Why is 30 my target for Gillette? Nice round number. It is not based on analysis to the last decimal point. Maybe its 33, maybe 27. I have some idea what it is worth, which I would put at 35-45, given today's interest rate environment (but I absolutely refuse to use the "Buffett methodology" of using the long bond rate as the discount rate. I use that plus a 5% risk premium. I also refuse to project a 10 year sustainable ROE greater than 25% even if the company has earned that in the past. I am very hesitant to use even that number. For example, Coke earns 50% or so on equity, but if you project that out 20 or 30 years you will find that Coke will be a very large percentage of the global economy. As Ayn Rand put it, when you come to a contradiction, check your premises.)
So maybe Gillette is within the arguable range of fair value, so why not buy now? Because a) I demand a margin of safety - I don't want to pay a fair price - I want to pay an unfair price. And so does Buffett. The idea is to pay a fair price to the seller, which is whatever they are willing to sell it to you for. Warren Buffett has not built his wealth by paying a fair price for what he has purchased. Gillette is down 30% from where it once traded, but that was loony-land. If it is just getting into the range where I can justify the price, why would I want to buy it there? I look for a 25% margin of safety even on great companies, and this IS clearly a great company. That tells me to wait. and b) the stock is still in free fall. With the market in the state it is in and Gillette looking very sick on the charts, why are you so sure it can't drop another 10 points given that it has already fallen 21 points from its high? When the stock was trading at 62 not long ago, we would have considered 41 inconceivable, at least this soon.
My point is that value investors by definition don't pay full value. Even we have gotten conditioned to expect to pay up for anything except dogs because all recent history is a speculative bull market. Step back to what value investing is really about, and you think, hey my money is in cash now. I'm negotiating a deal with Mr. Market, and I think I am in a better negotiating position than he is right about now. I will hold out on him. Maybe I'm wrong and the market surges up. So what do I lose? Ben Graham's first rule of investing is don't lose principal. And his second rule is don't forget the first rule. If I rush in on Gillette the first moment it looks remotely interesting I risk violating both rules.
I am sitting on 75% cash for a reason, and I am working on a wish list, but have no reason to buy the stocks tomorrow if they are not at my price. If I'm wrong and the market goes to 10,000 at year end, sure I'm frustrated, but I've still got my money. But if I am right that we are just at the start of a bear market, but succumb to the temptation to buy now, then I lose 30% as well as the opportunity to get in at the real low.
Jim |
