13 Safe Stocks in a Return to the 1970s 11 comments
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Technicians tell you there is a double-bottom before a stock starts rising. For those of us who are not pure techs, I’d like to propose that there is a double-bottom to market sentiment. And we are about to turn the corner on sentiment, albeit not in the way you might think.
The dictum that I wrote regarding Santelli’s Rant a few days ago can be found here. In that article, I quoted an email I wrote to my clients and posted called “Paper Is Dead”. Monday, I resurrected another email I wrote to clients, on October 9, 2008, entitled…
“One Caution: Back to the Seventies”
Oct 9, 2008 – Gents: I have not seen ANYONE talk about this. Not ANYONE.
When I was a kid, I’m talking ages 12-15, it was back in the late 1970s. My dad would bring home his Wall Street Journal, and I’d read the “B” section (stocks then) to spot good stocks. I recall that it was rare to see a PE multiple that was above 12. Most PE’s ranged 7X to 10X.
My dad said that stocks were at those multiples because they were less secure than bonds. While bonds were at 12% per year (and you’d get actual coupons, too), stocks were “yielding” more, since they were a second bet compared to the company’s bonds.
Per Dad’s rule, a stock’s “Yield” would be the numeral one, divided by the stock’s PE. Alcoa (AA), whose bonds were at 12%, had a stock multiple of 6 or 7. Take my dad’s formula of one divided by 6, and you get 16.7%. Stocks had to yield higher than bonds, in Dad’s world.
Around 1983, this flipped around. Bonds yielded 8.2%, but a company’s EPS multiple became, let’s say, 17S, or Dad’s “stock yield” of 5.9%.
Yes, with a stock you get upside potential. And when times are great, where do you want to be… fixed in a bond, or owning a go-go company in a go-go world?
Later on from my dad’s 1970s, mutual funds became prevalent, the market became a televised game, and our engineers were lured to the Street. The mantra: everyone must be in stocks. Further, easy money meant that the Street found new ways to pour new/created money into stocks (hedge funds, margin buying expansion).
I wonder now if we’re in for what I will call: The Great Multiple Compression.
Global de-leveraging may mean that we won’t see a global revolution / idea / productivity gain like the Internet for years, except maybe in a select industry like “green”.
It seems likely that over the next few years, my dad’s rule will hold. It will be far more common for PE multiples to be in the singles, rather than the teens.
That is why you should be looking at companies:
a. that reliably will be in business for a decade or more;
b. whose PE’s today are in the low teens or singles;
c. whose products are demanded by CONSUMERS; and
d. if you can get a good dividend, so much the better.
Folks, I am not prescient by any stretch: I own PBR at $34, XOM at $86, FXI at $33. But when we start to turn the corner on Sentiment, this will provide some opportunity for profit given the thesis above (admittedly, all my own thoughts).
God forbid we act like Motley Fools on these pages, but it may be that Mr. Buffett was onto something back in the 1970s, that he has not the stomach for – or has not the need for, given his 15% preferred returns from icons – these days.
Back to the Seventies: The Screen
The screen I propose to you follows:
- Consumer or consumer-support plays that have little to no near-term maturing debt relative to near-term cash flows, or generally “patient” capital structures. Here I propose Intel (INTC), Cisco (CSCO), Nestle (NSRGY.PK), and Hershey (HSY).
- Infrastructure and cyclicals that actually own assets in the ground, and can retrieve them on a cost-efficient basis. Here I propose Petrobras [PBR] and Potash (POT).
- Select financials that have been painted with the overall brush; they must be an early 1980s “GEICO” incarnate, with clean and transparent balance sheets. Here I propose Progressive Corp. (PGR), and Northern Trust (NTRS).
- Out-of-favor consumers that will thrive ten years hence; best to average down these at “window of opportunity” prices. Think Disney (DIS) at $14-16, Nike (NKE) at $35-40. Short-term EPS comes and goes. Durable global brand yields outsize economic profits in the long-term.
- Speculative plays that may not seem speculative, but are. Average down Kroger (KR) from $18-21 (everyone’s worried about WalMart (WMT) in grocery). Average down Target (TGT) from $22-26 (double the WalMart worry). Think about Apple (AAPL) if it gets back to $80, and add bits more.
Most of the above are not earthshaking calls. But they are safe ones, and safety with a bit of elan (like international, growth, a dividend) is to be prized. These firms either have high levels of customer involvement and loyalty, and/or whistle-clean balance sheets with patient capital, such that my dad’s “stock PE” calculation doesn’t really enter into the stock price.
I submit that it is no use trying to bottom tick the market unless indexes are your daily trade vehicle. If you are seeking alpha, short-term alpha will result from short-term beta.
Long-term alpha will come from a Buffett-like “Back-To-The-Seventies” approach. Find the unjustly tarnished, the ones that survive the five years of EPS due to broad-based (preferably global consumer) support. Harvest thy dividends where ye may. Grab some gains if the overall market bumps up.
But avoid the stocks on which my dearly departed dad would caution you. If there’s big debt coming due in the next five years, and the current yield-to-maturity on that debt is 10%, the stock PE has to be below 10X.
It’s Back To The Seventies: it just works that way in low growth times, and don’t think you’re so smart that you can out-think history and reinvent the wheel.
I welcome hearing other stock raves or pans, wish you good fortune, and as always welcome your comments.
Disclosure: Own Petrobras, FXI, and Intel. No positions in other firms mentioned.
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I suspect I may be a bit younger than your Dad, but I do remember the notion of "risk premium" that has been rendered quaint in the era of the Great Bubbles. This states that since stocks had higher risk than bonds, their return based on their earnings, of which a reasonable proportion was expected to be paid out as dividends, should exceed that of bonds.
In the era of the Great Bubbles, the notion of "risk premium" was replaced by the notion of the "greater fool", i.e., that someone will always be willing to pay you more for a stock, even if its earnings are miniscule and its dividend is nil. After all they say that "a sucker is born every day".
I agree that quaint notions like "risk premium" are back in vogue, as we are running out of "greater fools".
I would Add BP and FPL to your list. BP for the excellent turn around management has made the last few years, the diversification and the big fat 7.8% Dividend. Florida Power & Light may be one of the best run utilities that has been build wind farms in the Mid-West and is now either the largest or one of the largest Wind Generation Utilities.
Excellent point about Global Brands. I was already planning to buy Disney. Anyone who thinks Disney is going out of business doesn't understand that the bulk of consumer spending for entertainment is by and for the 8-18yr old market. Disney does it best!
I am also a member of Motley Fool so I have a right to admonish you for that "cheap" shot. I belong to their service for the same reason as Seeking Alpha. To learn investing and to discuss investment ideas in a professional forum.
1) You could likely substitute Microsoft for Cisco in your Consumer play, as MSFT has much more of its overall revenue exposed to the Consumer than CSCO, who only has some through its Linksys brand. Much more of their revenue is through SMB, Corporate and Government.
2) Don't know if I would include PetroBras in the category of a Low Cost producer. I like the company, but most of its production needs $60 to $80 a barrel to be productive, as the cost of Off-shore rigs is still high. They also still have a lot of exploration costs....
3) Apple, Disney and Nike are all solid brands, and will bounce back violently to the upside when the consumer starts spending.
Larry
I do not think your approach is a poor one, it just may not take the best advantage of a strong recovering market.
The reasoning is good enough and the perspective broad enough that I added you to my watchlist. Thanks for the good read.
When I penned this column, most of these stocks were at lower levels. I still like the set-ups around most of them. For TGT (was at $27, now at $34), I would sell all of my position. For AAPL (was at $90, dipped to $83-$85, now at $115), I would sell most (80%) of the position.
Still like PBR and POT and think that there's some room to run in the next 2-3 months for these.
Kroger (KR) is dead money, but reasonably safe at today's $20. Disney (DIS) and Nike (NKE) briefly hit my target prices, and I would sell most of those positions today, but at least half.
Best -- pg