Market Contraction? Value Investors Rejoice!

Includes: BBY, DIA, GME, QQQ, RSH, SPY
by: Dime Trader

Anyone net long in the markets felt like this after yesterday’s close:

Oh No!

Image source: (Brilliant!)

It is understandable. You (and I) took a walloping. Good companies fell with bad. Nothing seemed to make sense. Fundamentals? Pssh. Fundamentals be damned. The market didn’t give a damn. Just sell. Sell and get me the hell out of everything. Put your head between your knees and prepare for a hard landing. Should you feel like the guy in the picture? Should you move to unwind all of your positions (turning paper losses into real losses), clear out the supermarket of its canned goods, and rush to a self-constructed bunker in the woods to wait out the coming *gasp* big-D Depression?

My recommendation: No.

First, that guy’s posture is horrible for his back, and who wants to live in the woods? Also, it’s the wrong way of looking at the market’s contraction. You should feel like this:

the laughing baby

Image Source: Ben McLeod

Listen, I am not an eternal optimist. I’ll call bullshit with the best of ‘em, and believe me, I felt like the guy in the top photo. It is hard to see that much red outside of a Tarantino film.

But then over a glass of White Horse and a Come to Jesus moment, I realized my folly.

The truth is, this is a great opportunity. Consider two possibilities:

Possibility #1: The recent market decline is reflective of a real economic downturn (double dip)

First, recognize that this is by no means certain. Market performance and underlying economic fundamentals frequently diverge (this is especially true when entering and exiting a recession). Is the negative trend in recent economic reports indicative of a double dip, or merely turbulence as the economy regains its footing? Many experts think it signals a double-dip, while others point to record corporate earnings and strong balance sheets as a sign of strength.

Everyone has their datapoints, and no one knows for certain. The lack of certainty is what is causing the increased market volatility (well, now that the debt ceiling crisis has been put to bed).

But assuming there is a real economic downturn, what does that mean for you?

Well, If you’ve done your homework, your portfolio should be comprised largely of companies that are conservatively financed, generate strong returns and free cash flows. And you bought them at a significant discount. If they get cheaper because the market tanks, is that the worst thing in the world? You know (because you’ve done your fundamental research) that the companies you have invested in will be around in five years, that they’ll pick themselves up and dust themselves off, and carry on doing what they do best (generating strong returns for shareholders).

On its own, the fact that a company gets cheaper says absolutely nothing about its fundamental operating performance.

Just because Mr. Market has marked a company down further doesn’t mean that, like discounted fruit, its days are numbered. The market overreacts and ignores fundamentals, and this is never more the case than on days like yesterday when the entire market is tanking due to indiscriminate selling. If you don’t believe in that, then you aren’t a value investor.

Possibility # 2: The recent market decline is an overreaction

Obviously this is the better of the two scenarios, as the market will bounce back more quickly. You now have a platter in front of you with some of the best companies around on sale for less than any other point in the last year. The potential value opportunities in front of you should seem endless. Here’s a screenshot of my list of companies that I have already valued, but didn’t buy because I wanted a better entry price. The green ones are no more than 5% above my target price, signalling that now is the time to do a deep dive for red flags:

Last week, not a single one of those was highlighted green. Now I am going to go Cousteau on these. Borrowing from Buffett (circa 1974), I feel like an oversexed guy in a whorehouse. The opportunities are great, and becoming greater with every day like yesterday.

Be fearful when others are greedy and greedy when others are fearful – Warren Buffett

One more point. If you, like me, own a lot of companies that are repurchasing their own shares (Some good examples: Radioshack (NYSE:RSH), (See Radioshack Represents a Remarkable Value Opportunity), GameStop (NYSE:GME) (See Why I Love GME and Think You Should Too), and Best Buy (NYSE:BBY) (See BBY: A Shareholder Friendly Value Stock), and I have a few more I will be discussing over the next two weeks), then you should be absolutely thrilled by the market contraction. It means the companies you have invested in are able to stretch their buyback plans further than they otherwise would, which translates into you holding a greater economic interest in the company than you otherwise would (Another reason why I prefer share repurchases to dividends in this market).

So take a step back, relax and recognize that the reason you’ve worked so hard to analyze the companies you’ve bought is for times like this. Be thankful that your reason for purchasing had nothing to do with silly things like MACD, Bollinger Bands or alignment of celestial bodies. Be thankful that you have fundamentals and time on your side. No one ever said you wouldn’t experience short-term volatility. Now buckle up and go find next year’s returns, today.

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