A quick word here about valuations. All of the aforementioned companies were great businesses but poor investments over the past five years. Of the three, only J&J produced a positive return. As Bill Miller of Legg Mason Funds recently pointed out to investors in his fund: “A company that is doing terrifically well, that has great management and high returns on capital, and great products and prospects, may be a terrible investment if the expectations embedded in the current valuation are in excess of those fundamentals.” The flip-side of this is often true as well; while no rational investor seeks out companies with awful products and poor prospects, many factors can lead to a poor short-term results, which in turn, can have big impact on the stock price as investors project these short-term results into the future.
Of course reflexively buying any company’s stock just because it has dropped in price isn’t an effective strategy. Often times the markets’ assessment is correct and the stock price drop is warranted. For example, it would have been a big mistake to purchase the shares of most steel or textile manufactures at any time during the last 40 years believing that a return to earlier profitability lay just around the corner. The real trick to identifying good stock market investments is, again to borrow from Bill Miller, figuring out when “… the market is wrong about how important something is, or wrong about when something occurs, or both.” We feel we can do a pretty job at figuring those things out, but very often that means owning companies who shares are out of favor, mentioned in the business news in an unflattering way, or somehow “controversial”.
One final item to note about the present investment landscape; as mentioned earlier, short-term interest rates which had essentially been stuck at around one percent for the better part of four years have increased dramatically. Risk-free rates of almost five percent can be found on the short end of the yield curve and in the absence of many alternatives, represent pretty good value.
Please feel free to contact us with any questions or comments. As always, thank you for you trust and patience.
Very truly yours,
Eckart A. Weeck Managing Director