Today is my birthday. I now have had a lot of practice with dealing with them and yet the melancholy...
Band's Contrarian Bets
10/15/2004 12:00 am EST
Combining a safety-first approach, with a value and contrarian strategy, Richard Band has developed one of the best financial newsletters around—the appropriately named, Profitable Investing. Here are his latest long-term contrarian buys.
"The theory of contrary investing is based on the idea that markets never do what too many people expect. In fact they can’t. What’s expected is already embedded in the prices. So it is surprises that move the market. If you want to stay ahead of the market and ahead of other investors, you’ve got to look for events that might surprise the crowd. Quite often, these are events that are the opposite of what the crowd is expecting. Therefore, we call them contrary events.
"There are some false understandings regarding contrary opinion. One that you sometimes hear is that the majority is always wrong. Not so. In fact, the majority opinion is right most of the time. The trend is your friend—most of the time— until it goes to an extreme. So a contrarian looks for those extreme situations where opinion is one-sided and the trend has exhausted itself. That is when you can expect a reversal. The closer a crowd is in expecting an event, the less likely it is to have the impact that the crowd is expecting. Often, you will see a favorite company report blowout earnings. But the stock drops. Newcomers to the market always find that frustrating. Why does that happen? Because the event was fully anticipated in the market. After the good news came out, everybody that could have bought had already bought. There was too much unanimity with too many people thinking the same way.
"There are opportunities in this market, as well as dangers. The opportunity is that we have a lot of stocks that are historically cheap, and as long as I can find stocks that I want to buy, I’m willing to be a player in the stock market. I am not a bear and I am not retreating. On the other hand, I see some dangers out there. As we look out over the next five, ten, or 15 years, we are going to see a long period in which price to earnings multiples for stocks in general decline. This is trend that is tied to the fact that our society is aging, and that as people age, they prefer to buy stocks with low p/e’s and dividend yields, as they're no longer willing to take the big risks that they took when they were younger.
"More and more people will be reaching their retirement and pre-retirement years, in which they become more conservative as investors. They start to move away from the high p/e growth stocks and they move more and more towards value stocks. This is a mega-trend that will dominate the investment markets for the next ten or 20 years. This is something that I will be building my portfolio around for a long time to come. Price to earnings multiples are already on a decline. In 2000, the S&P was selling for about 30 times earnings. Today it is at about 17 times operating earnings. As our population ages, the amount of money that people will be willing to pay for earnings is going to continue to contract. Eventually, I think we are going to see that number drop into the low teens, and perhaps some day, into the single digits. This doesn’t mean that the stock market will go down. If earnings keep rising, prices can go up. But it will be facing a headwind, as multiples are likely to be contracting.
"For 2005 and the years to come, the watchword will be ‘income.’ A dividend yield is something that you want to see in most all of your investments. If you go back over the past 20 or 25 years, even during the great bull market, you will find that dividend paying stocks outperformed—on aggregate— non-dividend paying stocks. I think that will be true to the nth degree as we go forward. Maybe once in a while, you can take a flyer with a non-dividend-paying stock. But for the most part, you want to own stocks that pay dividends. For my current portfolio, I’m looking at stocks that have above average dividends and sell at below average multiples.
"Kinder Care Morgan Energy Partners (KMP NYSE) is an energy play, but one that doesn’t require you to bet on a rise or a fall in the price of oil or natural gas. The company runs a pipeline business. They are the largest in the US. It’s like a toll taker. They collect money as the various producers of oil and gas and refined petroleum products ship their materials through the pipeline system. You can be a toll taker too, with Kinder Care. What a great growth story this has been. A $10,000 investment in Kinder in 1997—when the current management took over—has grown to $142,000. The dividend has been increased so many times since 1997, that if you had bought in 1997, you would now be earning 35% a year on your original money— without taking into account the appreciation on the shares. That’s what I love. I want a stock that can pay me a good dividend today and a better dividend tomorrow. It’s currently yielding about 6% and about 80% of that payout is tax-deferred. It’s a publicly traded partnership that you want to own outside of a retirement account. I’d like to buy this stock at $45 or less.
"What other area of value is there in this market? There are some interesting ones in the global telecom sector. If you look around the world, you’ll find a lot of well-run telecom companies where the stocks have been absolutely smashed as a result of the tech crash from 2000-20002. Many of those stocks are attractively priced right now. Some of the foreign telecoms are in better competitive position than those in the US; they have stronger monopolies and are a little cheaper. If you are looking for pockets of value in today’s market— where the stocks won’t go down in a period of multiple contraction, look oversees. BT Group (BTY NYSE), formerly known as British Telecom, sold at about $240 at the top of the boom and is now down to $33. The company has recovered dramatically from the telecom collapse. They are reducing their debt; at one time they had to omit the dividend. The stock is at a tremendous discount. It is trading at 11 times earnings and yielding about 4.7%. And thanks to our ally, Tony Blair, there is no British withholding tax anymore on dividends paid to US citizens. Now is a good time to be buying this stock.
"KT Corp. (KTC NYSE) is a little more aggressive. The company is in Korea, which is a rapidly growing market. It is paying 7%—one of the highest yields among all of the telecom stocks in the world. I believe in buying stocks that are being bought by smart people. Two of the smartest international money managers—both based here in the US—are buying FT Corp. Brandes Partners, which manages money for endowments and wealthy individuals, is probably the sharpest organization right now that focuses on international investment. The second is the famous Templeton organization. And Templeton and Brandes together own $1.5 billion of little KT. You can be sure that these folks—who are the smartest of the smart money— have done their research on the Korean telecom market and the political situation. And I love the 7% dividend. So I have some of my personal pension fund in this stock.
"I’d also look at Telefonos de Mexico (TMX NYSE). The company is run by a savvy guy named Carlos Slim, who is the wealthiest man in Mexico. He has directed TelMex into various acquisitions throughout Latin America that I think will give the company a new burst of growth in coming years. It’s yielding a little over 3%, so it’s a decent dividend yield. There is no withholding tax. The company buys back about $1 billion worth of its stock every year, so in addition to the good cash dividend, they buy back stock. Typically, companies that buy back stock and shrink the number of shares outstanding are good prospects for us to purchase. And, Brandes and Templeton are also investors in TelMex. They own over $2 billion worth of the stock.
"I’m also recommending a convertible bond issue issued by a big property & casualty company that is yielding 5%. St. Paul Travelers convertible of 2002 (TPK NYSE) trades just like a stock. It has a low face value of $25, unlike traditional bonds, which usually sell for face value of $1,000 and up. Why would you want to buy a property & casualty stock right now? They are all in the dumps due to four hurricanes in Florida. All of the stock are down. But what will they do once the mess is cleaned up? Once the reconstruction has been completed, the property & casualty companies are going to raise their rates, to make up for their losses. So this is a great opportunity for contrarians. Plus, with TPK you can get a 5% yield up front, and nice appreciation as this convertible bond goes up in price."
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