Fixes for Bad Timing
If you're able to look beyond near-term trouble, you have an advantage over many professional investors.
By Whitney Tilson, Contributing Editor
John Heins, Contributing Editor
From Kiplinger's Personal Finance magazine, June 2008
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Investing too early is one of the more common sins of value investors. Watching as that well-researched idea you loved a few months ago falls 20% to 30% can be painful and nerve-racking. Bruce Berkowitz, of the highly successful Fairholme fund, calls it "premature accumulation."
Getting your timing wrong is inevitable -- especially in today's market, in which stock prices continue to plumb new depths in a wide variety of industries. Value investors like us can be particularly susceptible to bad timing because we often buy on bad news or bet on turnarounds -- both of which have the unfortunate habit of dragging on much longer than expected, often causing share prices to continue to decline.
Three possibilities
Although the pursuit of perfect investment timing is laudable, a more realistic goal is to respond smartly when timing isn't so perfect. If a stock you bought declines, there are three options. You could throw in the towel, promising to get back in when the company's situation starts to improve. You could sit tight, comfortable that the stock remains undervalued but not enough to add to the position. Or you could buy more, in the belief that the stock is now even more undervalued.
Your choice is one of the most difficult ones you'll make as an investor, as Richard Pzena, of Pzena Investment Management, points out: "I believe the biggest way you add value as a value investor is how you behave in those down-25% situations. We probably hold tight 40% of the time and other times split 50-50 between buying more and getting out. Making the right decisions at those moments adds more value, in my opinion, than the initial buy decision."
Each situation is unique, but if you're able to look beyond near-term trouble, you have an advantage over many professional investors. The Wall Street trading mentality and pressures on money managers to put up strong quarterly or even monthly performance numbers can make it hard for them to own obviously beaten-down stocks. Bosses may not want to hear why something looks attractive two years out if it might not go anywhere in the next six months. Investors see holdings of unpopular stocks and call managers to ask, "Don't you read the newspaper?" But it's precisely such negativity that creates bargains for investors with the patience and resilience to endure cheap stocks becoming even cheaper.
Consider Target (symbol TGT), one of the best-managed and most profitable retailers in the nation. Thanks to weakening consumer spending and highly negative investor sentiment toward any stock with exposure to the U.S. consumer, the shares have fallen steadily to the low $50s, from as high as $70 last summer. While the unfavorable economy will no doubt crimp earnings this year, Target's fundamental competitive strengths and potential to generate high returns in the future have not changed. Given that, it's an even better buy than it was last summer, but investors have fled in droves.
The stock's current weakness may actually enhance Target's long-term value because of the enormous $10-billion share-repurchase program the company has undertaken. If the stock remains at today's levels, Target will be able to repurchase more than 23% of its stock, thereby increasing earnings per share by 30% -- even if its earnings are flat. Of course, Target's earnings won't remain flat for very long. The company continues to increase its store count at a high-single-digit rate, and at a mere one-sixth Wal-Mart's size, Target has plenty of room to grow.
The compounding effect
If Target retires 23% of its stock, let's assume that earnings are flat this year and then grow 10% annually (well below historical rates) for the next two years. Earnings per share would be about $5.25 in 2010. And if Target trades at 20 times earnings (its historical ratio), you would wind up with a $105 stock, meaning a 25% annualized return from today's price.
In addition, Target has two valuable assets that provide both protection on the downside and possible catalysts on the upside. First, it owns the great majority of its real estate, which is worth an estimated $30 billion, or 70% of the company's current market capitalization. Second, it has announced that it's in discussions with JPMorgan Chase to sell a half-interest in its credit-card operations for about $4 billion. If this deal happens, Target might buy back even more shares.
More than meets the eye
A dicier investment that we believe is worth a second look is bookseller Borders Group (BGP), whose share price has cratered over the past year, down more than 70% to less than $7. Unlike Target, Borders doesn't have a great business. But managed properly, Borders has a much more valuable business than the market is giving it credit for.
Borders operates in three major segments. First, it runs more than 500 book superstores in the U.S. that generated approximately $2.8 billion in revenues last year, plus more than 500 mall-based stores, mostly under the Waldenbooks name. Finally, the company owns 20 superstores in Australia, four in New Zealand, assorted small operations in several other regions and Paperchase, a British retailer of stationery, cards and gifts.
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