Mr. Market Is Stupid

I have a colleague, a smart guy -- let's call him Manny. Manny fervently believes in the efficient market. When a stock gets hammered without any apparent cause, Manny says, the market is saying that things aren't as rosy as they seem.

Let me give you an example. Pfizer closed October 17 at $16.91. At that price, the stock (symbol PFE) yields an astronomical 7.6%. But Manny, being Manny, says the market is telling us that Pfizer will have to cut its payout, now $1.28 per year, "because the dividend is unsupportable."

Wrong. Pfizer's cash flow could sustain a dividend twice the present size. In fact, Pfizer has raised its dividend at an annualized rate of 17% over the past five- and ten-year periods, according to Value Line. What the market is telling us is that it doesn't know what is going on.

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Look, I believe in efficient markets, too -- in normal times. In normal times, investors make rational decisions, and share prices tend to reflect the sum of all knowledge about a stock. In times like this, rational decisions aren't being made. There is no efficient market. A smart investor can discover huge bargains while Mr. Market is being stupid -- that is, irrational.

Let me give you three examples of bargains waiting to be had. I'll start with Massey Energy (MEE), a big Appalachian coal producer. It has already sold almost all of its forecast 2009 production and at least one-third of its 2010 production. So it's not as if there are huge piles of unsold coal sitting outside its mines. Analysts on average forecast earnings per share of $3.56 in 2008, $6.46 in 2009 and $9.11 in 2010.

And what does Mr. Market think of this? Mr. Market is saying calamity awaits Massey Energy because its stock has fallen from $96 in July to its October 17 close of $23.30. Today's price is a mere seven times this year's earnings per share and four times next year's. But my colleague Manny says that, given the weakness of the global economy, this is the market's way of saying that those earnings estimates are pie in the sky.

But in this particular case, Mr. Market is not being rational -- he just doesn't get it. Remember, almost all of next year's production is already money in the pocket. Using conservative assumptions, Morningstar calculates the fair value of Massey as $49 per share. I own this stock.

Next is CSX (CSX), one of two big railroad systems in the eastern U.S. CSX just reported that third-quarter earnings were up 40% from a year ago, despite slightly less traffic. CSX could accomplish this trick because, even in this weak economy, it has the power to raise rates significantly.

Plus, CSX is carefully controlling its costs and buying back huge batches of its own cheap shares. As you know, the same earnings spread over fewer shares means higher earnings per share.

But Mr. Market hates CSX. The shares of this company, with an excellent earnings outlook, are down 39% in just a few months' time. At $43.33, you can buy them today for just 12 times expected 2008 earnings of $3.66 per share and only ten times estimated 2009 profits of $4.25 per share. Merrill Lynch's one-year price objective for CSX is $52. I own this stock, too.

Finally, there's Newell Rubbermaid (NWL), maker of scads of popular brand-name consumer and commercial products, including Calphalon cookware. The company has done a pretty good job cleaning up the leftovers of a big buying spree, and, on average, analysts expect earnings of $1.49 per share this year, $1.63 next year and $1.97 in 2010.

So let's bring back Mr. Market. What do you say, sir? Mr. Market is too busy selling Newell Rubbermaid stock to talk to us. At more than $29 a year ago, it closed October 17 at $14.68, so you can buy these shares for just ten times this year's all-but-in-the-bag earnings and less than nine times '09 forecasts. I'm tempted to own Newell.

Do your own research. You'll discover that Mr. Market is underpricing dozens of great, growing companies. In fact, Mr. Market is so loco that I suspect he's got the big picture wrong, too. In other words, to quote my friend Manny, Mr. Market is saying we're in a long, deep recession. Oh yeah?