Why I Shake Hands With Losers To Become A Winner

 |  Includes: FBP, GD, KO, MT, WU
by: Netwall

"What is the easiest way to become a millionaire in the airline business?"

Warren Buffett once quipped;

"Start with a billion!"

These comments were made after Buffett's foray into airlines in the early 1990s. He acquired preferred shares of US Air (LCC) and the stock tanked right after his purchase. He was lucky enough to break even after few years of holding the bag; however airlines continued to struggle even with full flights and low fuel prices. He became so disgruntled with the airline business that he later said that he would never invest in something that flew in the air (although it did not stop him from buying Flightsafety International in 1996, which trained aircraft pilots and ship operators using high-technology simulators). So much so, Buffett went on saying in an article for Fortune Magazine that had he been at Kitty Hawk in 1903, when Orville Wright took off and he would have been farsighted enough and public-spirited enough, he owed this to future capitalists-to shoot him down. Wow! Strong words of disdain for the airlines from one of the greatest minds in investing.

Before Buffett, Carl Icahn had positioned himself for a failure in 1985, when he bought the airline operations from the Trans World Corporation and appointed himself as chairman of the newly independent airline. Icahn was eventually ousted in 1993, though not before the airline was forced to file for bankruptcy in 1992. Some of you might argue that most domestic carriers have delivered excellent returns in the last few years with which I agree. The purpose of this article is not to bash the airlines or any other industry for that matter but to show you how to spot today's losers who could possibly become tomorrow's winners. The idea is to dig deeper and find hidden value by ignoring the crowd and buy into something which has a resemblance of a loser but will come out a winner in the longer term.

I have said earlier there is nothing wrong in reading about great investors and learning about their investment techniques. However, I am not a big fan of such websites, as "Insider Monkey" and "Guru Focus," which encourage you to mindlessly mimic portfolios of successful institutional investors. There are few problems with this idea:

  • You don't know what their investing strategy is. Are they buying for the long or short term? Are they buying so that they can take over the company? Intelligent investing depends on the right time of entry and exit into particular stocks as it is well said, "A genius does something in the beginning that a fool does in the end."
  • Typically these fund managers have large pools of money from which they may assign a small percentage to extremely risky investments to bolster returns. You don't want to be buying something with your retirement money which the big guy bought using his pocket money.
  • Finally, institutional investors typically keep their holding secret and the way various websites locate their trades is by going through the SEC filings (on form 13F). However, there could be a maximum gap of 4.5 months before the filing becomes public and it might already be too late by then to buy. The stock might have already produced desired returns for the fund manager. (Example: See Tesla Motors' (NASDAQ:TSLA) charts for the past few months).

Hopefully you got the point. However, if you admire someone, then study his investment philosophy and observe how he makes investment decisions. Then incorporate this philosophy into your own investment decisions. But please avoid blindly duplicating portfolios of your favorite fund managers.

Being an investor, I have no qualms about admitting that I follow few names that I admire and usually keep an eye on what they are buying and selling. Again this does not mean that I would mimic their moves but this gives me insights as to what they like to buy and sell in the current economic environment. One such obvious name is "Warren Buffett"; however his investment goals might be completely different than mine since his money pool is extremely large and he has to choose from fewer securities to bring any meaningful returns.

Another investor I greatly admire is "David Tepper" of Appaloosa Management. If you go to the website, you will only find the company's contact info and driving directions (maybe I'll just show up on his door someday to say hi and make a mention how much I admire him). David Tepper has been an elusive character all these years since he started Appaloosa in 1993. There is only a couple of live interviews with him to be found on the web; one on Bloomberg, and the other one on CNBC. The reason I admire David Tepper is that since he founded Appaloosa, it has netted investors 30% annual compounded returns and grossed the firm 40% yearly. To give you a little perspective, this performance is slightly better than that of Warren Buffett when he ran Buffett Partnership (1960s) and returned 29% compounded for over 10 years before folding it during the bull market of late sixties. He has an uncanny ability to spot trapped value not only in the stock market but in distressed debt also. Imagine this: if you had invested $1 million with David Tepper in 1993, it would have turned into $149 million by now. This is what I call a 149 bagger.

Now let's talk about few of his investments in the past, which all seemed to be losing proposition at the time.

"One of his first investments (1993) was in a distressed steel company, Algoma Steel, which was then going through bankruptcy court. Digging deep into the prospectus, Mr. Tepper uncovered the significance of the company's preferred shares. Instead of regular preferred shares, which are normally secondary to secured and unsecured debt of a company, Algoma Steel's preferred shares were essentially first mortgage bonds on the real estate of the company's plants and headquarters. Since this buried fact was ignored by the current investors in the company, the preferred shares were trading at approximately 20 cents on the dollar. After building a position at that price, Mr. Tepper unloaded the shares at an average of 70 cents over the course of one year.

In 1997, when the markets were embroiled in the Asian financial crisis, Mr. Tepper saw an opportunity in the first-world country South Korea. As investors were painting whole of Asia with the same brush, the Korean currency had declined by more than 50% although the dynamics of its economy was quite distinct from the rest of the region. By buying highly discounted futures on the currency and Korean sovereign debt, he managed a 30% return."

Here is my favorite!

"When NASDAQ peaked in 2000, Mr. Tepper placed a daring short on the index itself. He immediately started losing money as tech companies were still roaring upwards. His investors protested so strongly that he covered his short positions shortly before NASDAQ's historic crash. Only in a matter of a couple of months NASDAQ started its reckless downward spiral, and had he held onto the position that might have actually been one of his best trades ever. Mr. Tepper, since then, resolved to never pay attention to the nervousness of his investors regardless of what kind of trade he was executing.

Finally in the most recent financial crisis, Mr. Tepper went into a buying spree, grabbing the preferred shares of big financials such as Bank of America (12 cents on the dollar) and junior debt of Citigroup (19 cents on the dollar). He also bought a tranche at a 91% discount of a billion dollars of face value of commercial mortgage backed securities floated by AIG. All in all, he had over 30% exposure to financials at the depressed valuations. As things stabilized in 2009, his concentrated allocation to financials reaped rewards beyond anything Appaloosa had seen. The fund provided investors a 120% net-of-fees return and although Mr. Tepper's investors had seen such percentage gains before, a succulent $7 billion for the investors and a 4 billion dollar payday for Mr. Tepper himself."

Currently he holds a lot of SPY, QQQ and DIA in his portfolio, which leads me to believe that he is having a hard time finding bargains in the market place; and I concur. Warren Buffett also alluded to the same fact during his recent CNBC interview (Sep 19, 2013) in which he appeared alongside Bank of America (NYSE:BAC) CEO, Brian Moynihan. Below is an excerpt from the transcript:

"Quick: we've seen some major pickup. When you look around, are there still deals that you can see like the deal you did with Brian with Bank of America? Do you still see good positions or have stocks just moved too far?

Buffett: they've moved a long way. they were very cheap five years ago. Ridiculously cheap. That's been corrected. They're probably more or less fairly priced now. Ii don't think -- we don't find bargains around. But we don't think things are way overvalued, either. We're having a hard time finding things to buy."

Now let's bring our focus back to some of the past purchases of Warren Buffett. He seems to have a magic hand when it comes to buying under-valued securities. His stocks seem to march upward after his purchase. Now some of you might argue that many people mimic Buffett's purchases, naturally his stocks go up. This is not my point here as I am talking about at least a decade of performance if not more. Here I will show you charts of some of Buffett's favorite holdings that started an upward climb for 20 some years. Obviously, this has to do with his investing acumen, which allows him to spot undervalued securities before the market does. Let's study a couple of purchases that he made some two decades ago.

Coca-Cola (KO):

In 1988, Warren Buffett and Charlie Munger began buying stock in the Coca-Cola Company for Berkshire Hathaway (BRK.A, BRK.B). They purchased about 7% of the company for $1.02 billion. This turned out to be one of Berkshire's most lucrative investments. Berkshire Hathaway now owns 8.9 percent or 400 million shares of Coca-Cola.

It is also worthy of noticing that Coke's stock had been on sidelines for decades not producing any big returns. But watch the upward climb soon after Buffett purchased it as shown in the chart below.

Performance of Coca Cola since BuffettClick to enlarge

So what was the catalyst that was behind this stock growth. You can read Buffett's full shareholders' letter here. Below is an excerpt:

"In 1988 we made major purchases of Federal Home Loan Mortgage Pfd. ("Freddie Mac") and Coca Cola. We expect to hold these securities for a long time. In fact, when we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds. Our holdings of Freddie Mac are the maximum allowed by law, and are extensively described by Charlie in his letter."

Then let's look at the purchase of General Dynamics (NYSE:GD), which Buffett made around July 1992.

Performance of General Dynamics since BuffettClick to enlarge

Buffett wrote the following in his 1992 annual report for shareholders:

"We were lucky in our General Dynamics purchase. I had paid little attention to the company until last summer, when it announced it would repurchase about 30% of its shares by way of a Dutch tender. Seeing an arbitrage opportunity, I began buying the stock for Berkshire, expecting to tender our holdings for a small profit. We've made the same sort of commitment perhaps a half-dozen times in the last few years, reaping decent rates of return for the short periods our money has been tied up. But then I began studying the company and the accomplishments of Bill Anders in the brief time he'd been CEO. And what I saw made my eyes pop: Bill had a clearly articulated and rational strategy; he had been focused and imbued with a sense of urgency in carrying it out; and the results were truly remarkable. In short order, I dumped my arbitrage thoughts and decided that Berkshire should become a long-term investor with Bill. We were helped in gaining a large position by the fact that a tender greatly swells the volume of trading in a stock. In a one-month period, we were able to purchase 14% of the General Dynamics shares that remained outstanding after the tender was completed."

The reason I am giving you all this information is to analyze the thought process of Warren Buffett and see through his investment lens. Sure enough when he originally makes investments, based on value approach, these might look like laggards but almost always turn out to be winners in the long run. Most recent news as of May 2013 is that Buffett is sold out of General Dynamics completely:

Today's Losers:

Warning: Below you are going to see names that might seem losers to you at the first blush. I am not going to discuss individual names in great detail but rest assured these are good investments for today to get higher returns tomorrow.

At Netwall Investments LLC, we have recently discussed these ideas, so consider this is an insider's scoop for your benefit. We find these companies to be good bargains at current prices (as of this writing). However, that does not mean that we are going to initiate a position in these any time soon as we might or might not. Also note this is not intended to be an investment advice. Please perform your own due diligence. Since we are talking about shaking hands with today's losers to come out tomorrow's winner, I don't think this article would be complete without bringing into light some names that we consider to be today's losers. So please read on.

Western Union (WU):

I have written about Western Union before on Seeking Alpha and the article can be found here. Shares of Western Union took a beating on October 30 (down more than 12%) when the company announced that its compliance cost would go up in 2014 and it would cause pressure on operating profits.

The company has a strong balance sheet and throws about a billion dollars in free cash flow every year. Money transfer business requires minimal incremental costs to run since Capex requirements are minimal and is not a capital intensive business. While many investors punished the company for implementing systems to comply with government requirements (Dodd-Frank), we look at this initiative as a positive where the company is dealing with regulatory issues head-on thus avoiding any potential future fines. These fines can be substantial and destroy shareholder value. Also since the regulatory landscape is getting tougher for money transfer businesses, we see this as a high barrier to entry business. This creates an economic moat for companies already in the business since new-comers will have a hard time getting in. Western Union is clearly a fallen angel and with its stock trading around $16 as of this writing, we see a 20%-30% upside in the near future and much higher longer-term potential.

ArcelorMittal (MT):

I wrote an article earlier on SA discussing merits of ArcelorMittal, which you can see here.

MT is by far the biggest producer of steel in the world, yet it only meets less than 10% of total world demand. Recent recessions in the US and Europe (two important markets for MT) has caused the company's stock to trade around $15.70 as of this writing, which is near its 10-year lows. I see this company to be fundamentally strong and with US and Europe recovery on its way, the company should prosper in coming years. Company is also engaging in China, India and Brazil (3 of the BRIC economies, Brazil, Russia, India & China) with new projects on the horizon, which will give a huge boost to the company's earnings. Also with the automotive sector in a recovery mode, the demand for steel will only increase to build more vehicles. Thus the future looks bright for this steel maker, so investors should consider paying attention to this seemingly losing player, which will eventually be a winner.

First BanCorp (FBP):

A fellow SA author penned an excellent article on the merits of this investment opportunity, which can be read here. First BanCorp is the 2nd largest bank in Puerto Rico and has been caught in the debt controversy of this tiny island. FBP has roughly 86% of its assets in Puerto Rico, 7% in the US Virgin Islands (where it holds a huge 40% market share), and 7% of its assets in Florida. Since the financial crisis in the US, the bank has had its share of troubles from selling problem loans to reducing expenses to the Fed's money infusion. I think the bank has pretty much overcome its major problems of the past and is poised for strong growth in coming quarters as it is also evident from its Q3 2013 earnings announcement. This is another fallen angel that can reward investors who have the patience to wait as this bank slowly corrects its course, which has already begun.


Success in the stock market requires investing in under-valued securities and then waiting for the market to realize that potential over time. Now be careful, I am not suggesting that you compile a list of today's losers, dump your money into them and hope they would turn out to be tomorrow's winners. That would be a financial suicide in itself since many losing companies might eventually go bankrupt. What I am asking you to do is to enhance your financial acumen and become knowledgeable in some key areas that you are comfortable with. Then go research companies within these industries that are trading at some discount to their true intrinsic value based on your research. Buffett calls this the "Circle of competence" approach. Once you find these "gems," be sure to take a big swing at them and be patient; good things might happen to you in future.

Disclosure: I am long WU, BAC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.