Saturday, January 17, 2009

Game Plan for the Next Six Months/Negativity from Eric Savitz (Abelson's Twin?)/SEC Dropped the Ball on Bernie in 1992

The NYT ran a story about how the SEC had sufficient information to cause a reasonable person to investigate Bernie Madoff in 1992.  They of course let that opportunity  The Times does reveal the names of the individuals who failed the public, none of whom will talk to the press now.  The SEC had then more than adequate information to launch a full scale investigation of Madoff

Barron's had a favorable mention of the speech recognition software company Nuance Communications (NUAN), which is one of the smaller tech companies that I previously sold but continue to monitor (another short profitable trade bought in 1/08 on a break down, and sold early in 2/08 at over 18.5 on a daily spike 2/13/08)(again, I am keeping a daily blog now to keep track of why I did something like that trade) .  Its main consumer product is Dragon Naturally Speaking. I am interested in buying the shares back sometime in 2009, but not now.  I do become more interested in looking at it at less than $10.  

Admittedly, I am not much of a tech investor which is one reason that I still have my money without suffering much in 2000 to 2002.   I am also naturally adverse to the madness of crowds,  non-traditional methods to value companies, unreasonable assumptions about future growth, and parabolic moves in any asset class.  I remember back in 2000 that GE traded at over 55 with a  P/E of  somewhere over 40 assuming you excluded a lot of expenses which was the rage back then . I would no more pay 40 times earnings for a company like GE than I would buy a CMGI or a Cisco at 175 times "pro-forma" earnings which would have required the company to grow into the GDP of the U.S. in a decade or so to justify the price paid for that business in 2000.  What ever happened to the law of large numbers? It was all a just a bunch of foolishness.  Okay, so that is where I am coming from when I read Eric Savitz's blog in Barron's whose negativity on the tech sector reeks from virtually all of his columns.  Possibly, there is something in the air at Barron's headquarters.    As everyone already knows, Intel is going to have a bad year in 2009, so Eric assumes that anyone now buying Intel at 13 or lower is simply gambling and ignoring all the bad news. He does not see any evidence right now of a turnaround in chip demand.  Well, of course, that is true now but has the demand for processors evaporated or merely been postponed?  Do you value a company based on what may admittedly be a bad year and assume a continuation of its worst year for the indefinite future? This is what is happening now, not only to Intel, but virtually every major company in the world.  Or, is it rational to assume, due to economic downturns, at least two bad years for every eight to ten good ones, and then price the stock with those expectations?  Oddly, this does not happen even though it would be rational to do so based on history.  Boom times are followed by a bust, and we are having a really good one now.  Does a rational investor use the pricing given to the company by those possessed by the same worldview and spirit of Eric Savitz which apparently means avoiding purchasing any shares when the stock of a major company like Intel has fallen to lows not seen in more than a decade?  I do not view the buyers of Intel as being Pollyanish, or gambling, or ignoring the bad news.  Instead, they are doing what all investors should be doing at all times.  A prudent investor will wait to invest when the pricing of the stock suggests an economic downturn will continue for years, and then sell -or at least significantly reduce- stock holdings when the reasonably foreseeable future is priced into the stock, particularly when the price can only be reasonably justified by a growth rate continuing at the same rate as the best year or years the company has ever had into the indefinite future and putting a high multiple on that level of growth.  Basically, this is not news but it might as well be a revelation.  There are few companies that have maintained a 20% compounded growth rate for every year over an entire decade.  Microsoft was the only one to do that to my knowledge.   So valuing a company based on that kind of assumption is just foolish.  Valuing a company like Intel that is going to have a down year, as  if it will never have earnings growth again, is equally foolish.  The good is melded with the bad and then a valuation is placed.  Yes, easier said than done.  So, I would not be negative about buying when valuations are extremely depressed due to a well recognized and obvious economic downturn.

The problem is when to start investing.  There can be no clear and universal answer.  This downturn is the worst in my lifetime and the government response to it is unprecedented. And,the most that I can say about the government response to date is that it is costing a great deal of money and working only in the sense that it avoided the Great Depression II starting in September 2008 which is where we were headed without a doubt.    Thus, I do believe that you can not rely on benchmarks from previous downturns and less severe downturns.  One guideline that I use now is for the VIX to return to below 20 and stay below 20 for at least 3 months. I explain this indicator in several prior posts, mostly in bit and pieces, including the following:.

Another guideline is to wait for one year into the recession and then start back into the stock position. I am currently using both guidelines by allowing myself to invest cash flow back into stocks but withholding the bulk of my cash position until I receive my VIX signal. 

Then, I have to decide where are my best long term opportunities with the limited amount of cash that I will allow myself to invest now.  I have ruled out buying retailers and restaurants.  I am not going to buy companies with high labor costs and large capital requirements such as an auto or steel company.  Someone else can be brave with the banks and their preferred stocks and AIG bonds.  I want to focus mostly on companies with good balance sheets and preferably paying a dividend.  I want to spread the money around, never buying a full position in any security at one time or over a one quarter period. I will take my time given the uncertainty about the depth and length of this recession.  I have already positioned myself in a large number of quality bonds and bond ETFs, as well as many other income producing securities.  Cash flow into the accounts is both constant and steady.  So I am positioned to start my accumulation of common stocks again from where I am now, and have been since 2007- seriously under-allocated in common stocks. 

The areas that I have decided to concentrate on for just the next six months are as follows:

1.  Large Cap Tech Companies with solid franchises, a history of innovation, selling at depressed historical valuations-frequently at lows last seen in the mid-1990s, and possessing  solid balance sheets with a lot of cash;  

2.  Energy companies that provide a good dividend yield with dividends paid in cash rather than reinvested to buy additional shares; 

3.  Small cap stocks with appealing risk/reward characteristics at their current depressed prices, focusing on those less dependent on economic cycles for success;  

4. Increasing my exposure to commodities gradually;

5. Electric and gas utilities; and

6. Adding about $500 a month to an international mutual fund where most of the position was sold prior to 2008. 

Since I am only using cash flow, this means slow and steady with small scattered purchases.  

Say you have no idea where Intel will be in the next six months or a year.  It may be at 8 or 16 a year from now.  Within the next five years, will the stock rise again and ultimately hit 25 at some point in five years?  If you believe that is a good possibility even probable, then a buy at 12 1/2 would double your money within 5 years, yielding close to a 15% annualized return plus a dividend that is currently 4% based on the last price.  INTC Stock Quote - Intel Corporation Stock Quote - INTC Quote - INTC Stock Price  I calculated the return using moneychimp.The Rule of 72 (with calculator)

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