07 Sep 2001 It’s Time to Watch the Trees and Not the Forest
Bear markets remind us just how devastating market forces can be to individual companies’ stock prices, regardless of their individual merits. The degree to which pessimism and doubt gripped this economy and market surprised most market followers. But with all this attention on the markets and the economic numbers one might miss the trees for the forest – COMPELLING VALUES have been created in the wake of the market’s (NASDAQ) crash. While it is generally agreed that the values of information and communications companies in March of 2000 were unrealistically high, an equally strong case can be made that they are now unrealistically low.
An observer just planted on earth might get the impression that peoples’ desire to communicate with one another was waning, or that productivity enhancement was suddenly a much lower priority for businesses. The observer might ask if some new, unrevealed paradigm was expected to replace existing tools of communications and information technology. His would likely receive an answer that might include details of a bubble, a telecommunications overbuild, tight investment capital, etc. To those issues he might follow with the following question; aren’t these issues of a short duration, don’t the values of some or your leading corporations fail to realize their huge long-term potential?”
Nortel closed yesterday at $5.36. Just a year ago investors couldn’t get enough of the shares at $80.00. This technology leader was leading the charge of the Internet and telecommunications build out. If the valuations were to return to their pre-bubble level of twice sales, Nortel would trade at $17.50, three times its current level. Similarly, Lucent at $6.00 currently, could double.
Cisco, the world’s leader in routers and switches now trades at $14.40. The company has 7 billion dollars in cash and securities and is operating profitably. If Cisco were valued at it’s pre-bubble level relative to sales, it would trade at $40.00 per share – a 177% gain. Cisco will likely go shopping very soon. In contrast to their past acquisitions of relatively obscure technology companies when prices were high, don’t be surprised to see them announce plans to acquire a Nortel or an Alcatel.
Calpine, the nations’ leading operator of gas-fired electric generating plants now trades at $29.69, down 50% from its high of $58.00. This stock is priced as though our demand for electricity will decline, not grow, or that existing electric plants will last forever. If the stock’s P/E were to match its growth rate of 35%, the stock would trade at $70.00, or 140% higher than today’s price.
Microsoft, the nations’ leading software company is also undervalued. The company is entering several new product cycles with the introduction of Windows XP, Office XP and their .NET initiative. The stock could trade at $75.00 or 35% higher if it returns to similar valuations pre-bubble.
Veritas the industry leader in information storage, backup and retrieval software is down 85% from its high. The company has over a billion dollars in cash and securities, representing over 10% of its market value. Valued at pre-bubble levels the stock reaches $45.00 per share on trailing 12-month revenues or 100% above its current price.
The market is not operating efficiently now. It is driven mostly by fear at this point. Good news is ignored and bad news is exaggerated. In many ways the world has changed before our unbelieving eyes. We now find ourselves in uncharted territory and we are scared by the uncertainty of it all. With few historical benchmarks to guide us, we struggle to determine the impact of current events on long-term economic trends. The speed in which it all seemingly fell apart has left many shell-shocked. Lionel Barrymore’s Mr. Potter in “It’s a Wonderful Life”, a greedy and mean old businessman, made a very profound statement to George Bailey; “You and I kept our heads when others were losing theirs.” While there were many reasons to dislike Mr. Potter, his observations of the frailties of human nature under extreme circumstances are instructive. If we keep our heads and buy when others are selling we will be the winners in the long-run. I have sold a few of the toys that I have accumulated in recent years to invest the proceeds in the stocks of our model portfolios. I want to own as few depreciating assets as possible in the face of this incredible time in history.
THIS KIND OF OPPORTUNITY COMES ALONG ONLY RARELY.
Economic Releases and Other News
Economic indicators this week were mixed, but most of the leading indicators were positive. Unemployment, as I have pointed out, lags economic recovery so don’t get too concerned about that noise.
The National Association of Purchasing Management said Tuesday its index of business activity rose to 47.9 from 43.6 in July, the biggest improvement in five years. A reading below 50 signals contraction of activity, and August marked the 13th straight month of contraction. But many economists had expected the index to improve only slightly to a reading of 44, according to a survey by Thomson Global Markets.
The new orders component, which accounts for 30 percent of the index, rose to 53.1 in August. That’s the highest since April 2000 when it was 55.9 and followed a reading in July of 46.3. The production index, a gauge of current work being performed, rose to 52.2 last month from 46.4. The production index is the highest since 53.2 in July of last year. The August inventory index rose to 37.7 from 35.8 the previous month.
Texas Instruments, whose chips run two-thirds of the world’s mobile phones, said last week it sees the first signs of a rebound in global demand for handsets as wireless-phone makers place new orders for equipment.
The NAPM employment index rose to 40.8 from 37.2 in July. Manufacturers have shed almost 900,000 workers since August 2000, helping to push the unemployment rate up to 4.5 percent, according to data from the Labor Department.
The index of orders for export increased to 51.9 last month from 48.2 in July. The backlog of orders index rose to 44.5 from 42.5.
The NAPM report showed inflation was still subdued. The index of prices paid for raw materials fell to 33.9 in August from 38.7 the previous month.
Antitrust enforces won’t seek a breakup of Microsoft, but they will ask a federal judge to impose broad restrictions on its business practices. Antitrust officials also will drop a legal claim over whether the company illegally tied its Internet browser software to the Windows operating system.
The jobless rate jumped to 4.9% last month in the U.S., jumping much higher than expected as payrolls plunged by 113,000 jobs. Manufacturers slashed 141,000 jobs, their biggest retrenchment this year. The U.S. Non-Manufacturing Index declined unexpectedly in August to 45.5 from 48.9 in July. Experts were looking for a 49.5.
