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Waiting for the Perfect Pitch
Posted by: Charles Mizrahi (IP Logged)
Date: September 4, 2013 01:31PM
During the months preceding the market low in March 2009, there was plenty of low-hanging fruit to pick — financially sound companies that were trading at bargain prices.
After I researched a company and was about to recommend it in one of our portfolios, I checked and double checked my numbers because I thought I had made a mistake. Mr. Market was offering these companies for a fraction of their worth — which I found hard to believe.
I sent an email to a colleague and asked whether he’d go over my work to see if I had made a mistake. His response: “Nope, you’re right. That’s what stock prices sell for at market bottoms.”
Title: Strong & Cheap
Companies that had rock-solid balance sheets, little to no debt and good/great businesses were there for the taking. Here are just five of the big-cap stocks we bought just prior to the market low:
Note: Shareholder equity/Total Assets (SE/TA). Ben Graham stated that companies that have a SE/TA ratio of .50 or greater, were to be considered financially sound.
Since the March 9, 2009, market low, the S&P 500 index has soared to new highs, up more than 160%. Needless to say, there isn’t as much low-hanging fruit to pick at these price levels.
Our approach is a two-pronged one: we want to buy only financially sound companies when they are trading at attractive valuations. During bull markets that isn’t always so easy.
It’s not hard to find financially sound companies—that’s the easy part. The stocks in the table below all have strong balance sheets, are leaders in their industries and are continuing to increase their revenue and earnings.
Strong but Not Cheap
We would love to own all the companies in the table, but only if we can buy them at an attractive price. Because a great business bought at too high a price usually yields terrible returns. One of the most important factors in achieving high returns is the price paid. An old Wall Street adage states, “A stock bought right is half sold.”
Wait for the Fat Pitch
Boston Red Sox outfielder Ted Williams was the last baseball player to have a batting average of .400. In 1941, Williams batted .406, and since then, only four players have hit as high as .380. Many baseball historians say that Williams’ record will never be broken.
Investors can learn a lot about investing from him.
Williams had an analytical mind and was a disciplined hitter. He estimated his batting average in each area of the strike zone and would swing only when the ball was in the area where he had the highest probability of getting a hit.
Ted Williams’ Strike Zone
He calculated that if the ball were thrown right down the middle (red zone), he would have a .400 batting average. If he swung at pitches in the lower-right or left-hand corner of the strike zone, he figured his average would plunge. The differential is extreme. In his best zone he hit .400, and in his worst zones he hit just .230, for a difference of .170.
Baseball historians have surmised that there were seasons when Williams could’ve notched another season of hitting .400. Instead, Williams refused to expand his strike zone. He would rather walk than swing at a pitch that could lower his average.
His analytical mind and discipline, along with a great swing, made him the last player to hit .400.
Advice for Investors
Williams’ approach to hitting is very similar to our approach to investing. It too involves discipline coupled with analysis.
We don’t use a strike zone as our guide and swing only at the pitches down the middle. Instead, we use a bull’s-eye and invest in only those stocks that are financially sound trading at bargain prices. Any stocks that pass one but not the other criterion we don’t invest in.
At the end of the day, after we find financially sound companies, it comes down to the price we pay. Over the past few months it has become increasingly difficult to find financially sound companies trading at bargain prices. The recent rise of the stock market has left very few stocks in bargain price territory. For now, the low-hanging fruit has already been picked.
Howard Marks of Oaktree Capital said:
The greatest risk doesn’t come from low quality or high volatility. It comes from paying prices that are too high. This isn’t a theoretical risk; it’s very real.
As long as we continue to buy financially sound companies trading at bargain prices, we’re confident we’ll keep hitting the bull’s-eye. All it requires now is discipline and patience.
Stocks Discussed: SPY, DJI, QQQ,
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