BY: WHITNEY TILSON and JOHN HEINS
“The only source of knowledge is experience,” said no less an authority than Albert Einstein. This is certainly true of investing, where your ability to learn from both successes and failures is a key determinant of how successful an investor you’ll be.
Thomas Gayner, of Markel Gayner Asset Management, puts it this way: “Having invested since I was a kid, I’ve lost money every single way it can be lost. The good thing is that by process of elimination, you can figure out how things work and how they don’t.”
While that sounds straightforward, the learning process for investors can often be complicated by human nature. One of the most basic psychological barriers to drawing useful lessons from our experiences comes from what psychologists call “self-attribution bias.” That is, we attribute good outcomes to our own prescience, wisdom and skill, whereas bad outcomes are caused by rotten luck.
So if your investment in cigarette maker Altria doubles, that merely confirms your prescient analysis. But if your Altria stake is cut in half, it occurs because of external factors beyond your control — overzealous regulators and half-baked juries, for example. If investors don’t recognize the true reasons behind good or bad outcomes, they learn little.
In preparation for a seminar that Whitney teaches prior to the Value Investing Congress investment conferences he hosts each May and November, he went through every investment he’d made in his career and grouped them into categories. He made every effort to stick to the facts and avoid selective interpretation of how he’d earned and lost money. He was surprised to find that he’d made money in 18 different types of investments.
Space won’t allow us to describe all 18 situations in one column, so we’ll discuss half of the money-making opportunities this month and the rest next month.
Out-of-favor blue chips. Even the world’s greatest companies encounter problems or otherwise fall out of favor. Correctly differentiating between those suffering temporary rather than permanent issues is the key to success here.
McDonald’s was a classic out-of-favor blue chip when it fell below $13 in early 2003 (thanks mainly to home-grown missteps). When new management aggressively tackled menu and franchise-relations problems, the company’s fortunes turned dramatically and the shares now trade above $65.
An example today is mass retailer Target (symbol TGT), whose shares have fallen from nearly $70 to below $50 over the past year as the U.S. economy and consumer spending have slowed. But the positive fundamentals of the company’s business remain intact, and we believe the stock is a good bet to double over the next few years as the economic environment improves.
Distressed industries. Buying a good company in a distressed industry is often a great way to make money. It would be hard to find a more distressed area today than financial companies with exposure to U.S. consumer spending, so it’s not surprising that the stock of American Express (AXP) has fallen roughly 40% from its 52-week high. This is an extraordinary business, but the company’s shares have always been too expensive for most value investors — until recently. While the company will no doubt face challenges for quite some time, we think the stock provides exceptional value at less than $40.
Turnarounds. Turning around a broken business is difficult and often takes much longer than expected — but when it occurs, a stock can rise many-fold. Our favorite turnaround situation today is Winn-Dixie (WINN), a deeply out-of-favor supermarket chain. Since the company emerged from bankruptcy in 2006, having shed half its stores and nearly all its debt, new management has done all the right things, such as renovating stores. Initially, the stock more than doubled, but weak consumer spending, especially in Florida, where 70% of Winn-Dixie stores are located, caused the stock to drop by more than 50%, to a recent $14. We think the turnaround story is still valid.
Overlooked small caps. Among the thousands of publicly traded U.S. stocks that analysts don’t cover are fine businesses that are cheap because either no one is paying attention to them or their stocks are thinly traded.
A good example is Weyco Group (WEYS), the maker of Florsheim Shoes. It’s a well-managed business that we invested in a few years ago after the company announced an exceptionally good acquisition. The stock has more than doubled, but so have earnings, so we still hold it.
Fallen growth angels. When growth companies stumble, growth and momentum investors often sell indiscriminately, which can be a great opportunity for value investors if — and it’s a big if — the high growth resumes or the stock falls so much that it’s a bargain even at lower growth levels.
Starbucks, which fell from $40 two years ago to around $15 today, is certainly a fallen growth angel. Whether it represents a buying opportunity is another matter, however. We’re not convinced that the company will ever return to its high growth rates of the past, and the stock isn’t yet priced to reflect this reality.
Growth at a Reasonable Price (GARP). High-quality growth businesses whose stocks haven’t fallen can also be excellent investments. They may not appear cheap by traditional valuation metrics, but the stocks may be worth it if they maintain their strong growth. McDonald’s is a good example of a GARP situation today: The stock isn’t cheap (it sells for about 19 times this year’s earnings estimates), but the company is reporting very strong sales and earnings growth, so investors will likely still do well from here.
Activism. Activist investing — in which an outsider leans on a company to change its policies — has been a hot area. The key is whether the activist’s proposal for creating value makes sense and whether there’s support for change. If the situation is favorable, great money can be made by investing alongside the activist.
Bookseller Borders Group (BGP) has seen its stock decline 75% from its high last fall. But we’re confident that the company, which is now for sale, will fetch a price meaningfully higher than today’s market value, partly because of the involvement of hedge fund Pershing Square Capital, which has an excellent track record as an activist.
Oddball companies. Some companies have economic characteristics that are very different from the typical company in their industry. As a result, analysts and investors may initially misunderstand them and misprice their stock. Classic examples are Southwest Airlines, Dell Computer and Kinder Morgan, all of which came to be industry leaders after a period when investors misread their prospects.
Let someone else do the investing. It can pay to let others do the investing for you — if you can invest with them at a reasonable price. One of the ways has been to buy Berkshire Hathaway (BRK-B) and let Warren Buffett work his investing magic on your behalf. Less-well-known vehicles include Leucadia National (LUK) and Alleghany Corp. (Y). Such companies go on sale from time to time, which we think is the case today with Berkshire, whose shares are down more than 20% from their high last December.
The list of ways to make — or lose — money in the stock market is ever-changing. Our hope is to add to this list of potentially lucrative opportunities forever. As Warren Buffett’s Berkshire Hathaway partner Charlie Munger likes to say, “If you don’t keep learning, other people will pass you by.”
Columnists Whitney Tilson and John Heins co-edit ValueInvestor Insight and SuperInvestor Insight Mutual
