, news, msgs) at $48 in the belief that upcoming earnings reports will validate the companys value. (Microsoft is the parent of MSN Money).
Alternative vehicles
Bottom fishers, on the other hand, firmly believe that an undervalued asset can stay undervalued for a long, long time. The emotional blinders blocking wider view of a stocks true value dont have to come off this quarter, or next, or indeed in any year in the near future.
Thats why deep value investors so often look past the common stock of a company to find alternative vehicles that will pay them while they wait for the market to come around. For example, I wrote in my column, Another lesson from Warren Buffett, about Buffetts preference for the convertible bonds (paying 9% interest) of Level 3 Communications (LVLT, news, msgs) over the companys common stock. Whitmans investment in Pacific Gas & Electric mortgage bonds in the middle of last years energy crisis fits into the same category.
Looked at from this perspective, investments by bottom fishers in the current market arent exactly a call of the bottom. Theyre more in the nature of a judgment that this or that asset is cheap enough to provide reasonable safety. The moves hedge against mistakes and provide a solid upside during a potentially long recovery period.
Its typical to say that a successful bottom fisher must combine deep reserves of patience with extraordinary analytical skills that uncover value where no one else sees it.
To those traits Id add:- An extraordinary humility about those very same analytical skills. (The bottom fisher knows that he or she will often get it wrong.)
- A belief that no one can call the turn in markets or in individual stocks.
- A full recognition of how long it can take for the market to recognize value.
- An understanding that theres no way to force the market to recognize value.
3 fish worth a look
If you have these six traits (patience and analytical skills, plus the four Ive just numbered), you may be ready to do some bottom fishing. If you are, here are three situations that are worth a look.
Flextronics International (FLEX, news, msgs). This contract electronics manufacturer has been crushed as the industries it serves have headed south. But with a debt-to-equity ratio of just .19, Flextronics looks like it will survive the downturn. And in the upturn, whenever it comes, Flextronics will pick up even more business as the trend toward outsourced manufacturing continues to gain speed. (For more on why Flextronics should profit from a profit-less recovery, see my March 26 column, 5 stocks that profit from a profit crunch.)
Lucent Technologies (LU, news, msgs). Lucent isnt out of the woods, and the stock isnt without risk. But at less than $2 a share, its worth a look here. The company is still cutting workers in an effort to bring its size down to match its diminished markets, and Im pretty sure that even the latest round of cuts wont be the last. But the balance sheet now looks healthy enough that the company stands a good chance of escaping financial default. The toughest question for Lucent right now concerns its technology: You can make a good case that Lucent is either, 1) positioned in the wrong technologies (in TDMA wireless, for example), or 2) bringing to market an impressive set of new products that will enable it to gain market share. Investors who believe alternative #1 should stay away. Those on the fence should watch for news that significant customers are adopting Lucents new gear.
Nvidia (NVDA, news, msgs). Almost certainly too early, but it bears watching. Nvidia just issued a truly stunning warning of massively lower revenue and earnings for the next quarter, and investors should definitely remember the cockroach rule of investing: When you see one cockroach, you can be sure there are many more in hiding. Warnings like this one from Nvidia are typically followed by more bad news. But in all the turmoil, remember that this is the market leader in computer graphics chips and that some of the current weakness simply stems from normal product cycle woes that are magnified by the bear market. At some point, this gets cheap enough to deserve casting a line.
When thinking about any of these or other bottom-fishing opportunities, please remember that were still in a bear market until proven otherwise, and that Im not calling a bottom in the market or in these stocks.
Its then that you understand if youre really ready to be a bottom fisher.
New developments on past columns
The accounting outrage you never hear about
Dont think the issue has gotten any less contentious just because General Electric (GE, news, msgs) has decided to jump on the bandwagon and start expensing stock options. On July 30, General Electric made the switch. Until now, General Electric has buried the cost of options in a footnote to its financials. The hit to earnings, GE estimates, will be about a penny a share in 2002 and 3 cents or so a share over the next three to four years. Well, maybe. Under current rules, companies that switch to expensing options dont have to include the costs of options granted before the accounting switch -- only the cost of new options counts. Thats why General Electric estimates the cost of expensing options at just a penny a share. But the Financial Accounting Standards Board -- a generally toothless watchdog of the accounting rules -- has decided that it might consider requiring companies to include the costs for all outstanding options. That rule change, Merrill Lynch estimates, could cost companies up to 10% off their earnings per share. Stay tuned. And for those readers whod like to see an intelligent argument against expensing options, Id highly recommend a read of Marty Whitmans most recent semiannual report for the Third Avenue mutual funds.
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. The Wednesday edition stems from Jim's appearance on CNBCs Business Center most Wednesday nights at approximately 5:45 p.m. ET. Selected CNBC stories can be found in the TV Reports index.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Citigroup and Lucent Technologies. He does not own short positions in any stock mentioned in this column.
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