How to Profit in Uncertain Times
By Richard Gibbons March 19, 2008
We're living in uncertain times. Is the housing market only months away from recovery, or has the fall barely begun? Is the economy slowly sliding into recession, or have we seen the worst of it?
This is a trying time for investors. If you have no idea whether consumers will still be buying big-ticket items over the next few years, how can you possibly decide whether, say, Ford (NYSE: F) is a good investment?
Although it might seem contradictory, you can make uncertainty work for you. The most unpredictable stocks can sometimes be the best opportunities.
Flipping coins
Investors often equate unpredictability with risk, but these are two very different concepts.
For instance, suppose I offered to play a betting game with you. You'd give me a dollar. Then we'd flip a coin. If the coin came up heads, I'd give you $2. If it came up tails, I'd give you $10.
Now, this is a very uncertain game. In any flip, your profit varies dramatically from $1 to $9. But it's not a very risky game. There's no way for you to lose money. You'd have to be the witless descendant of subnormal baboons not to want to play.
Of course, the odds may not always be that good. But as respected value investor Mohnish Pabrai wrote in The Dhando Investor, you should aim for situations where the situation is at least "heads, I win; tails, I don't lose too much."
Profiting from uncertainty
Stocks sometimes offer a similar opportunity in which the outcome of a situation is unclear but not particularly risky. Regardless of what happens, the stock will do well.
For instance, think back to MasterCard's (NYSE: MA) IPO in the summer of 2006. At the time, the market was concerned about litigation. MasterCard had lost a merchant lawsuit in 2003 that was costing the company $100 million annually until 2012.
Profiting from uncertaintyStocks sometimes offer a similar opportunity in which the outcome of a situation is unclear but not particularly risky. Regardless of what happens, the stock will do well.
For instance, think back to MasterCard's (NYSE:) IPO in the summer of 2006. At the time, the market was concerned about litigation. MasterCard had lost a merchant lawsuit in 2003 that was costing the company $100 million annually until 2012.
What's more, MasterCard had for years prohibited financial institutions from issuing competing cards. This strategy helped keep out competition, but it also resulted in a big lawsuit from American Express (NYSE:) and Discover (NYSE: ) on charges of anticompetitive practices.
Investors were scared, because it was unclear how much the lawsuit would cost, but the number was likely north of a billion dollars. However, when Philip Durell, advisor of our Inside Value newsletter, looked at the situation, he noticed something strange.
If the litigation didn't result in a huge judgment against MasterCard, then the company was insanely undervalued. Yet if a big judgment did come down, then the stock was "only' very undervalued. Heads, we win. Tails, we win even more.
Naturally, he recommended the stock to subscribers at a price below $50. The lawsuit still hasn't been resolved, though Visa settled a similar lawsuit for $2.25 billion. The stock, however, is now trading for more than $200.
Roll the diceOften, this scenario arises simply because uncertainty drives the price of a stock to extremely low levels. Altria (NYSE: MO) periodically plummets because of fear over lawsuits, even though the lawsuits will probably never bankrupt the company. In fact, Altria has been one of the best long-term performers in the market, and the uncertainty has just provided buying opportunities.
Of course, when buying in unpredictable times, you have to make sure that, no matter what, you're unlikely to lose much. For instance, although MBIA (NYSE: MBI) looks cheap if the housing market recovers, it's not clear that the company won't end up diluting earnings per share if the economy continues to sputter.
Similarly, Capital One (NYSE: COF) will probably head out of the stratosphere if it hits its estimates over the next of couple years, but it's unclear how leveraged unsecured lenders will cope if the economy worsens.
The Foolish bottom lineThe key to investing in uncertain times is to focus particularly on undervalued stocks while you analyze all of the potential outcomes, including the downsides. You can't go wrong buying stocks that offer huge returns if things go right but stand to at least break even in a worst-case scenario.
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Friday
Buying Stock?
A $10,000 investment is worth more than $4.5 million today
Take Wal-Mart for example. Not long after Sam Walton figured out how to bring powerful consumer access to suburban and rural America, some forward-thinking investors grabbed up shares. The really smart ones held on tight...
Now to billions of people around the world, Wal-Mart is the place you go to buy tootsie rolls, a ping pong table, motor oil, diapers, a microwave, ice skates -- you name it, all at great prices.
What has Wal-Mart's stock done since 1980 (a full decade after it went public) through all kinds of up and down markets... all kinds of inflation... deflation... rising dollar... falling dollar... and a couple of wars?
With shares trading around $51 today, Wal-Mart has risen 467 times in value over the past 28 years. That's 25% annual growth -- every year for over a quarter century!
Let's face it, getting in on a blockbuster investment like Wal-Mart in 1980 was a life-changing event for early investors.
The same can be said for getting into Nike in 1987, just as that stock went on a historic run, making over 5,000% for its early investors.
And Starbucks went from zero to full-blown global phenomenon practically in the blink of an eye - another bonanza for early investors!
Companies like these don't come along too often. And that's precisely the reason for this email.
The customer is king
Did you know that the average company loses more than half its customers every 5 years? Why?
It's simple. Most companies start to think they're more important than their customers. And they get greedy, too. That's when they try to stick it to their customers in ways they don't think their customers will notice. I'm talking about excessive fees on things like hotel phone bills... rental-car gas charges... credit card fees, to name a few.
Or they cut customer benefits, while raising prices. What happens? Customers start to feel ripped off and they look for alternatives. And once they're gone, they're near impossible to get back.
That's just dumb. Yet it happens all the time.
Some companies, however, have kept the "customer experience" front and center. Remember the Starbucks example? Or take Apple for instance, they pride themselves on dreaming up what customers want before they know it...
Always a better product, always a better customer experience. And what has Apple's stock done? Shares have soared -- up 1,543% in the last 5 years.
Take Wal-Mart for example. Not long after Sam Walton figured out how to bring powerful consumer access to suburban and rural America, some forward-thinking investors grabbed up shares. The really smart ones held on tight...
Now to billions of people around the world, Wal-Mart is the place you go to buy tootsie rolls, a ping pong table, motor oil, diapers, a microwave, ice skates -- you name it, all at great prices.
What has Wal-Mart's stock done since 1980 (a full decade after it went public) through all kinds of up and down markets... all kinds of inflation... deflation... rising dollar... falling dollar... and a couple of wars?
With shares trading around $51 today, Wal-Mart has risen 467 times in value over the past 28 years. That's 25% annual growth -- every year for over a quarter century!
Let's face it, getting in on a blockbuster investment like Wal-Mart in 1980 was a life-changing event for early investors.
The same can be said for getting into Nike in 1987, just as that stock went on a historic run, making over 5,000% for its early investors.
And Starbucks went from zero to full-blown global phenomenon practically in the blink of an eye - another bonanza for early investors!
Companies like these don't come along too often. And that's precisely the reason for this email.
The customer is king
Did you know that the average company loses more than half its customers every 5 years? Why?
It's simple. Most companies start to think they're more important than their customers. And they get greedy, too. That's when they try to stick it to their customers in ways they don't think their customers will notice. I'm talking about excessive fees on things like hotel phone bills... rental-car gas charges... credit card fees, to name a few.
Or they cut customer benefits, while raising prices. What happens? Customers start to feel ripped off and they look for alternatives. And once they're gone, they're near impossible to get back.
That's just dumb. Yet it happens all the time.
Some companies, however, have kept the "customer experience" front and center. Remember the Starbucks example? Or take Apple for instance, they pride themselves on dreaming up what customers want before they know it...
Always a better product, always a better customer experience. And what has Apple's stock done? Shares have soared -- up 1,543% in the last 5 years.
Wednesday
How to bottom-fish for stocks
Here are some calculations to help you decide when the risk of buying a stock is worth it. If you'd rather not attempt the math, don't worry -- I'll do some of it for you.
By Jim Jubak
Tired of trying to figure out if the Jan. 22 low was the bottom for stocks? Whether the recent rally will hold or turn into a massive bear trap? Whether to buy now or wait until, well, until who knows when?
Today, I'm going to put you out of your misery and tell you when it's time to buy.
No, I'm not going to call a bottom for the stock market as a whole. (Cue the boo birds.) I don't think anyone is in a position to do that. What I'm going to do instead is show you how to calculate a fair-value price for an individual stock and how to use that to figure out when to buy. This method won't tell you when a stock has hit its absolute bottom, but it will tell you when the price is low enough and the potential return high enough to justify the risk of getting in too early.
It's not about calling a bottom but learning how to bottom-fish.
As guinea pigs, I'm going to use the stocks I picked in my Jan. 29 column, "10 stocks to buy after the bloodbath." And don't worry if you see this column veering toward the dreaded land of Math. I'll do all the hard work and give you fair-value prices for each of these 10 stocks at the end of the column without any heavy lifting on your part.
2 key numbers The simplest method for figuring out a fair value for a stock starts with the company's projected earnings for the next year and some estimate of a company's appropriate price-to-earnings, or P/E, ratio. Multiply the two and you've got what the stock should be worth in a year.
For example, Wall Street analysts, on average, expect Chevron (CVX, news, msgs), one of my 10 stocks for after the bloodbath, to earn $9.33 a share in 2008. Using the Feb. 15 P/E ratio of 9.4, a fair value for Chevron shares is $87.70. That's above the Feb. 15 close of $83.60 but only about 5% above that price. Holding for the rest of 2008 to make 5% (plus dividends), which is by no means guaranteed in a risky stock market and a slowing economy, isn't my idea of a great investment.
(A target price is different from fair value, in my opinion, because a target price takes into account market conditions, including investor sentiment and momentum. So a target price can be, for periods of a year or less, above or below fair value. You can make money, for example, buying above a fair-value price if the stock market is in a strong bull rally.)
Resting on assumptions Of course, this method is only as good as the two data points that go into it. The Wall Street earnings consensus can be wrong. In my example, though the average of the analyst estimates is $9.33 a share, the high is $10.75, and the low is $7.85. Somebody's wrong.
Or maybe the P/E ratio is out of line. Chevron trades at a P/E ratio of 9.4 now, but over the past 10 years it has traded at a P/E ratio as low as 7.8 and as high as 76.6.
The stock market rallied during the first couple of weeks of February, and seasonal stock-market patterns suggest the market should continue the upward trend. However, if stocks take a downturn, MSN Money's Jim Jubak says, it could be an indication we're still in a bear market.
You can see what a difference these assumptions make by going to the target-price page of the Stock Research Wizard on MSN Money. This tool will plug in the high, low and average earnings estimates and the current company and industry average P/E ratios, and then calculate a target price. The resulting prices for the next year range from $74 to $102 a share.
By Jim Jubak
Tired of trying to figure out if the Jan. 22 low was the bottom for stocks? Whether the recent rally will hold or turn into a massive bear trap? Whether to buy now or wait until, well, until who knows when?
Today, I'm going to put you out of your misery and tell you when it's time to buy.
No, I'm not going to call a bottom for the stock market as a whole. (Cue the boo birds.) I don't think anyone is in a position to do that. What I'm going to do instead is show you how to calculate a fair-value price for an individual stock and how to use that to figure out when to buy. This method won't tell you when a stock has hit its absolute bottom, but it will tell you when the price is low enough and the potential return high enough to justify the risk of getting in too early.
It's not about calling a bottom but learning how to bottom-fish.
As guinea pigs, I'm going to use the stocks I picked in my Jan. 29 column, "10 stocks to buy after the bloodbath." And don't worry if you see this column veering toward the dreaded land of Math. I'll do all the hard work and give you fair-value prices for each of these 10 stocks at the end of the column without any heavy lifting on your part.
2 key numbers The simplest method for figuring out a fair value for a stock starts with the company's projected earnings for the next year and some estimate of a company's appropriate price-to-earnings, or P/E, ratio. Multiply the two and you've got what the stock should be worth in a year.
For example, Wall Street analysts, on average, expect Chevron (CVX, news, msgs), one of my 10 stocks for after the bloodbath, to earn $9.33 a share in 2008. Using the Feb. 15 P/E ratio of 9.4, a fair value for Chevron shares is $87.70. That's above the Feb. 15 close of $83.60 but only about 5% above that price. Holding for the rest of 2008 to make 5% (plus dividends), which is by no means guaranteed in a risky stock market and a slowing economy, isn't my idea of a great investment.
(A target price is different from fair value, in my opinion, because a target price takes into account market conditions, including investor sentiment and momentum. So a target price can be, for periods of a year or less, above or below fair value. You can make money, for example, buying above a fair-value price if the stock market is in a strong bull rally.)
Resting on assumptions Of course, this method is only as good as the two data points that go into it. The Wall Street earnings consensus can be wrong. In my example, though the average of the analyst estimates is $9.33 a share, the high is $10.75, and the low is $7.85. Somebody's wrong.
Or maybe the P/E ratio is out of line. Chevron trades at a P/E ratio of 9.4 now, but over the past 10 years it has traded at a P/E ratio as low as 7.8 and as high as 76.6.
The stock market rallied during the first couple of weeks of February, and seasonal stock-market patterns suggest the market should continue the upward trend. However, if stocks take a downturn, MSN Money's Jim Jubak says, it could be an indication we're still in a bear market.
You can see what a difference these assumptions make by going to the target-price page of the Stock Research Wizard on MSN Money. This tool will plug in the high, low and average earnings estimates and the current company and industry average P/E ratios, and then calculate a target price. The resulting prices for the next year range from $74 to $102 a share.
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