Is Altria's Moat Wide Enough Now?

Many many long years ago there once was a stock. Not really so long ago, only 8 years ago. It was a world leader with a brand recognized around the world. It just had one major problem, an overhanging lawsuit. I am referring to Altria group (MO), better known as Phillip Morris. In 1998 MO went from a high of $59.5 to a low in 2000 of $18.7. Almost a third of the price. As all value investors' hero would say [Warren Buffet’s mantra]: Buy great companies with a wide moat when they have problems. The question is would Altria go the way as Wythe and its diet product Phen Phen, or are investors being “ Irrational” and the down move is overdone? It is nice to say that in retrospect we thought that the move was overdone and that to purchase MO at 1/3 of the value was a fantastic “Fat Pitch”.

We looked at MO from a technical approach and it was so greatly oversold as well when we looked at the fundamentals. Earnings were increasing year over year. In 1999 the earnings were $3.19 and in 2000 in the middle of the abyss the earnings were $3.75. Another thought was the wonderful dividend which in 2000 was $2.02. Earnings were increasing year over year over the last 7 years at a rate of 15.71%. Warren Buffet would look for consistent earnings and, of course, here they were. The earnings were predictable.

One tool we use is comparing the earnings per share to the current rate of return for US government bonds. According to many analysts this gives the intrinsic value. This comparison showed the stock almost 70% undervalued. The bonds at the time were approx at 6.55%. However this is not close to exact and shows what the company is relative to the return of government bonds. This is another confirming idea, but Warren Buffet uses the formula of future earnings discounted to present value. This too has limitations but we confirm that MO was extremely undervalued.

Regardless of the fact that MO was undervalued and at 1/3 of its prior high, we simply asked ourselves some basic thoughts. We are big believers of the KISS principle so we asked ourselves these simple questions. 1. Would people stop smoking? Quick answer no. 2. Does MO have a wide moat that cannot be infringed? Quick answer, no. 3. Can the earnings continue in the future? Yes!

Before we jumped in, the thought of Benjamin Graham and 1929 sank in. He stated in his writings that he got in too early. Were we getting in too early? We had a great company and a great value, but, as always, anything can happen. We did not want to catch a falling knife. What we did at the time was wait until MO turned up and took out a 50 day moving average. All this did was show us that at least MO was moving in the right direction, but we knew it could easily turn back down and cheap could get cheaper.

The real point is that as investors and traders we must be aware that anything can happen, accept the risk and have a well thought out plan. One needs to be aware any trade is 50/50. It is paramount to one's success that an investing plan needs to include where one enters, exits (which might be never) with either a profit or loss and, most importantly, money management. Just like you are reading this article in order to learn, we also try to learn and expand our knowledge all the time. Through many sources we learned about Joel Greenblatt and his fund Gotham. What Mr. Greenblatt does in situations like this is buy long term call options called Leaps. The value of this is that he defines his risk as the amount of the option he purchases: if the shares implode his risk is only limited to the amount he paid for the options. In a situation as we detailed with MO in retrospect we would have used the principles detailed by Mr. Greenblatt.

Constantly learn, grow and read as much as you can.

Comments

[ing_rivera:]

I think Altria has a huge moat, one of the biggest I can think of. Smokers preference for Marlboro is overwheming and they won't smoke anything else. I smoke Marlboro, my siblings do too, my roomate, my officemates and I assure you that we won't smoke Camel, Winston or any other brand no matter how cheap they are relative to Marlboro. If someone gives me a gift and is a pack of another brand of cigarrettes, I will throw it away and still pay $6 (retail price in AZ) for a Marlboro Light's pack.

2008 Oct 03 09:14 PM