Sometimes I feel that investing can turn the most rational people into the most irrational people. It doesn't matter if you buy stocks, real estate, commodities or old coins, you can do well as long as you make smart investment decisions. Ignore the benchmarks. Ignore the news headlines. And most of all ignore the daily market variations. All that matters is that you understand what you're doing and why you're doing it.
I am currently reading "Black Swan" by Nicholas Taleb, which deals with unexpected events. One of the points that Taleb makes is that all species similarly herd together when a major event occurs. Think about it, when the market rallies, everyone jumps in together. When the market sells off, everyone jumps out together. Is that much different from when a school of fish senses a predator and then tightly herds together? You do not need to participate in the herd. In fact, you would be better off doing the exact opposite of what the herd does in most cases.
In my opinion, Ben Graham's biggest contribution is the idea of someone named Mr. Market. It is the idea that Mr. Market is completely irrational, bipolar and carefree. Mr. Market will sell you any business at any price and he will buy from you any business at any price. What you need to remember is that Mr. Market cannot force you to buy or sell. He cannot force you to become part of the herd of irrationality. So the next time you are about to buy or sell anything, ask yourself why are you doing this? If your answer doesn't make any sense then walk away for a few days and wait for Mr. Market to be in a different mood.
So what is the herd doing that you shouldn't do? The herd is always buying pieces of companies at any price regardless of how out of proportion the price is to the value of the companies. I try not to overpay for anything. I don't want to be part of the herd that is willing be ripped off. As a result I've built a model that helps me identify when a company is fair or being sold for less than it is worth. My model doesn't worry about PE ratios or other misleading Wall Street factors. My model focuses on two things, the past history of the company and the cash the company will make in the future.
So far I've found one large-cap company and one mid-cap company that can be purchased for a bargain price. The two companies are Corning Inc. (GLW), which I've written about before and Deckers Outdoor Corp. (DECK), which I only began buying shares of.
Starting with Corning, we have a company with a great track record that makes specialty glass used in modern electronics. Corning has a gigantic moat around the industry. It is a company that I can check on once a year and not worry. Yet, Wall Street analysts have continually beaten this company down. Corning just released its quarterly earnings beating Wall Street's analyst expectations as it has continually done. Regardless of whether Corning would have beaten quarterly expectations or not, you want to consider owning a piece of this company.
Here is Corning's equity and free cash flow for the last 10 years. This graph demonstrates that Corning has a management team that understands how to use its assets to generate cash and increase equity. This graph also leads me to believe that Corning will continue to generate cash and remain relevant into the future. In recent years, free cash flow has fallen due to increased capital expenditures but I expect to see FCF become positive again.
In addition, Corning has an impressive gross margin for the last 10 years.
Now let's look at Deckers, which is most known for Ugg boots. You might wonder why Wall Street doesn't like this stock. Well as it turns out, the cost of lamb skin has increased and we just lived through a mild winter. I'm not joking. They have beaten this company down because of an increase in material costs and a calm winter. Never mind that lamb skin isn't a commodity traded in the open market. Never mind that Deckers enjoys an almost 50% gross profit margin. Never mind that winter will come again in about seven months and then again the year after that. Never mind that Deckers has been buying up other companies lately.
DECK has had its free cash flow dip due to capital investments in new brick and mortar stores it is opening. I expect these new store fronts to provide the company with a boost in the coming years.
I'll be providing more research on these companies in the next few days. Stay tuned for Part 2, which will discuss the margin of safety available on these companies.
Disclosure: I am long GLW and short DECK.