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Your Only Edge with Large Cap Stocks is Valuation

March 10, 2014 | About:

The other day, I told you about my mistake of being an arm chair investor.

That is, just sitting at my desk, reading filings and believing I understood the business.

But today, I’m going to look at the flipside.

When it’s actually ok to be an arm chair investor.

You Have Absolutely ZERO Edge with Blue Chips Stocks

CONN’s Inc was a story about a small-mid cap company where you need to put in the extra work.

It’s under-followed, misunderstood, had solvable issues and cheap.

These are the stocks where you can get One Up On Wall Street.

But for blue chips, it’s never under followed and rarely misunderstood.

The minute something happens, you will be one of the last to know.

If you have special insight, that’s called insider trading.

Otherwise, it’s already been analyzed, scrutinized and argued to death.

That’s why when I invest in a company like Apple (AAPL) or Microsoft (MSFT), I don’t bother trying to predict what the next iPhone screen size is going to be or how well it will do in China. This is one of the times where it’s ok to be an arm chair investor. It’s better than spending days or weeks trying to find information that is totally useless in the end.

An article came out today on Seekingalpha talking about Apple’s role with new future 4K resolution screens. I have no idea how this has anything to do with Apple itself. Samsung has one out already for $40k. ASUS, LG, Sony and other manufacturers have their own too.

Just like that referenced article, everything has already been written to death so much that useless noise is spread with large caps.

Ultimately, with blue chips, the only two avenues you can focus on is finding companies with

  1. big but solvable issues or
  2. get it dirt cheap

Examples of Big Solvable Issues and Cheapness

Take a look at BP.

BP Gulf Oil Disaster

BP Gulf Oil Disaster

If you had iron guts, and managed to tune out the noise, this turned out to be a great investment.

Tokyo Electric Opportunity 1 Year after Freak Disaster

OSV guest author Evan wrote about the same thing recently but used net nets as an example.

In the article, he made two big points that are spot on

  1. a crisis opportunity is a terrible opportunity to waste
  2. you have to spot the fixable problems

Back to Big Solvable Issues and Cheapness

The only two avenues you can focus on is finding companies with

  1. big but solvable issues or
  2. get it dirt cheap

Both 1 and 2 end up pointing to valuation. Your only edge with large cap stocks is the price you pay.

A great investment opportunity occurs when a marvelous business encounters a one-time huge, but solvable problem

The biggest stock I own is Apple and when I wrote about Apple over a year ago, I just focused on the fundamentals and valuation.

My stance was that Apple was NOT worth the $460 it was trading at.

It was worth more.

Today, it’s priced at $530 which is a slight improvement but my stance now is that Apple is still not worth $530. It’s worth more.

Apple may not have the one-time huge solvable problem to take advantage of, but it does fit the second characteristic.

I’ll be doing a one year follow up on AAPL in the coming days so that you can see more of the details behind the valuation numbers below.

For now, here’s a quick look at the numbers.

I’m doing this quickly with the OSV Analyzer so the values may change slightly in the actual follow up in a few days. If you have the analyzer in front of you, try to figure out how I’m getting my numbers and tell me what your assumptions are. Should be a good quick valuation exercise.

Apple (AAPL) Fundamental Valuation

First some basic valuation ratios. I hope you can read my writing.

AAPL Valuation Ratios

AAPL Valuation Ratios | Click to Enlarge

When you look at the above numbers, the business still looks amazingly consistent and strong since 2008.

And here are the intrinsic value calculations using different valuation models. Using different valuation models helps you to look at different scenarios instead of getting so reliant on one method.

It’s important to keep things simple and you may think that using multiple fair value models is a useless effort. However, you don’t want to accidentally focus on the incorrect valuation technique or oversimplify.

AAPL intrinsic value numbers

AAPL Intrinsic Value Calculations – As of March 9, 2014

How to Value Stocks Since You Have Zero Edge for Large Caps

You can’t control disasters.

But you can only control the price you pay. Unless you know how to calculate what the fair value of a stock is, it’s pointless.

So use this valuation resource to either remind yourself how it’s done or get started today.

Here’s a free dashboard PDF report you can download from this blog post only simply by clicking one of the like or share button below.

About the author:

Jae Jun
Founder of Old School Value (http://www.oldschoolvalue.com) dedicated to offering the most complete and detailed stock valuation and analysis spreadsheet. Investing made easy by importing 10 years of financials and 5 quarterly statements directly to excel for your analysis needs. Save time, make smarter decisions and make more money.

Visit Jae Jun's Website


Rating: 4.0/5 (6 votes)

Voters:

Comments

Moses Larsen
Moses Larsen - 8 months ago

Jae, what do you think of SPLS? Big and solvable? Thanks for the article. Regards, RL

traderatwork
Traderatwork - 8 months ago

Jae, great info. What is your opinion about Black Berry? Big and solvable or too hard?

Adib Motiwala
Adib Motiwala - 8 months ago

I would say in addition to the valuation, the edge is patience or time arbitrage.

shaved_head_and_balls
Shaved_head_and_balls - 8 months ago

You cannot predict the success or failure of future Apple products. This should be obvious in the case of Apple. Its personal computers dwindled to niche status after being the category leader for years. In other words, you have no edge with Apple based on valuation. This is a speculative stock with the illusion (or delusion) of low valuation. Repeat after me, "I have no edge with ANY consumer technology stock because the future cash flow cannot be predicted with any degree of confidence."

Dr. Paul Price
Dr. Paul Price premium member - 8 months ago

The three most important factors in stock picking?

1) Valuation

2) Valuation

3) Valuation

KJHValue
KJHValue premium member - 8 months ago

Patience and true understanding of the underlying business are edges.

Jae Jun
Jae Jun - 8 months ago

Patience yes. True understanding for large caps? That's the area I don't agree. With small caps, yes.

xtddd
Xtddd - 8 months ago

individual investor's edge is small caps

batbeer2
Batbeer2 premium member - 8 months ago

>> But for blue chips, it’s never under followed and rarely misunderstood.

Yeah, they're well followed but I for one can't think of any blue chips that are not misunderstood. This probably explains why they get very cheap at times.

BP dropped because it wasn't well understood to begin with.

Same with Buffett's famous acquisition of American Express and the more recent HPQ dip.

In short, I think there is no such thing as a "valuation edge" if the stock is not misunderstood. It was the case with CONN some years ago and I think it is the case with IBM now.

Just some thoughts.

KJHValue
KJHValue premium member - 8 months ago

I get your point and agree that there are most certainly bigger edges in small caps, but I don't agree that large caps can't be misunderstood. I think there are plenty of Large Caps that get ignored or fall out of favor because of issues that aren't important to someone who understands the business better than the market. I think they are misunderstood or at least under appreciated more often than one would think.

Microsoft, Wells Fargo, Bank of America, Berkshire are a few examples of Large Caps that were extremely cheap over the last few years.

I guess I don't get your point that your only edge is valuation with large caps. It's not IMO. The market is extremely impatient... I am patient. Edge 1. I care about long term ROIC and cash flows... the market cares about quarterly earnings. Edge 2. Of course this also leads to cheap valuations, but I want to buy at cheap valuations regardless of cap size.

Again, I agree that your edge is bigger within the underfollowed small cap space, but there are still plenty of edges over the market in the large cap space. Mr. Market is extremely irrational, large or small.

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