Posted 8/2/2002
Jubak's Journal
Are you ready to bottom fish with Buffett?
A not-so-random walk through the minds of bottom fishers reveals a deep strain of pessimism. That said, I’ve found three sunken companies worth a hard look.
By Jim Jubak
Warren Buffett’s doing it. So are William Miller, Martin Whitman and the buyout team at Hicks, Muse, Tate & Furst.
Yep, even before the impressive rally of the last few days, the deep value investors were out snapping up the busted, the distressed and the despised. They’ve bought wholesale phone service providers, natural gas pipelines and telecommunications equipment makers.
Itching to follow their example? This is the point in a long bear market where the impulse to go bottom fishing can get downright overpowering. Prices are low. No, check that. Prices are ridiculously low in comparison to where they stood not just two years ago but even at the beginning of 2002. We all know the case histories of investors who made a killing by buying a despised stock at the bottom. Didn’t that Saudi prince make a gazillion dollars buying Citibank -- now Citigroup (C, news, msgs) -- when everybody thought it was going bust? What would be sweeter than making up some of the losses of the last two-and-a-half years with profits from the battered shares of the very companies that produced those losses in the first place?Check out your options.
Record low rates
could save you a bundle.
And finally, if Buffett and the others are buying, doesn’t that mean we’ve hit the bottom in this long bear market. And isn’t the smart thing to do to go bottom fishing yourself?
Asking for disappointment
Unfortunately, I don’t think most investors are pessimistic enough to be successful bottom fishers. Going bottom fishing with an ounce of optimism in your soul is asking for disappointment. And nothing about bottom fishing is more misleading than the idea that the busy deal-making of these investors is calling a market bottom.
So here’s how to answer the question, “Are you ready to be a bottom fisher?” -- plus suggestions for how to invest if you can summon the requisite patience and pessimism.
Bottom fishers are the most pessimistic of all investors who are long stocks. I know that description goes against the conventional wisdom, but I think it’s the essential point to grasp if you want to understand what bottom fishing signals and how to profit from it.
Now, of course, bottom fishers are at some level optimists, like all investors who buy stocks on the long side of the market. Everyone who invests long -- as opposed to going short -- does so in the belief that stock purchased today will be worth more tomorrow.
But within that optimistic framework, bottom fishers are deeply pessimistic, especially in their reading of human abilities and human nature.
Real bottom fishers can’t see the bottom
Bottom fishers, for example, are deeply skeptical of anyone’s ability to call a bottom in the market. Scan the writings of articulate bottom fishers like Buffett or Third Avenue Funds' Martin Whitman and you’ll find the repeated refrain of fallibility: I cannot predict the short-term movement of stock prices or pick the bottom of any market, these very successful investors say. In his most recent semiannual report to shareholders of his mutual funds, Whitman put it this way: “As far as I can tell, near-term prices for common stocks in non-arbitrage situations will continue to be a ‘random walk.’”
Burton Gordon Malkiel, the author of "A Random Walk Down Wall Street," about the unpredictability of stock prices, couldn’t have put it any better himself.
But I think the bottom fisher’s pessimism about the ability of anyone to pick stocks profitably goes well beyond this traditional doubt. Bottom fishers emphasize the likelihood that any investor will make mistakes in evaluating a stock. It’s human nature to get it wrong -- with great frequency.
That’s why bottom fishers emphasize buying assets at extremely low prices. Getting a dollar of assets for 25 cents certainly minimizes the damage that will result if the investor gets it wrong. And buying at such a deep discount means that an investor can get a lot about any stock wrong and still make a profit. Whitman roughly managed to break even in his investment in Exodus Communications, something I’d certainly like to be able to say. The gambit worked because he bought the senior debt so cheaply that even the company’s bankruptcy filing and eventual liquidation didn’t hurt much.
Bottom fishers are equally as pessimistic about the ability of other investors -- the stock market in general -- to recognize value in a stock or asset until it slaps them in the face. In this, they’re at the opposite pole from those optimistic investors who buy Microsoft (MSFT, news, msgs) at $48 in the belief that upcoming earnings reports will validate the company’s value. (Microsoft is the parent of MSN Money).
Alternative vehicles
Bottom fishers, on the other hand, firmly believe that an undervalued asset can stay undervalued for a long, long time. The emotional blinders blocking wider view of a stock’s true value don’t have to come off this quarter, or next, or indeed in any year in the near future.
That’s why deep value investors so often look past the common stock of a company to find alternative vehicles that will pay them while they wait for the market to come around. For example, I wrote in my column, “Another lesson from Warren Buffett,” about Buffett’s preference for the convertible bonds (paying 9% interest) of Level 3 Communications (LVLT, news, msgs) over the company’s common stock. Whitman’s investment in Pacific Gas & Electric mortgage bonds in the middle of last year’s energy crisis fits into the same category.
Looked at from this perspective, investments by bottom fishers in the current market aren’t exactly a call of the bottom. They’re more in the nature of a judgment that this or that asset is cheap enough to provide reasonable safety. The moves hedge against mistakes and provide a solid upside during a potentially long recovery period.
It’s typical to say that a successful bottom fisher must combine deep reserves of patience with extraordinary analytical skills that uncover value where no one else sees it.
To those traits I’d add:
An extraordinary humility about those very same analytical skills. (The bottom fisher knows that he or she will often get it wrong.)
A belief that no one can call the turn in markets or in individual stocks.
A full recognition of how long it can take for the market to recognize value.
An understanding that there’s no way to force the market to recognize value.
3 fish worth a look
If you have these six traits (patience and analytical skills, plus the four I’ve just numbered), you may be ready to do some bottom fishing. If you are, here are three situations that are worth a look.
Flextronics International (FLEX, news, msgs). This contract electronics manufacturer has been crushed as the industries it serves have headed south. But with a debt-to-equity ratio of just .19, Flextronics looks like it will survive the downturn. And in the upturn, whenever it comes, Flextronics will pick up even more business as the trend toward outsourced manufacturing continues to gain speed. (For more on why Flextronics should profit from a “profit-less recovery,” see my March 26 column, “5 stocks that profit from a profit crunch.”)
Lucent Technologies (LU, news, msgs). Lucent isn’t out of the woods, and the stock isn’t without risk. But at less than $2 a share, it’s worth a look here. The company is still cutting workers in an effort to bring its size down to match its diminished markets, and I’m pretty sure that even the latest round of cuts won’t be the last. But the balance sheet now looks healthy enough that the company stands a good chance of escaping financial default. The toughest question for Lucent right now concerns its technology: You can make a good case that Lucent is either, 1) positioned in the wrong technologies (in TDMA wireless, for example), or 2) bringing to market an impressive set of new products that will enable it to gain market share. Investors who believe alternative #1 should stay away. Those on the fence should watch for news that significant customers are adopting Lucent’s new gear.
Nvidia (NVDA, news, msgs). Almost certainly too early, but it bears watching. Nvidia just issued a truly stunning warning of massively lower revenue and earnings for the next quarter, and investors should definitely remember the cockroach rule of investing: When you see one cockroach, you can be sure there are many more in hiding. Warnings like this one from Nvidia are typically followed by more bad news. But in all the turmoil, remember that this is the market leader in computer graphics chips and that some of the current weakness simply stems from normal product cycle woes that are magnified by the bear market. At some point, this gets cheap enough to deserve casting a line.
When thinking about any of these or other bottom-fishing opportunities, please remember that we’re still in a bear market until proven otherwise, and that I’m not calling a bottom in the market or in these stocks.
It’s then that you understand if you’re really ready to be a bottom fisher. |
