One advantage of being a geezer on Wall Street is that you\u2019ve seen a lot of markets and the different ways people can think about stocks.\u00a0 In the mid-1980s everyone was looking for \u201crestructuring plays\u201d that a junk-bond financed corporate raider might attack.\u00a0 After the 1987 crash there was a takeover boom and every broker became an overnight expert in merger arbitrage. In the late 1990s it was all about one-decision growth stocks; Cisco looked cheap in 1999, provided you calculated the PE using estimated 2010 EPS.\u00a0 Coming out of the financial crisis it was all about macro; correlations were high so you could trade ETF\u2019s and forget about individual stocks.<\/p>\n
In recent years another distinctive characteristic of Street thinking, and Wall Street research, is the search for a catalyst.\u00a0 It\u2019s not enough to find a stock with a reasonable valuation that really will grow 15% per year over the next five years.\u00a0 To give it a compelling \u201cBuy\u201d rating that will excite the sales force, the analyst needs to find a reason why it will perform well soon.\u00a0 That is what many hedge funds, a key client base of brokerage firms, are looking for, because they can use financial leverage and stock options to make a good return quickly.\u00a0 For hedgies, 10% in two months is better than 25% in 12 months, or so I was told by the research director of a giant fund.<\/p>\n
I have no problem with this approach to investing, but it only works for certain smart professionals who are staring at their screens 14 hours a day and are constantly getting new ideas from dozens of analysts and salesmen.\u00a0 It doesn\u2019t work for individual investors.\u00a0 They are better off owning solid growth stocks for long periods of time, much as Buffett does.\u00a0 That means holding them during periods when there is indeed no \u201ccatalyst,\u201d as the stock goes sideways or even down for a few months even as earnings grow.<\/p>\n
Consider Starbucks, which I own.\u00a0 The stock climbed above 80 last November but has since declined to the low-70s.\u00a0 The chart looks pretty bad.\u00a0 The company reported earnings last Thursday, and the news was mostly good \u2013 on target EPS, 6% comp sales despite bad weather, interesting new initiatives.\u00a0 Yet one well-respected analyst maintained his \u201cHold\u201d rating and $80 price target (implying 14% total return in a year) because consensus EPS estimates were not likely to be raised.\u00a0 In other words, the company will keep growing and you will make good money in a year, but the stock is fairly priced and it is hard to think of a reason why there will be upside surprises in EPS and stock price.\u00a0 Me, I\u2019ll take a 14% annual return every day of the week.<\/p>\n
Perverse Side Effects<\/strong><\/p>\n The \u201cwhat\u2019s the catalyst?\u201d mentality has certain perverse effects.\u00a0 It draws Wall Street\u2019s attention to controversial and volatile but fundamentally terrible stocks.\u00a0 A great example is J.C. Penney.\u00a0 What a mess.\u00a0 Take a mediocre company in a bad business\u2014selling to middle class Americans under assault from Obamanomics\u2014and bring in a Silicon Valley retail guru who revolutionizes the business (out with weekly coupon circulars, in with coffee bars and branded boutiques) and pretty much destroys it.\u00a0 (You have to try really, really hard to get minus 25% same store sales when the U.S. economy is not in a depression.)\u00a0 Investors should have simply stayed away, or stayed short, for two years as the stock dropped 78% and underperformed the SPX by 110%.\u00a0 But Street traders, attracted by JCP\u2019s volatility, kept playing the short and the long side of the name.<\/p>\n Another perverse effect is that analysts will oversimplify a business as they search for a catalyst.\u00a0 Most large companies have many divisions serving diverse markets.\u00a0 They are not highly \u201cleveraged\u201d to a single market.\u00a0 But, in search of a catalyst analysts and investors will oversimplify a business and argue that the shares will be driven by one macro variable.\u00a0 For example, John Deere (which I also own) has been a consensus short of hedgies on the theory that corn prices will drop, U.S. farmers\u2019 incomes will fall, and their purchases of tractors and combines will plummet.\u00a0 But, there is more to the DE story than farmers in Iowa.\u00a0 Fully 36% of revenues are outside the U.S.\u00a0 Looking at 2013 operating income, 6% is construction and forestry (which are improving) and 15% is financial services.\u00a0 As for the 79% of operating income generated by the \u201cAg and turf\u201d division, U.S. farmers\u2019 income is driven by the price of soybeans and other crops, in addition to corn.\u00a0 The bear story on DE may ultimately be proven right, but so far it has not worked.\u00a0 Over the last six months DE has outperformed the market by 590 bps.<\/p>\n Another case, similar to DE, is Caterpillar, which supposedly was a \u201cplay\u201d on weakness in China.\u00a0 Although China\u2019s economy has indeed been weaker than expected, which has hit CAT\u2019s mining equipment business, CAT shares have performed well because other end markets that it serves, such as construction and energy, have been strong.<\/p>\n Copyright Thomas Doerflinger 2014.\u00a0 All Rights Reserved.<\/p>\n <\/p>\n","protected":false},"excerpt":{"rendered":" One advantage of being a geezer on Wall Street is that you\u2019ve seen a lot of markets and the different ways people can think about stocks.\u00a0 In the mid-1980s everyone was looking for \u201crestructuring plays\u201d that a junk-bond financed corporate … Continue reading