2002 Report Card, 2003 Opportunities

At the turn of each year, Whitney Tilson owns up to his advice from the previous year. Bad calls? He's made a few. Great picks? He's had those, too. Today, he'll file his 2002 report card and make some predictions about 2003.

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By Whitney Tilson
January 8, 2003

One of the reasons I like writing on the Web is that, while it sometimes comes back to embarrass me, there's a high level of accountability: Every column I've ever written is still posted online.

When the year turns, I like to review the best and worst advice given in my columns the previous year and share my thoughts about the future. While I will review my stock picks and pans, keep in mind that I strongly discourage anyone from buying or selling based on what I -- or anyone else -- recommends. My goal is to help people think sensibly about investing and develop the tools to make good decisions on their own (keeping in mind that the best decision for many people is to avoid picking individual stocks altogether. There's no shame in mutual funds -- or, better yet, index funds).

Last year, I suggested 18 stocks to consider and 18 to avoid. (I've posted the entire list, with performance information, on the Fool on the Hill discussion board.) On average, my picks were up 16%, and my pans declined by 8% -- a decent performance, though not as spectacular as my 2001 picks and pans, which were up 30% and down 24%, respectively.

Comments on picks
I suggested most of my 18 stocks in the column Stocks to Buy Now, just as the market was collapsing in late July. "It's a great time to be an investor. In fact, I think it's the best time to start buying stocks in years," I wrote. Since then, the major indexes are up 15% to 17%.

The best performer among the 18 was Liberty Media (NYSE: L), which has risen 39%. The company has many parallels with Berkshire Hathaway (NYSE: BRK.A), a diverse collection of public and private assets managed by the smartest guy in the industry with a spectacular long-term track record. Plus, the stock is cheap, due largely to the complexity of the business and a cyclical downturn in the industry. I expect the media/advertising sector to rebound in 2003 and Liberty's stock to follow.

Another favorite is Barnes & Noble (NYSE: BKS), although I shorted one share of Gamestop (NYSE: GME), a majority-owned spinoff, for every two shares of Barnes & Noble purchased. Both Barnes & Noble and Gamestop issued earnings warnings, and the stocks fell 24% and 47%, respectively, during December. The net result: The bookstore business declined in value by 8%.

When a company reports an earnings miss, it's important to understand the magnitude of the miss and the reasons for it, to recalculate its intrinsic value, and then reevaluate the attractiveness of the stock based on the new -- usually lower -- stock price. In some cases, the disappointing news can fundamentally alter my investment thesis, and I will sell a holding; in other cases, I conclude the market has overreacted, become even more confident of the investment, and sometimes add to the position.

Barnes & Noble's recent announcement falls into the latter category. The earnings miss will likely prove to be small, and it was driven by slow sales during one of the weakest holiday seasons on record in the retail sector. I remain confident that Barnes & Noble's bookstore business remains at least 50% undervalued and have recently purchased more stock. In addition, with Gamestop down so much, I believe it is somewhat undervalued as well so I have closed out part of this short position.

Another stock I continue to like is Gemstar-TV Guide International (Nasdaq: GMSTE), which I discussed in Bottom Fishing in Tech, along with E*Trade (NYSE: ET), which I still like as well. Since I bought Gemstar in August, nearly everything that I hoped would happen has, in fact, occurred. The dreadful prior management team is out, a strong new CEO and key senior managers are in place, the aggressive accounting of the past is in the process of being restated and will be very conservative going forward, and the threat of delisting is gone.

Yet the stock has fallen (though it's up 5% since I wrote about it in September), in part because Q3 earnings were weak -- hardly a surprise given the turmoil at the company and the weakness of the advertising/media sector -- but mainly, I suspect, due to factors such as tax-loss selling, window dressing, and the company being removed from the Nasdaq 100, which triggered the sudden sale of tens of millions of shares. All these non-fundamental factors disappeared on Jan. 1 and, sure enough, the stock is up 17% already this year, a trend that I believe will continue.

Comments on pans
Despite some precipitous declines, my opinion remains unchanged on the stocks I panned last year. (Incidentally, it is such a travesty that a worthless stock like WorldCom, which is now down to 18 cents, is still allowed to trade!) My worst pan so far has been Farmer Mac (NYSE: AGM), which has risen substantially. Do I consider this a mistake? Not at all. The story hasn't changed, and I remain confident that this company is a house of cards that will soon collapse. I think there are a number of potential catalysts in early 2003, including the Q4 earnings report, the annual audit by a new auditor, reports by the General Accounting Office and Farm Credit Administration (both of which are examining the company critically), and possible congressional hearings.

Future outlook
In recent columns, I've expressed doubts that the economy will rebound this year, as is so widely expected. Consumer spending, which accounts for roughly two-thirds of the nation's economic activity and has almost single-handedly kept the economy afloat, was very weak during the holiday season. That this occurred despite the short-term stimulus of lower interest rates, which led to another wave of mortgage refinancings, does not bode well for the future.

As for business spending, it's hard to believe that this is going to bail out the economy given that, according to yesterday's Wall Street Journal, "Nonfinancial corporations' debt loads were 57.2% of net worth in the third quarter -- highest in modern history... debt to cash flow, at 15.4%, is also at a peak." Given so many uncertainties (the threat of terrorism, a war with Iraq, and so forth) and the fact that we are nearly three years into a bear market, one would expect stocks to be cheap, but instead, on nearly any valuation metric, they trade at levels near historical peaks (prior to the bubble of the 1990s, anyway).

Stocks on my radar screen
While I find little reason to be enthusiastic about stocks in general, there are always pockets of opportunity. Particularly interesting to me right now is the quick-serve restaurant sector, which has been getting killed by an insane price war, led by McDonald's (NYSE: MCD). With new management at McDonald's and new owners and managers at Burger King, I think the price war will end in the not-too-distant future, operating results will improve across the board, and stocks will follow. Worth a hard look in this sector are McDonald's, Wendy's (NYSE: WEN), Yum! Brands (NYSE: YUM), Jack in the Box (NYSE: JBX), and Chuck E. Cheese (NYSE: CEC).

The retail sector has also reported poor results recently, and some solid companies are now trading at or near five-year lows. Despite their recent woes, Barnes & Noble, BJ's Wholesale Club (NYSE: BJ), and Home Depot (NYSE: HD) all have strong franchises and balance sheets, generate healthy free cash flow, and are buying back stock.

Guest columnist Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. He owned shares of Liberty Media, Berkshire Hathaway, Barnes & Noble, Gemstar, E*Trade, McDonald's and BJ's, and was short Farmer Mac and Gamestop at press time. Mr. Tilson appreciates your feedback at  the Fool on the Hill Discussion Board or at To read his previous columns for The Motley Fool and other writings, visit