Timing Purchases; Portfolio Changes
October 23, 2008 | Joe Ponzio | about: AAPL / ADBE / AEO / LNY / MMM / NTRI
I am a bull on America and the stock markets, even if we see more short-term, quotational (and real) pain in the overall markets. On October 30, 2008, GDP numbers will be released, likely confirming what we’ve all known for some time – we’re in (or technically starting) a recession.
No matter how short or long, shallow or deep the recession turns out to be, you can usually bet on one thing: The stock markets tend to rise before the economy turns around. So, forget timing the markets. Instead, let’s look at timing your purchases.
The Backwards Mentality of Riding Waves
We all know Buffett’s saying: Be fearful when others are greedy; be greedy only when others are fearful. We also know that this likely means that now is the time to get greedy, and that any continued decline means that we should all “get greedier.”
Investors, however, tend to have a natural tendency to want to ride waves. As the markets are falling, we tend to hold off on purchases, hoping to squeeze the last nickel out of our buys. When they rise, we find some satisfaction in watching our positions grow 1% or 3% in a single day.
Considering all we know about Buffett…how backwards is that? (And don’t tell me you don’t experience those feelings at least a little. Unless you have 50+ years experience and $60 billion, you know exactly what I’m talking about.)
Timing Your Purchases
When is a good time to buy stocks? All the time…so long as the price is right. But, here’s a little tip to help shake the market fears out of you: Only buy stocks when the markets are falling.
I’m not talking about buying in a “down” market like we’ve been experiencing over the past year. I’m talking about buying stocks on days like yesterday – a day when the Dow opened at 9,027.84 and never saw that level again, falling more than 700 points (7.8%) before ending the day down “just” 5.6%.
I’ve said it before and I’ll say it again – most people should not be entirely “in the markets” in general, and should opt for an intelligent strategy of bonds, or bonds and a few gigantic, “safe” companies.
Not sure if that’s you? Make it a point to pull the trigger only when the markets are falling. Then…make it a point to close your browser and walk away for three full market days. If that’s too much to handle, consider changing your strategy.
Believe me – when you can make purchases knowing that the markets are falling and that you’ll likely lose money for the day, investing will “make sense” just a little bit more.
Changes To The F Wall Street Portfolio
I mentioned that there have been changes made to the F Wall Street portfolio. As I’m at home, I can’t tell you the exact prices right now (I have them at my office); but, I can tell you that we:
- Dumped Apple in the low-$100s.
- Dumped half of Nutrisystem in the $19s, and the other half in the $16s.
- Nutrisystem keeps pulling me in – I bought some back today (when the markets were down) at $10 and change.
- Took a beating on the Landry’s workout, and sold out of the position in the low $13s earlier this month.
- Sold out of Adobe at near break-even prices.
- Sold out of American Eagle Outfitters in the $14s.
It seems like an awful lot of activity; but, Landry’s aside, it was all for one simple reason: As the markets began to melt down, I made a bet that some potentially “permanent” holdings would become available at very attractive, perhaps-never-again-seen prices. For that, I wanted to have cash on hand, as a Coca-Cola with a moderate margin of safety is a lot more attractive than an American Eagle with a moderate margin of safety (if it still had/has one).
(The reason for that discrepancy is predictability. You know Coca-Cola will be around, and most likely bigger, ten years from now. AEO? Though I don’t think it’s going out of business, I think we can all agree that it doesn’t offer the clarity of a Coca-Cola. The jump from “discount” to “fair value” would provide substantially the same returns; so, it’s better to opt for the easier, more predictable opportunity.)
Adding 3M to the Portfolio
So, I pulled the trigger on a new, perhaps permanent company – 3M (MMM). I won’t make the “permanent or not” decision on 3M if and until it approaches intrinsic value. Still, F Wall Street invested as though it is a permanent holding (20% of the portfolio) because it seems to offer the clarity and predictability I like in permanent holdings.
3M was added yesterday at $58.86 per share – the average of the high, low, open, and close for the day because I never discussed a price target for it before. Here’s the chart of intrinsic value versus market capitalization:
As you can see, the net price change in MMM over the last eleven years has been abysmal (even including dividends). I don’t attribute that to a bad business; I think it’s because 3M got overpriced a long time ago, and the markets had to wait for the business’ value to catch up.
So, the F Wall Street portfolio is now more invested than not, and has four positions, three of which make up the lion’s share of the value. For all intents and purposes, it is highly concentrated; but, I think our risk is a lot lower than the risks that many of these mutual fund managers are taking on General Motors and Amylin.
Portfolio performance? We’ll look at it again in June – the site’s second anniversary. Until then, we’ll focus on making intelligent decisions, regardless of the short-term price outcome.
wbfan-
I agree that the selections have been more buffet-like than all year. But they are the picks that Buffet is making when he is in charge of allocating 100,000,000,000 dollars. Unfortunately, that is not a problem that I face. I think that we can probably find companies trading below net working capital, and researching beaten-down, smaller companies with strong fundamentals at this time will be far more rewarding.
If you want to be 50 cent dollars, now is the time to do it. I’ve been looking at companies with market caps under 1 Billion, that have little debt and cash as a high percentage of their market cap. I think opportunities like these are much more worth my research time. So while they may be more “volatile” in their stock price movements, that does not concern me the least bit when I am certain that in a liquidation, they have cash and enough strong assets to back up a very large percentage of market share.
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g-
I agree that there are gret opportunities in smaller companies but I also know that Buffett’s greatest successes were in Coca-Colas and American Expresses when everyone else was scared or stupid. I think that’s why Buffett put 40% in Amex and 20% of Berkshire in KO but never seemed to commit major resources to small $0.50 dollars.
Five or ten big easy bets (IMO) is better that ten or twenty small, less predictable bets. Different strokes for different folks. I think the strategy is brilliant in this market. If you can buy $0.50 dollars, why not buy the ones that are almost guaranteed to work out regardless of the size?
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Hey Joe,
It%u2019s always good to see a new post when I log on, (especially in the midst of this incredible sale!) I have a quick question…
When making the ‘Market Cap vs. Intrinsic Value’ Chart, how are you judging the Intrinsic Value of 1997, 1998…?
I%u2019m trying to create a chart of my own like this one, but I can%u2019t find pre-1997 data in order to discount the cash flows back to calculate the various intrinsic values.
Are you using 1987 (10yr) data for inputs into the intrinsic value of 1997? Or are you estimating it somehow else?
Thanks a million Joe!
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Here’s my thinking. If one of Joe’s big names gets into the “ridiculous” range, I’m scooping it. For instance, JNJs 52 week low is $52.06. That’s getting close to ridiculous and if it goes under $50 I’ll have to seriously look at it. But I’m not buying too much into those big names just to get a good value, when there are a gazillion great smaller (but not small) companies out there that are being given away. This market comes once in a lifetime and I’m not gonna get weak-kneed during the greatest opportunity I’ll ever see.
Take Joe’s AEO. It’s under $10 right now. So what I’m gonna try to determine is this, which of the teen retailers is not only gonna survive, but take the market share left by the bankruptcies? And so on in each industry. I own some AMAT, so what I need to find out is, who’s the strongest, AMAT, KLAC or LRCX? In other words, who is gonna eat who’s lunch?
I absolutely will be applying all the criteria we all agree with here, but as always, the big picture will weight heavily with me. So I’m not talking about wild speculation, but I’m not going to even entertain the possibility of the S&P 500 becoming the S&P 100, with only the JNJs and WMTs surviving.
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Portfolio Strategy: Investing is 99% art and 1% science. I’m no Warren Buffett; so, I find that bigger, more stable, more reliable companies tend to provide “easier” valuations and less opportunities for being wrong in the long-term. I didn’t put 20% of the portfolio in JNJ, WMT, and MMM because they are necessarily permanent, but because they offered (in my opinion) the greatest combination of value and safety. Odds are, if I’m wrong on one of these companies, I won’t be “way wrong” like I was with AEO.
With mid-sized companies, the future is less certain; hence, I put a smaller portion in these. Same with small companies. When it comes down to risk versus potential reward, there is a much greater chance that a mid- or small-sized company falls off the face of the Earth, or is crushed by a competitor, or is knocked out by the economy, etc. than for the larger companies; so, they get less of the portfolio’s money.
I can say with a high degree of confidence that JNJ, WMT, and 3M will report earnings much higher five and ten years from now; so, I put my money where my confidence is. That said, if it was “business as usual” in the markets and these big, reliable companies were mostly trading at fair or high prices, I’d be looking for smaller opportunities. Right now, however, traders are willing to sell some of America’s finest businesses for bargain prices; so, I think it’s time to scoop up those permanent holdings.
Rene is trying to figure out which teen retailer will come out a winner — a great strategy which, if done correctly, will likely provide returns greater than WMT or 3M in the short-term. If, however, you can’t get a grasp on who will come out on top, you shouldn’t horse around just because prices are low. Again — it depends on what you are good at.
Personally, I strayed away from financials for the entire year because they’re outside my sphere. When I bought Graham Corp, I didn’t try to do so at the bottom like a lot of great investors. Instead, I waited until there were signs of recovery/success in the business. I’m not a bottom feeder. I’m a purchaser of businesses at attractive prices.
Like Seth Klarman has about his strategy, I’ll miss the bottom and the top, but I’m not trying to pick a bottom or a top. I’m trying to buy stocks the way I’d buy a hot dog stand or a movie theater. And if I’m going to buy those, I’d rather buy the best.
As wbfan said: Different strokes for different folks. I’m not committing to only finding these big companies; but, if one comes along and pulls me in, I want to make an appropriately sized bet.
Valuations: The EDGAR database has filings back to 1994, which will usually then give you financials as far back as 1992 or 1993. When I do the Market Cap vs. Intrinsic Value, I try to calculate intrinsic value as though I were an investor in that year. So, for my 2000 intrinsic value calculation, I don’t use 2001-2007 numbers. Instead, I use what I think I would have estimated at that time, the same way we have to predict the future today.
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As a follow-up: I’ll use real estate as an example. Two years ago, if you had $1 million burning a hole in your pocket, you could put a down payment on a house in, say, Hollywood and hope to flip it for a profit. Today, if you have $1 million burning a hole in your pocket, you can do the same thing; or, you can put 30% down on a 75-unit apartment building in foreclosure because — surprise surprise — the developer didn’t realize that there isn’t a need for 75-, $250,000 studio condos in wonderful Podunk, USA (a building that the developer purchased two years ago for $7.5 million); or, you can purchase five 15-unit buildings in neighborhoods of varying degrees.
Today’s stock market is offering all three. So long as the neighborhoods are great, I’d rather buy the 75-unit buildings. Once those move out of my price range, I’ll start looking at 15-unit buildings again.
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Thanks for the response Jae Jun,
I do understand that DCF uses future cash flows, but what i don’t understand is where you find the discount rate to discount the cash back to find the PV of cash flows.
The Fwallstreet sreadsheet generally takes the FCF or CROIC median growth for the PAST 10 years, in order to project the FUTURE years of cash.
So I assume that when calculating the 1997 ‘intrinsic value’ figure, the investor should use the ‘real’ rate of return (that we see by comparing one years financials to the next) to determine the rate of return.
Ok, I admit, i just answered my own question.
Thanks for the help !
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One thing I just thought of is that everyone seems to assume that all of these companies will reach intrinsic value at the same time or in the same amount of time. I’d bet that the big out-of-favor companies would come back in favor first. In that case, wouldn’t the current strategy make even more sense in this market? I’m really not sure which is why I’m asking.
Which would come back in favor first? A big company or a small one?
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wbfan, I hadn’t thought about that much, but I would think it’s not the size of the company so much as the industry. I’m not sure what industries would come back first, but I have a pretty good idea of which will come back last. For me though, that is a small consideration, I want great companies for cheap. I look for value, but I’m a total contrarian as well, it’s in my genes. I like whatever everyone else hates. It’s true that we are all probably going to be drinking Coca-Cola twenty years from now, but is it any less true that we will still be in need of iron, steel, semiconductors, dry bulk shippers and yes, even banks and weird clothes for teenagers?
I think that what we are learning here is that even within this philosophically cohesive group, there is plenty of room for differentiation within the same basic approach. A lot of it has to do with how far from retirement you are, what your family obligations are, what your investment goal is, etc., etc., etc. I would never advise anyone on what stocks to buy, the ones I like fit me and only me or someone in a very similar circumstance.
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Someone was talking about what companies Buffett would invest in if he were running less money. He has always said he would be looking at very different things than what he looks at now. Yes he has to look at giants now but he has said he would be looking at small-caps and probably cigar-butts(stocks selling for less than net working capital). Berkshire Hath was such a company when he bought it as that is what he used to invest in with smaller capital. and special situations etc. No problem buying monsters like KO, MMM with options in my opinion to maximize return. The market looks to be still crashing you might be able to get KO at trailing PE of 8. big margin of safety
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screw DCF in my opinion. If your going to buy a large-cap it better have a big margin of safety. As Monish Pabrai basically says, if I have to use the DCF it probably isn’t a good enough price. Of course the balance sheet , fundi’s should be good and you should predict EPS for 5 or so yrs, haha 10 if your Buffett and figure what multiple it will trade for then off that EPS and figure your compound return.
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Speaking of large companies with large cash reserves and long records of solid returns, how come no one is talking about XOM??? was getitng clsoe to buying, and, after I do, i would appreciate y’all making ahuge run on it please!!
As for 3M, I looked at them decided to pass based on past performance. I hope for Joe’s sake I am wrong he makes a mint on it.
I would like others to expand on these small companies they are looking at and the story behind them, if they can share. I rarely if ever look at such companies, as I am ore of a safe and steady kind of investor, but I would be interested in hearing/learning about the “other” side of the investing world….
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Joes change in tactics has left me on the other side of the fence. If I did the same to the positions I hold I would suffer a big loss. Not only that but I dont have any valuations on any of the larger more reliable companies. I will have to do more study.
I think Joe is right. It makes sense to back the best horses offering the best odds.
cheers
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I tend to agree with Darren on ‘XOM’
Cash returned on invested capital – 12.3% median 98-07
FCF growth at 32.5% median 98-07
If FCF slows to just a 1/3 of what it has been for the last 10 years, the discounted cash flows valuation should be in the ballpark of 558,083,000,000. (cash growth rates of 10%, 5%, both 10 yrs, and a discount rate of 15%)
If FCF continues to grow as it did for the past 10 years, it could be estimated as worth 1.9 trillion, using cash growth rates of 32.5%, and 5% both for 10yrs, and discount rate of 15%. This gives per share fair value of around $340.
With the total valuation at 558 billion, per share value is around $100. With a price at 69, its selling at around 2/3 of full value, and this is if growth SLOWS by 2/3rds.
Does anybody tend to disagree with this valuation?, I’m open to constructive criticism as I am currently a student, and still attempting to grasp the big picture.
Thanks all!
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Joe,
You said: “I won’t be “way wrong” like I was with AEO”
Could you please share your thoughts on why your opinion of the business and the valuation of the future perspectives of AEO changed?
I know that AEO’s price is down roughly 60% from when you valuated and put it into the portfolio. But have you really been wrong on the future perspectives of AEO? Did something dramatically change in the business? Did the future really became cloudier?
In your post “Where Are We With AEO?” (about 2 month ago) you said “I have to say that, in my opinion, management is handling this downturn well…if not brilliantly” and you had good arguments for this. What did change in the past two month or which deeper insights into the company or the company’s business did you get?
Why aren’t you applying Phil Fisher’s 3-year-rule to this stock?
Many questions, but I anyhow got the impression that the currently generally negative situation is also starting to have an effect on your decisions.
I will keep on following your advise “Do As I Say, Not As I Do” (May 29) and can only give you the advise to re-read your “Where Are We With AEO?”-article.
Cheers,
Eric
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I will have to agree with Eric on that question..What happened within two months?? I mean the business as usual..Of course the bigger picture(economy & consumer spending) got screwed. So it dragged down the prices of every security including AEO. I agree that sales, margin & FCF will be down for the short term because of the lower consumer spending.. But people will be buying clothes in AEO in my view & the company will be around in the long run(5 to 10 years).
I am planning to stick with Phil’s 3 year rule & studying the business progress. After all Its 99% art as you mentioned 
..
Gopi
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Alex et al.
I am also a newbie at this, but I did the almost exact same thing. I figured a growth in free cash flow of 10% for the next ten years and then 5% after that. As you pointed out, thats 1/3 of the growth rate that they experienced in the last ten years.
I got a fair value (15% DCF) of about $103 per share . I like to use a 30% Margin of Safety on that, bringing me to a purchase price of about $72. Unfortunately, I also have a currency issue, as the Cdn dollar is what I earn and, for the short term, it’s down big time against the US dollar. I figure thats a short term thing and we’ll be back closer to par once the comoodity issues work themsleves out. So I have to work in some currency valuations also, to cover my butt when the Cdn dollar shoots back up and I am stuck with shares in US currency..
Of course, that will be a mute point when the Cdn dollar gets stronger than the US dollar and we come down and buy your fine country at a discount. ( that assumes the chinese don’t beat us to it) Hope y’all like pancakes and maple syrup!! *S* If not, hope y’all like dim sum….
So, now..what am I doing “wrong” here. This seems like a no-brainer, as they say in the vernacular. It can’t be this easy..I must be missing something here… I reduced growth by two thirds and took another 30% off that and still I can buy for less than I calculated. Are things that out of wack???
A request for someone smarter than me (not difficult) to straighten me out on this one.
Darren
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Interestingly, AEO just opened its first in Montreal in the heart of downtown St-Catherine Street at a time when the street’s flooded with vacant ex-clothing boutiques and shops.
We will have to see how this plays out in 3-10 years time, 14$ purchase may be solid… too bad Joe unloaded this one IMO too soon.
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The first thing you guys need to do with AEO is figure out if it’s in the top 2-3 in teen retailing and therefore likely to survive an extreme consumer contraction. The second thing you need to figure out is that even if it is and everything looks good, is it the best place for your investment dollars right now? I really don’t think Joe dumped it because it went down a lot or because of the scary market, I think he just saw a significantly (in his view) better place to put those dollars to work. Your opinion may differ and your mileage may vary. I have it on my radar, but frankly, I see better places to go right now, the status of the consumer is not a confidence builder right now.
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Joe made a logical argument concerning his portfolio changes, and I respect it. Time will tell whether they are correct. But I think g’s comments are accurate about gravitating toward those big Dow stocks versus a nimbler stock picking approach. Why not just buy the DIA and get the added diversification? Why bother reading 9000 ARs. To me this is the time for a stock picker to show his stuff – to buy quality businesses on the cheap not components of the World’s most famous index.
As for KO, the old goat has gotten in everyone’s head w/ this one. KO is yesterday’s news. The OG did so well with it because he bought before the bull market went crazy and management did a massive restructuring of a bloated enterprise. Those days are long gone. The Chinese don’t even like it. One simple fact. When I was a kid, we rode our bikes to the local convenience store after finishing up a baseball game or whatever and everyone of us kids bought a Coke or Pepsi. When was the last time you saw a kid drinking a coke? Case closed!
Conclusion: Should have stuck with AAPL rather than over thinking the whole thing.
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@ Phil, KO will still grow though this is concerning. Here’s your case closed part two maybe for the US. International growth I’d imagine would supplement.
“Beverage Digest reported that the total sales volume of soft drinks in the United States fell 0.6 percent in 2006, following a 0.2 percent decline in 2005. The industry sold 10.16 billion cases of soft drinks in 2006, down from 10.22 billion in 2005(reuters.com).”The carbonated soft drink industry has moved from roughly 3 percent growth in the 1990s to modest declines in the last two years,” Beverage Digest reported, saying the estimate included energy drinks, a very fast-growing segment.”
Someone mentioned just buying the market vs one of these mega giants. You know I was thinking about that and it makes sense. When KO, MMM get a valuation they more deserve the market will have rebounded. So, you could buy an ultra ETF of the S&P (SSO) that goes up 50% when the market goes up 25%. These giant companies aren’t going to grow earnings fast enough to get the same performance you can get in this ETF and you get way, way less externalities and uncertainty. If the market crashes or is flat for 2 yrs will KO MMM be much higher. I doubt it.
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I don’t think that I agree with the current FWallStreet approach for two reasons.
1. While huge companies like 3M, GE, KO and JNJ are trading at an apparent discount to their intrinsic value, they only seem that way when giving much weight to favorable earnings forecasts. I don’t know if these companies would still seem highly attractive if you placed more weight in your analysis on the possible downside of these companies (i.e earnings taking a major hit for even 1 or 2 years in the next decade, or even worse).
2. There are many smaller companies with strong balance sheets that are getting hammered in the market these days. Focusing on these companies at this time should be far more rewarding, and in my opinion, less risky than the mentioned companies.
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