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Is It Time to Start Being Cautious??

February 19, 2013 | About:
whopper investments

whopper investments

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A couple of days ago over on twitter, I tweeted this article and wondered if it was a sign of a market top. To save you the trouble of reading it, here’s a quick summary: A 16-year-old actress is day trading on technicals and momentum in her spare time, and the article wonders if she’s the next Buffett. We’ve all heard stories along the line of, “When shoes shiners and taxi drivers start giving out stock tips, you know the markets are getting frothy.” In my mind, this story is probably even worse than those, though obviously not on the same scale!

So with that in mind, I thought I’d do a quick comment on my thoughts on the state of the markets.

To review, I’m generally a pretty bullish guy. I can remember when I was in college in 2008 and 2009, desperately waiting for my next paycheck to get deposited so that I could put more money in the markets as they were crashing. Unfortunately, at that time I was just started out and buying mainly large cap stocks, so while I made good money in the end, it was not as much as I likely could have made buying small caps.

More recently, in 2011 I put up a post entitled “Don’t Panic!” that argued for buying stocks in the wake of the mini-crash from the U.S. downgrade. And in 2012 I put up a post discussing the IPO craze and how the huge increase in IPOs and, in particular, Oaktree’s IPO could signal markets were starting to get a bit frothy. Despite that, I felt there were plenty of values to be found in stocks.

But now, it’s getting more difficult to find value. Stocks continue to run up, and there’s not much left on my watch list that’s anywhere close to its 52-week low.

Can you still find value? Yes, it’s out there. But I think it’s coming in a different form. Previously, there were companies like JCTCF selling for 5 or 6x earnings. Insiders owned a nice chunk of shares, the balance sheet was strong, and they were buying back shares hand over fist. Everything was aligned very nicely, and it would have taken a doomsday scenario for investors to lose money investing in the company.

Now, I’m finding more value in stocks with a lot of hair on them. These are stocks where it’s almost impossible to argue they’re trading for less than the sum of their parts or asset value, but there’s questions around management intentions. Pay might be too high, or the controlling shareholders might be pretty dismissive of minority shareholders. Reading (RDI) comes to mind, with their related party transactions and high management pay, but there are some others that I’m currently researching with much worse insider transactions and treatment of minority shareholders, and I’ll be sure to post them soon.

Is there good news? Sure. Stocks still look cheap relative to alternatives like bonds or cash, and there’s still plenty of cash on the sideline and fears to overcome (mainly, slow growth and debt fears). Traditionally, big market tops happen when people completely ignore downside risks and pretend there’s nothing that could go wrong in the world, and it’s tough to argue that’s the case today.

Bottom line: There’s value to be found out there, but you need to dig deep. Stay wary, and don’t be scared of selling stocks that are at fair value to raise cash.

Disclosure: Long JCTCF, RDI


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Comments

tonyg34
Tonyg34 - 1 year ago
it always time to be cautious, this real money at play; think about how many hours of labour you'd have to work to recover a 10% loss on your portfolio (answers will vary).

(IMO) The kid daytrading is totally different than the late 90's silicon valley boom when chauffeurs were betting on inside tips, its really a story about the change in how trading takes place and the tools available online to facilitate learning and trading, and not really about joining the gold rush. When kids start dropping out of school to "play" the stockmarket, like college kids that dropped out to play online poker back in 06, now that would be a powerful indicator!
ramands123
Ramands123 - 1 year ago


I would aggree to that. For all the potential downside risks this market is overpriced on a risk adjusted basis. Well there is merit to relative attractiveness of stocks , but any major bad news could trigger selling especially when memories of 2008 and 2001 are very fresh on investors mind.
Matt Blecker
Matt Blecker premium member - 1 year ago
Whopper,

Great website. I appreciate your in-depth analysis. I would not say it is time to be cautious, as I do not think the domestic market is significantly overvalued. But while I would not say it is time to be cautious, I would say it it time to be patient, as obviously there are not nearly as many attractively valued securities as there were in the summer of 2011.

While there are many overvalued stocks in this market, I am finding many securities that are moderately below fair value, but do not carry a big enough discount to intrinsic value to pull the trigger. One example is Wal-Mart. Based on simple projections for revenue growth, operating margins, share buybacks, etc...I believe Wal-Mart can deliver a total return (including dividends) of about 10% per annum for the next five years from today's level. The same could be said for many high quality blue chips. Would I sell Wal-Mart if I held it considering I think it can deliver a 10% return per annum the next five years while risk-free securities offer nothing? No. But I would not buy more until there is a greater margin of safety and the projected return for the next five years increases to say 13-15%. This decision is very tough. If you sell you have more money to buy Wal-Mart if the stock corrects. But if the stock or market never correct much and steadily move upward over the next few years, you would have been better off buying than leaving your money in risk-free securities earning nothing.

I think the key is to determine what rate of return is acceptable for the risk you are taking. For a high quality security like Wal-Mart or Pfizer purchasing with a projected rate of return of 13% might be acceptable while on a riskier security you might demand a much higher return. In terms of what to do if you already own a security, say in the case of Wal-Mart, you might hold until the projected total return dips below 6 or 7% as that might be a level where holding more cash and waiting is more acceptable. It all depends on the investor and their goals, risk tolerance, time horizon, etc...

I tend to be a very long-term patient value investor like you and am holding 16 securities which I believe are undervalued. I own one net-net with a market cap below 50 million, 3 European stocks, but also several higher quality U.S. large cap stocks.

I think the summer of 2011 will be seen as the second best buying opportunity of our lifetime next to March of 2009. I purchased more than 50% of the 16 securities I currently hold during that correction, as well as several which I have already sold. While I only bought 5 throughout all of 2012 and only 1 so far this year. I have certainly made my mistakes as I took two losses last year of roughly 20% in each security in Targacept and Best Buy. I also have a cost basis in the high teens in Hewlett Packard. But I have also had my successes, as I have realized gains of 50% or more in a short time span in stocks such as LyondellBasell, Whirlpool, Pfizer, Seagate, MasterCard, Travelers, CVS Caremark, and Google. Several of those I wish I held longer, and a few I realized I sold too early and underestimated the intrinsic value.

This is a time to patiently hold securities you still believe to be undervalued, even if they may only be 25-30% below intrinsic value versus 40% or more when you purchased them. But also hold some cash to buy more of existing holdings at better values and for new investment opportunities. Having the discipline of buying enough below intrinsic value is also key in this environment. If your goal is to buy 40% below intrinsic value after you have thoroughly researched a security and you think it is currently selling at 30% below intrinsic value, either wait patiently, or buy a little and leave cash to buy at lower levels. That is exactly what I did with the one security I bought this year. I had not purchased a new security in almost a year so I was almost overjoyed to find one I had thoroughly researched selling 45% below my base estimate of intrinsic value. However I assigned a bit more risk to this security than normal and wanted to by 50% or more below intrinsic value. So I bought half of my target amount and will buy more at lower levels. If those lower levels are never seen I will be happy with the shares I have already purchased.

I would love to hear further thoughts from you and others on gurufocus. Thanks again for the valuable information on your website.

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