Saturday, March 14, 2009

Intrinsic Investing Part III, School One, School Two, Cooked Goose, Yahoo News

Intrinsic Investing Part III

With the 9% rally in financial markets last week, we are left in two competing schools of thought.

School One: Suggests that stocks are incredibly beaten down, and are all on sale right now. That there are many companies that have a much higher intrinsic value than the current price dictates. That given a recovery... any type of recovery... these stocks could easily double or triple in value, especially if their earnings beat lowered analyst expectations. Additional liquidity will revive the consumer, banks will return to old lending practices, and credit markets are thawed. Moreover, Treasury Secretary Geithner's "Bad Bank" will simply wipe out all the toxic assets on bank balance sheets. We are on the road to recovery... Now is the time to buy!!!
Case in point would be the statements of Vadmir Pandit and Ken Lewis last week. Both CEO's hinted that their companies are returning to profitability. According to Pandit and his internally leaked memo, their first two months of 2009 have been profitable. Ken Lewis echoed similar views. Taken at face value, it appears as though these CEO's see opportunity.

School Two: In simple accounting terms, the assets must out-weigh the liabilities. This suggests that earnings and asset values determine a company's true worth. For a company to have value, it must have positive earnings on a consistent basis. Sure, there are times when the company may re-structure. Or, a company may just have a bad year or two. This differs from a company which has based its business model on unsustainable if not completely false premises, or simply made extremely poor investment decisions. See LEH, BSC, WM, or MER. In many cases, we (as in the investment community) have been led astray if not out-right lied to by analysts and company representatives alike. The question is, are they telling the truth this time?

The Goose is Cooked
As for me and my investment portfolio, I have made more positive than negative plays betting against companies if not their CEO's. The credibility factor is in play, and will continue to stay in play. While the easing of accounting rules... a moritorium on foreclosures... and initial signs that credit is thawing, I tend to error on caution. In many cases, companies have been allowed to create their own realities, and report these realities as fact. The difference between how things are, and how you wish them to be allows rationization. And rationalization means excusing actions and behaviors, or simply justifying a false interpretation of reality. That is the type of thinking that has led us to TYCO, MCI, and ENRON just to name a few. (For more information, please see the Theory of Cognitive Dissonance )

People like Bernie Madoff created their own reality... and many of the investors willingly believed the "too good to be true results." We know about Madoff. Are there others like Madoff? Until standardized accounting regulations are made and enforced by the powers that be, who can you trust? We are reminded that in many respects, Wall Street has caused its own goose to be cooked!!!

From Yahoo News:



The banks may not be dead, but they're still sick. So are those giant, complicated credit markets. JPMorgan analyst Thomas J. Lee noted that the markets for securities backed by residential and commercial mortgages have recently deteriorated to their worst levels since Lehman Brothers' bankruptcy.

The market needs a plan for these "toxic assets" -- either by selling them to private investors, or allowing banks to mark them differently. A failure by the government to deliver such a plan sparked a sell-off last month, and if investors don't get one soon, the market could be in for another tumble. Analysts aren't ruling out a Dow drop to 5,000, or an S&P decline to 500.

"We don't believe that the bear market's over yet," said Scott Fullman, director of derivatives investment strategy for WJB Capital Group in New York. Toxic assets "either need to come off the banks' balance sheets, or they need to improve on the banks' balance sheets."


Economies, like stock markets, don't decline in a straight line. The recent spate of better-than-expected retail sales data could be merely a short-term blip.

Sandeep Dahiya, a finance professor at Georgetown University's McDonough School of Business, said he wants to see three months of sustained increases in the Conference Board's consumer confidence index. It is currently at the lowest levels since the gauge started in the 1960s.

"Until that happens, I'm not willing to say this thing is behind us," he said.


A big chunk of last week's rally was driven by what's known as "short-covering" -- when investors buy stocks simply to offset short trades, in which an investor borrows a stock then sells it right away, hoping to buy the same shares back later at a lower price, thus profiting from the decline.

It's difficult to differentiate between short-covering and regular buying, but floor traders last week estimated that between 50 percent and 60 percent of Tuesday's 379-point jump in the Dow was due to short-covering. And a rally driven by short-covering can disappear quickly when a scary headline hits the wires.


The market fears something wildly unexpected could happen. The Sept. 11, 2001 terrorist attacks threw a wrench in the market's recovery following the bursting of the technology bubble. And an unintended consequence of addressing the Great Depression with protectionism in the 1930s was global trade war, which hampered the U.S. market's recovery.


Even if you didn't invest in Bernard Madoff's fund, you might still be an indirect victim. Trust in the markets took a major hit after his $65 billion Ponzi scheme was revealed last December. It took another blow when R. Allen Stanford's $8 billion scheme came out in February. Without trust, the stock market can't rise for long.


AX said...

We've seen this trick before, haven't we? For how long it sticks, who knows. Last summer's rally was over 2 months....but what's changed other than things getting worse. China's exports down 29%? Ours down 49%! Where is the spending going to come from to prop up our Ponzi economy? Enjoy deflation while it lasts, because when the switch gets reversed, it's going to happen fast.

Tiger Coach said...

Ax... Big Ben's notion of "weakening lending" standards is ludicrous. If he really thinks will work, I think Obama should pardon Madoff and put him in charge of the Fed. At least his scheme fooled everyone...