FOOL ON THE HILL
We are currently faced with more economic uncertainty than we have seen for some time, and it's being reflected in the stock market. But now is not the time to sell stocks and hoard cash, says Whitney Tilson. Investors would do better to look for good companies trading at attractive valuations. In this column, Tilson shares some of the stocks he is looking at, and the rationale behind his investigations.
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Terrorists have attacked our country, killing thousands. We are preparing for war with an amorphous enemy. The economy is slowing, more than 100,000 people have suddenly been laid off, and we may already be in a recession. Stocks are tumbling: The Standard & Poor's 500 Index has declined in five of the past six quarters, the Dow Jones Industrial Average recently had its worst week since 1933 and just concluded its worst quarter in 14 years, and the Nasdaq Composite Index had its second-worst quarter ever. Time to sell stocks and sit on cash until the situation stabilizes, right? WRONG! The best time to buy stocks is when uncertainty is at its greatest, because that is when prices are often at their lowest. As Warren Buffett wrote in his 1986 annual letter to Berkshire Hathaway (NYSE: BRK.A) shareholders: "We have no idea -- and never have had -- whether the market is going to go up, down, or sideways in the near- or intermediate term future. What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable. And the market aberrations produced by them will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." So is it time to wade into the market, buying stocks left and right? Absolutely not! Many stocks are still richly valued: The S&P 500 is trading at 28x earnings and the Dow at 23x, both nearly double their historical averages. But with so many stocks down significantly in the past year, some bargains may be beginning to appear. It's about time! For quite a while, excessive valuations across the board have forced me to invest primarily in special situations and in the stocks of very small companies. I much prefer to invest in good businesses at good or great prices, and then hold for a long time. Without further ado, here's a quick overview of some companies I am now investigating seriously: Berkshire Hathaway Though it may sound awful to say that, Berkshire -- primarily an insurance conglomerate -- can easily afford the estimated $2.2 billion cost of claims, and will benefit hugely from the following factors: Airline, aircraft, and travel companies
Boeing Over the past two-and-one-half years, the company generated huge free cash flows -- far exceeding net income -- and bought back $6.8 billion of stock, reducing shares outstanding by 13.5%. The stock appears quite cheap today: it's trading at nine times trailing earnings and 13 times estimates for next year's (presumably depressed) earnings. (For more on Boeing, see Paul Larson's column from last week.) Rockwell Collins Sabre Embraer Miscellaneous other ideas Aetna (NYSE: AET) infuriated doctors and, after enduring a 70% decline in the stock over the past two years, investors hate the company too. The stock therefore looks very cheap, and with health insurance premiums due to rise more than 20% next year, earnings could pop, rewarding investors who are willing to hold their noses. Arbitron (NYSE: ARB), which has a virtual monopoly on measuring radio audiences, has some of the most mouth-watering economic characteristics of any company I've ever encountered. The company reached agreement on a multi-year contract with its largest customer, Clear Channel Communications (NYSE: CCU), in August. This removed the biggest risk factor surrounding the stock, yet it is down slightly since then. I'm intrigued by the real option value (.pdf file) embedded in a new device Arbitron is testing, the Personal People Meter. While the shares are intriguing at current prices, I won't be trembling with greed until they fall perhaps another 20%. Conclusion -- Whitney Tilson Guest columnist Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. He owned shares of Berkshire Hathaway at press time. Mr. Tilson appreciates your feedback atTilson@Tilsonfunds.com. To read his previous columns for The Motley Fool and other writings, visit http://www.tilsonfunds.com/
Berkshire is already my largest position, which is why I didn't buy more when it dipped under $60,000 less than two weeks ago. (Berkshire's "B" shares, which have the ticker "BRK.B", trade for approximately 1/30 the value of the "A" shares.) It's a decision I'm already regretting. The stock has gone straight up since then, with more and more investors apparently agreeing with my assessment that the events of Sept. 11 were a net positive for the company.
Most stocks in the airline/aircraft/travel industry have been crushed since Sept. 11, but I believe the industry will rebound as it always has -- maybe not 100%, but close to it. If you share this belief, I suggest looking at high-quality, market-leading companies with strong balance sheets that can withstand a severe, prolonged downturn. (A rebound won't help companies that have gone out of business.) Here are four ideas:
In the aftermath of the Sept. 11 tragedy, airlines have pushed back delivery of new aircraft, which will likely hurt Boeing's (NYSE: BA) earnings. (The company has not yet conceded this.) But Boeing's military aircraft and missile business, which accounted for 20% of revenues and 25% of operating earnings in the first half of this year, should rise substantially.
Rockwell Collins (NYSE: COL), a recent spin-off from Rockwell International (NYSE: ROK), describes itself as "a world leader in providing aviation electronics and airborne and mobile communications products and systems for commercial and military applications." The company has a strong competitive position, high margins and returns on capital, and now trades for less than 11 times trailing earnings. Like Boeing, its commercial aircraft business will be hurt in the short term, but 38% of sales are to the military, which should offset the decline to some extent.
Sabre Holdings (NYSE: TSG) has a proprietary computer network used by thousands of travel agents and others in the travel industry. It's the market leader, has high margins and returns on capital, and generates abundant free cash flow. If you think earnings will eventually rebound to anything close to pre-attack levels, the stock is very cheap -- especially considering that Sabre's 70% ownership of Travelocity (Nasdaq: TVLY) is currently worth about $3.50 per Sabre share.
Headquartered in Brazil, Embraer (NYSE: ERJ) is one of two major manufacturers worldwide of regional jets. (The other is Bombardier, a Canadian company that trades over-the-counter.) The company has been growing like gangbusters and -- where have you heard this before? -- has high margins and returns on capital. The stock is now selling at about six times reduced earnings expectations for 2002. Investing in international companies, it should be noted, can add substantial additional risk to the equation, and may not be for everyone.
The entire retail sector has gotten whacked on fears of damaged consumer confidence, presenting many interesting opportunities. At the top of my list are Intimate Brands (NYSE: IBI), which is mainly Victoria's Secret and Bath & Body Works, and Limited (NYSE: LTD), which owns 84% of Intimate Brands. At present valuations, you can buy the latter for its stake in the former and just about get the rest of Limited's businesses free -- though it's unclear whether this represents a bargain.
As always, do your own homework and don't hesitate to email me with any insights you might have about any of these companies.
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