At the turn of the 20th century, Bernard Baruch moved from Camden, South Carolina, to New York City and started his career on Wall Street. He gained a reputation on Wall Street as the “Lone Wolf” because he kept to himself, acted on his own information, and didn’t rely on the rumor mill. By the time he was 30 years old, he was worth over $1 million ($26 million in 2010 dollars).
“Buy straw hats in the winter” is an old Wall Street proverb that has been attributed to Baruch. Its message still rings true today. The trick is to buy stocks when both demand and price are low and sell when demand and price are high. It’s as simple as that.
“Buy straw hats in the winter”
While the message is simple to understand, it’s not so easy to put into practice. It seems that investors find it hard to stand apart from the crowd. Recent studies in neuroscience suggest that real pain and social pain are felt in exactly the same places in the brain. When standing apart from the crowd, activity in both the anterior cingulate cortex and the insula kicks into high gear. Those are the two same areas that are activated when you hit your thumb with a hammer.
Investing in stocks over the past two years is an example of standing apart from the crowd. When the stock market bottomed in March 2009, both institutional and individual investors expected another move lower sometime in the near future. The crowd was avoiding stocks and piling into bonds.
Cash flows into domestic stock mutual funds highlight the aversion for equities. From the market bottom of March 2009 to December 2010, investors redeemed close to $108 billion from stock mutual funds. The crowd was redeeming when it should’ve been buying, and most investors missed out on one of the greatest rallies in stock market history. The S&P 500 soared 92% and was certainly the uncrowded trade and the place to be if you wanted a great return on your money.
I recently heard a financial analyst refer to this period as “ABS,” which stands for “anything but stocks.” While buying straw hats in winter makes sense and is easy to understand, it takes a lot of fortitude and discipline to stand apart — but it also offers the greatest rewards.
During the past three months, our selections for both the Prime Time and Special Situation portfolios would qualify as areas investors avoided. While the stocks we selected did not trade low enough to hit our price triggers, they still offered insight as to the kinds of companies we like to select.
Chevron (NYSE:CVX), Novartis (NYSE:NVS), and AstraZeneca (NYSE:AZN) are not high on many investors’ shopping lists. When we selected Chevron, the second-largest oil company in the U.S., our analysis revealed that the intrinsic value of the company was greater than the stock price. However, we still required a margin of safety and wanted to purchase it at a greater discount. The stock closed at $83.61 the day we published the October issue of Hidden Values Alert. Our buy price was $80, just 4% lower than was the closing price on October 15.
Unfortunately, the stock price never traded at our buy price and we missed the trade. Chevron closed on January 31, 2011, at $94.93, more than 11% higher than the close when we issued the recommendation. Sometimes we let one get away because we require a margin of safety that, in hindsight, should have been smaller. Our goal is to take layups and not three pointers.
Novartis and AstraZeneca are two companies in an industry that is so bearish that even the bears are bearish. Both companies are drug manufacturers that face patent losses and tough competition. We selected them because they are financially sound and according to our research are trading at discounts to their intrinsic value.
Giving ourselves an ample margin of safety, only AstraZeneca was added to the portfolio. The buy price for Novartis is above the trigger price. What is common to most, if not all, of our selections is that they are selling at low prices because the herd is selling. Keep in mind that we are trying to buy straw hats in winter when demand and prices are lowest. Sometimes we let a good one get away, and other times we get lucky and buy pretty close to the low.
The stock market environment we are currently in bodes well for value investors. Investors continue to shun stocks, and financially sound companies are trading at good if not great valuations. Buying the stocks that Wall Street is dumping into the unloved and unwanted pile is a good place to start looking for tomorrow’s winners.