The Markets, The Book and Comments
January 23, 2008 | Joe Ponzio | about: AEO / JNJ / TRB / WMT
I’ll have to finish Workouts Work Out on Friday. Let me get some housekeeping done regarding the book and the markets. I’m not going to give you the standard “stay the course” or “now is the time to buy” garbage – there are plenty of other places to go for noise. Let’s, instead, look at the news of what’s happening.
The Market and The Looming Recession
To help delay or stop the looming recession, the Fed cut interest rates by 75 basis points. What does this mean for silent partners/business owners? Not a whole lot. Mr. Buffett on this year’s stock market, economy, interest rates, and the upcoming election:
Stop trying to predict the direction of the stock market, the economy, interest rates, or elections.
The hardest part about watching the markets crash is, well, watching the markets crash. We will see the markets up 20% or down 20% (or more) in future years; still, great businesses will grow and their stock prices will follow. The solution? Stop watching the markets!
I’ll admit – it’s easier said than done. And yet, for decades leading up to the 1990s, that is exactly how regular people had to invest. Quotes were only available the next day, in the newspaper. To invest in the stock market, you had to buy great companies at great prices and then let time do its thing.
Yesterday morning, I work up to an e-mail sitting in my inbox that read:
Tomorrow (or I guess it’s today) is going to be a blood bath for U.S. markets. Right now, U.S. futures are posting steepest decline since 2001. I’m predicting the DJIA to be down 500 tomorrow. People are already calling tomorrow “Black Tuesday.” It’s going to be bad.
Watching CNBC in the morning, you would have thought the world was coming to an end. And what did I think? In fact, what was my exact response to that e-mail? (Word for word):
I know. I have been excited all morning. Businesses are going on sale today!
The Lesson
Buffett tells us:
Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.
If, for even a second, you became “panic-stricken” yesterday and sold – or considered selling – your great, underpriced companies because of market movements, you probably shouldn’t be in the markets. Unless there was a fundamental change in your business from Friday to Tuesday, there was no real change.
The Major Drops In Prices
I don’t know what you experienced, but here is what I noticed: A lot of great, underpriced companies have not dropped nearly as much as the markets. In fact, a combination of workouts, patience, and long-term outlook have provided some very rewarding results over the past six months. (Not a good timeframe, but appropriate for this discussion).
In the past six months, I have only showcased three underpriced companies (JNJ, WMT, AEO) and one complete workout (Tribune). Hey, investing is boring.
Putting 10% of your portfolio into each position at those prices (Note: Do your own research, don’t just buy what I say, and don’t judge your portfolio on six-months results!), your portfolio would be up 4.1% since June 27, 2007 (the JNJ post and first position) versus down 10.6% for the DJIA (and likely more for those fee-heavy mutual funds).
If you can lose less in down markets, gain in sideways markets, and keep up (in whole or in part) in up markets, you’ll end up with some very satisfactory results.
What Does This All Mean?
If nothing else, it should remind you that there are always a ton of overpriced companies that, from time to time, must be corrected by moderate to severe market drops. When the value of those companies cannot support the inflated prices, prices begin to drop. Considering that great, underpriced businesses are hard to find, it is no wonder that, regardless of the markets, you often get more protection in great, underpriced businesses than great, fairly priced businesses, speculation, or any other form of “investing”.
(What are the markets but a collection of businesses? When the majority of businesses are overpriced, that pricing will correct and the markets – the collection – will fall, regardless of any individual company’s price or value.)
What Should We Be Doing Now?
Look for opportunities – workouts, great businesses, etc. I’m not going to tell you to “stay the course” because, well, there is no “course” – just opportunities. If you panic when the markets are down, regardless of the health of your businesses, consider getting out now, buying individual bonds, and never looking back.
And for goodness sake, don’t even think about selling now, just to jump back in when the markets have “rallied” to new highs. If you don’t learn from history, you are doomed to repeat it – at the ultimate expense of your goals and dreams.
The Book
Enough market talk. What’s up with the book? Thanks to my superstar agents at Jonathan Scott, I have signed on with Adams Media to publish F Wall Street. Until the actual release date is firm, I can’t say when it will be out, but we are shooting for in or before mid-2009. Rest assured, you’ll know when I know.
Comment Housekeeping
I am working my tail off to keep up with comments, but please be patient. It may take a day or two for me to respond.
The new comment system has helped kill most of the spam comments, but I fear that some comments aren’t getting through. If you post a comment, you’ll get a “submitting comment” notice while it writes to the database and sends me an e-mail. If you leave during that time, I won’t get your comment.
When submitting a comment, please wait for the confirmation to appear – which may take a few seconds or, in the case of longer comments, up to a minute.
Sorry for cutting in to the Workouts Work Out thread. I’ll finish up on Friday. And thanks for visiting!
Filed under: How to Think About Stock Prices
Joe,
Prices are down, I am a dissappointed because they haven’t gone down enough! My mindset is based on two things. First, I believe in the companies on my watch list, and second, a significant portion of my investable assets are in cash waiting for good opportunities. If I were fully invested, I would probably feel somewhat different.
My question is this: What are some guidelines as to what percentage of investable assets to keep in cash? Buffett has kept around 20% in cash the last two years, but of couse he is working on a much different scale than we mortals. Is it ever advisable to invest it all?
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Joe,
YES, I wanted to sell yesterday (and today and probably tomorrow as well) but only so I can BUY! I do not tend to keep much free cash lying around and therefore when great bargains come along I need to sell securities to finance new acquisitions. I told my wife I was just “converting” from one security to another and she said my “converting” sure involves a lot of “buying” and “selling” 
.
It looks like the price of Adobe has fallen to within our intrinsic target range. Can you send me an updated market cap -vs- intrinsic value chart for Adobe. The last one you sent ends on 7-14-07. My personal evaluation of Adobe defines the intrinsic value to be $35.38. I am in the process of reviewing/updating and making an investment decision.
Glenn
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I can’t wait to read Joe’s take on Adobe. I come up with an intrinsic value of 34.XX, but I consider software to be outside my circle of compentence.
My question is, how would you decide if it was an attractive enough business to merritt buying with almost no MOS, the way WB did with Coke.
As a former Web designer, I can tell you that Adobe has several “Cokes” in the lineup. There is virtually no competition in the professional space for Photoshop, Illustrator, Flash or Dreamweaver.
From what I understand, the industry standard page layout program Quark is rapidly losing out to Adobe’s newer InDesign, which is amazing — Quark was considered untouchable just 5 or so years ago.
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Dean: You got it – and thanks!
Adobe is one of the few software companies with a huge moat. As you run your own analyses, be mindful of the goodwill on the balance sheet. That represents, in large part, Adobe’s acquisition of Macromedia at a premium to net assets.
Why should you be mindful? If Adobe purchased Macromedia and ran it separately (under the Macromedia name), you could make a case that the Macromedia business could be sold at a continued premium and that goodwill could be recouped.
What actually happened is that Adobe took over Macromedia and ran it all under the Adobe name. Other than a few legacy Macromedia products, there isn’t much left to the business. Adobe After Effects is taking over Macromedia’s Flash. Adobe Photoshop has all but wiped out Macromedia’s Fireworks. And so on.
The acquision was a wonderful synergy of products, but also a move to wipe out a competitor. If the Macromedia business were sold today, it would not likely command the full premium that Adobe paid when Macromedia was a viable competitor.
How, then, should you approach Adobe? Consider using equity minus the $2.1 billion of goodwill. We haven’t really seen a situation like this on F Wall Street, but next week’s post will dive right in and tear it apart.
Above all, remember that there is a business behind that stock and you have to dig into the financials to see what is of value, and what is a mere accounting standard.
Hope that helps!
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Joe,
Since this was a blog of random thoughts, I thought I’d post my random thought here as well. What’s your take on how to value treasury stock in your analysis? By default stockholders equity makes up a large part of your valuation since it is usually many times over the annual free cash flow of a company and is the only figure that is not present value discounted.
In the case of Texas Instruments, which I was looking at recently, they hold approximately $12 billion in treasury stock. I understand that for accounting purposes, TXN has to treat share repurchases as a reduction to equity, however, one could argue that short of going bankrupt (which I perceive as a remote possibility for a company like TXN), Treasury Stock is an asset that could be resold on the open market (hopefully at a profit). Even if you discount treasury stock to account for the possibility of reselling the shares below what management purchased them for, you still are reducing your stockholders equity figure by say $9 billion (assuming a 25% discount rate on treasury stock).
This $9 billion swing in the valuation of TXN is signficant for a company with a $42 billion market cap, and greatly affects the intrinsic value calculation. What are your thoughts on this matter? I personally am leaning towards adding back a portion of treasury stock to stockholders equity because I feel that in reality the company’s own shares are an asset that could be resold on the open market.
By just using net stockholders equity in your valuation, it would appear that TXN’s net equity was DECREASING from 2004-2007, however, this is only because of increased Treasury Stock, in reality TXN has been growing retained earnings at a pretty nice clip over this time period.
I would appreciate your input on this matter.
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Joe,
Adobe%u2019s goodwill initially represents, as you said, the purchase price of Macromedia over the fair market value of net assets. In Macromedia%u2019s case the majority of their net assets was their software (intellectual property).
If a manufacturing company takes over a competitor just to eliminate the competition and closes the competitor%u2019s plant, then I would agree with your assessment that goodwill will have to be reduced. Management determines goodwill on assets (intellectual property) based on the assets ability to generate cash flow. Macromedia%u2019s programs may no longer be available to the public, but their intellectual property may be incorporated into current or future programs at a premium which would then offset the goodwill.
Another angle to consider.
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Dave: Great point. Another reason why we have to dive deep into the annual reports to understand the business and the industry. If the Adobe valuation vs. price doesn’t scream BUY! with or without the goodwill, I’m not going to spend too much time trying to understand it.
BPal: I’ll put up a post about buybacks and treasury stock as there is a lot to talk about. Give me a little time and I’ll try to answer it for you.
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great post. sometime investing is made difficult by all the circus the goes along with it. economic downturns and market crashes do not translate much in the long run and that’s why people have to think of their ownership as a business rather than a stock went up or down 2 points.
You got a loyal reader.
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