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Thursday, February 25, 1999

Good Company, Bad Stock?

by Charles Hudson

I have enjoyed reading what many other investors have had to say in this column, so I thought that I would take my own crack at it. As the Co-President of the Blyth Fund, Stanford University's student-managed investment fund, I have had the opportunity to encounter a variety of questions about the difference between a good company and a good stock. Ideally, a good stock would correspond to a good company (by "good," I mean a company with a strong management team, good execution, and a decent balance sheet). But should every good company make a good stock? I have, rightly or wrongly, tried to impress upon the group's members that every good company doesn't have a correspondingly good stock.

Take one of our recent buys, Whole Foods Market (Nasdaq: WFMI), as an example. Whole Foods Market dominates the healthy/organic food retail space, dwarfing its nearest competitor, Wild Oats Market (Nasdaq: OATS). Whole Foods recently pre-announced an earnings shortfall (consensus was $0.58 and they are expecting $0.45-$0.50 for the quarter). The stock sold off strongly on the news and has recently been mired in the low $30s ever since. I still think that Whole Foods is a great company and a dominant player in its industry. But I still think that it should be sold.

Right now, the market is not recognizing the value that exists in small cap stocks. And, as many of my colleagues pointed out, one bad quarter does not a terrible company make. I think that in times like this it is important to look at what the market is rewarding. Right now, big cap stocks are en vogue, end of story. The few small caps that are performing well are ones that will soon become mid or large cap issues and have strong prospects for growth. Is the market really going to recognize and reward a company whose market cap is less than $1 billion and has slashed its EPS growth forecasts? Not in this market environment!

"But it's so cheap now! We can't sell it at this kind of loss!" I winced when I heard them say that. As I have learned, you can't let stocks that you bought for their growth prospects become value plays because the fundamental story around the company has changed. That is a reason to sell, not a reason to dig in and ride out the wave. Take it from someone who has learned the hard way.


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