Amidst the turmoil and uncertainty that attends the markets these days, I often find it relaxing to sequester myself for a while and do some analysis. Part of my job as an analyst is to discover things that others may have missed. These may be opportunities to identify “Special Situations.” Some very successful opportunities of mine in the recent past have been companies such as Nucor, Landstar System, C.R. Bard, Laboratory Corp., PACCAR, Asta Funding and Student Loan Corp (STU). I have had some excellent runs with these companies because I was able to isolate their uniqueness early – before Wall Street discovered them.
Student Loan Corp, for instance, is a company that is 80% owned by Citigroup and handles most of their student loan business. During my research, I also discovered that the late super money manager of the Sequoia Fund, Bill Ruane, was a big fan of STU and owned a lot of shares.
Investing need not be complicated if you are able to find just one or two things that others may have missed. If you get there first, there is a high probability of making a handsome profit. Nucor, for example, is the premier steel manufacturer in the world and in 2004 I learned that China was poised to build a city the size of Austin, Texas every year. From this information I concluded that China would need to import large quantities of steel and so I looked to Nucor. With Nucor, I went against the general trend in the stock market – which was to short the entire Steel Industry. By not adopting the herd mentality, I was able to win big with Nucor, being up 111% at one point. In doing so, I chose to follow the advice of Benjamin Graham, author of The Intelligent Investor and Security Analysis,-
“Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it – even though others may hesitate or differ.”
My 2005 analysis of the Steel Industry can be found in the following link:
http://www.righttimeinvesting.org/Essays%20and%20Writings/Steel%20Industry.pdf
Asta Funding (ASFI) is a company that I stumbled across because I had read in the Wall Street Journal that Congress was planning to change the laws in regards to how people can file for bankruptcy protection. Based on this article, I initiated a search for companies that would stand to benefit from this change and I subsequently identified ASFI. Asta Funding is a company that buys distressed debt from credit card companies for pennies on the dollar and then tries to collect on this debt in court. So if they buy $1 worth of debt for $.05 and then settle the case for $.10, it becomes a 100% profit on the transaction. The new bankruptcy laws enacted by Congress held the consumer more responsible for their debt. Unlike previous legislation, the new law did not permit the consumer to become absolved of debt by simply filing for bankruptcy. This meant that Asta Funding would be poised to make significant profits, and indeed this was the case.
Special Situations are always out there, but at times you need to search hard to find them and think through the idea of what makes them different and special. In 1984 Coca-Cola (KO), for example, decided to spin off their bottling plants and create separate companies from them. This allowed Coca-Cola to dramatically change the way it reported its financials and as a result of spinning off their bottling plants, their shareholder’s equity was reduced dramatically and their return on shareholders equity increased substantially. The beautiful thing about all this was that though their shareholder’s equity was reduced (buildings, trucks, factories were transferred to the new bottling companies), their profits now came exclusively from selling syrup to the bottlers and their only expense was advertising. Thus their profit margins exploded and after many years of malaise, suddenly Coca-Cola became a growth stock. Every year the company would split off another bottler and continually reduce their equity while increasing their margins. For some 14 years this successful pattern was followed until they finally ran out of bottlers to spin off. If you look at the historical records for the symbol KO, you will find that the stock was selling for a split adjusted price of about $1.75 in 1984 and when they ran out of bottlers in 1998, it traded for about $75 a share. For those keeping score, that amounts to a return of 4,186% or an average compounded return of 30.79% per year. (Now you know why Warren Buffett, who bought 8% of KO during the market crash of 1987, is a multi-billionaire). Once Coca-Cola completed their bottler spin offs, their growth rates slowed and that is probably why the company has done nothing for the past 8 years. About five years ago, Pepsi arrived late to the game but finally discovered that they could follow a similar pattern. It’s no surprise that their growth rates exploded as did their stock price as soon as they started splitting off their bottlers.
I myself sold Coca-Cola in 1998 to move into Nokia Corp. I had thought that Nokia, which had significant market share, would conquer the world, owing to the fact that everybody either had a cell phone, or wanted one. I got in big at $18 a share in 1998 and saw the stock hit $62 by 2000. Being a confirmed “Philip Fisher” analyst, I adhered to his methods, as detailed in his book Common Stocks and Uncommon Profits, where he outlined his belief that one should never sell a great company and should ride out the bear markets. However, 2000-2001 showed us that this was absolutely the incorrect strategy for Nokia, as the stock of Nokia fell from a high of $62 in 2000 to about $10+ before rebounding slightly. My investment in Nokia taught me that no one system is perfect for all market conditions and one should never follow any one system exclusively, but should compliment an investment strategy with good old-fashioned common sense.
Consistency in earnings is a key landmark for identifying Special Situations. Low debt, strong return on equity, nice net profit margins and finally, little in the way of competition. All the companies that I have mentioned in the first paragraph are “islands” and have little in the way of competition. In addition, the best time to buy Special Situations is in a bear market.
In my recent research at Right Time Investing Research I am finding out that investing in Technology is really a game for gamblers and traders. I have learned the hard way that the Technology Industry is basically just one big commodity market these days. Stocks like Lucent Technologies, Dell Computer and Intel are proving this everyday as their profit margins are consistently getting squeezed by foreign competition. It took me 20 years to finally understand why Warren Buffett never invests in Technology stocks. The reason quite simply is that they are unpredictable. Buffett states that he does not understand them but I am sure that he does.
It’s all well and good to talk about the past, “but what have you done for me lately?” One stock that has caught my eye recently, Home Depot (HD), is just getting massacred by Wall Street at the moment. Justifiably the worry over housing and how higher interest rates may affect Real Estate in general, creates great uncertainty for Wall Street. Wall Street abhors uncertainty (ironically) and rather than waiting to see what happens, they prefer as a group to cut and run. This “lemming effect” creates opportunity for those who have a longer time horizon and are willing to wait for large gains in the future. Home Depot is the best-run retail operation out of one hundred big-name retail companies that I analyzed for this article. I have generally found that the best way to analyze the Retail Industry is to determine each company’s profit per store. The following is a list of the top ten retailers by profits per store.
|
Company
|
Ticker
|
Number of Stores
|
Profit per Store ($Million)
|
|
Home Depot
|
HD
|
1,890
|
$3.45
|
|
Nordstrom, Inc.
|
JWN
|
187
|
$3.37
|
|
Lowe’s Cos.
|
LOW
|
1,087
|
$3.05
|
|
Costco Wholesale
|
COST
|
433
|
$2.67
|
|
Federated Dept. Stores
|
FD
|
621
|
$2.01
|
|
Wal-Mart Stores
|
WMT
|
6,141
|
$1.99
|
|
Target Corp.
|
TGT
|
1,397
|
$1.97
|
|
Coach Inc.
|
COH
|
275
|
$1.78
|
|
Best Buy Co.
|
BBY
|
786
|
$1.76
|
|
Tiffany & Co.
|
TIF
|
154
|
$1.72
|
As you can see, Home Depot management is doing a wonderful job and though housing may be slowing down, the do-it-yourself/remodeling market is still going strong. Another thing that Home Depot has going for it that its sales per share are expected to be around $45 a share in 2006 and its stock price is at $33.85. This is important in that on Main Street, when one sells a retail operation, the buyer usually looks to buy at around one time sales. Thus when we divide 33.85/45 we get 0.75, which would amount to a bargain on Main Street. In addition, Home Depot exemplifies an “Economies of Scale” retail model. Economies of Scale refers to a company that grows large enough where it expands to the point that everything it sells gets purchased in bulk and the more it buys, the greater the discount it receives from suppliers and wholesalers. The table below demonstrates the Home Depot (HD) model of “Economies of Scale” in action in terms of how it relates to their profits per store.
|
Year
|
Number of HD Stores
|
Profit per Store ($Million)
|
|
1996
|
512
|
$1.83
|
|
1997
|
624
|
$1.86
|
|
1998
|
761
|
$2.12
|
|
1999
|
913
|
$2.54
|
|
2000
|
1,134
|
$2.28
|
|
2001
|
1,333
|
$2.28
|
|
2002
|
1,532
|
$2.39
|
|
2003
|
1,707
|
$2.52
|
|
2004
|
1,890
|
$2.65
|
|
2005
|
2,042
|
$2.86
|
|
2006
|
2,160
|
$3.45
|
In conclusion, I hope that I was able to impart the importance of finding just one or two unique things about a company that can make you a lot of money. Who knows what will happen with the stock market in view of the current uncertainty in the Middle East, and whether the Federal Reserve will raise interest rates again. What I do know is that Home Depot is a well run “Special Situation” and when the markets do turn around, it should do quite well. Other Special Situations that I find compelling these days are Amgen and Medtronic, but that’s a story for another day.
Note: Peter George Psaras is not an Investment Advisor and nothing mentioned above can be construed as investment advice. All Research is written and produced as an information source only, and is not a solicitation to buy or sell securities. Investing in securities is speculative and carries a high degree of risk. All information contained in this research should be independently verified. Investors are reminded to perform their own due diligence with respect to any investment decision. Factual material is obtained from sources believed to be reliable, but Peter George Psaras is not responsible for any errors or omissions. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice.