The BMW Method
The Market is Whacko!

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By BuildMWell
July 24, 2006

Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light. How are these posts selected? Click here to find out and nominate a post yourself!

I have been watching two stocks in particular for about two years. They are Abbott Labs and Hospira. But, my story actually goes back a total of four years to a time when there was no Hospira. Back then it was the Hospital Products Group of Abbott Labs and merely contributed slightly to the overall revenues and profits.

The Hospital Products Group caused Abbott Labs a great deal of pain during 2002 and 2003. They were cited by the FDA for several violations that resulted in a $150 Million fine and lots of bad press. Abbott Labs stock dropped from the high of about $57 to $42/share...a Market Cap loss of $25.9 Billion. But, Abbott's whole Hospital Products business was worth between $4 to $5 Billion to them. In other words, the market chose to hurt the parent company by almost 26 Billion for a problem that was worth a fraction of the real value. Unfortunately, ABT paid the $150 Million fine to Uncle Sam and the FDA and ABT put out a statement that said they were not admitting guilt of any wrong doing. I argued at the time that they should have fought the ruling because the whole thing came down to the opinion of the FDA investigators rather than a real "cleanliness" issue. But, ABT management wanted their name out of the newspapers. Some might call this government extortion, but obviously it seems to work.

The market soon forgot the problem had existed and ABT's stock again rose in price...everyone seemed happy. Well, everyone except the FDA. They loved that $150 Million so much that they came back for more. They fined ABT another $125 Million in 2003 and claimed they still had cleanliness problems in the same lab. The stock plummeted again. And, again, ABT coughed up the cash and claimed they had done nothing wrong.

I could tell by reading the Annual Reports that ABT management was pissed off about this whole affair. I know that I was too. So, it came as no big surprise when they asked the shareholders to approve the spin-off of that division as a separate be called Hospira. The vote was overwhelmingly in favor of dumping this problem division that had cost the shareholders so dearly.

In May of 2004, HSP went public with the shares being distributed to Abbott shareholders on a 1 for 10 basis. The value was set at $30/HSP share or $3/ABT share. On the day of the spin-off ABT dropped about $3/share and within a week I was the proud owner of some HSP stock that I had no real desire to own. But, I decided to give it a fair chance. Maybe they were better than I thought they were and we would soon know...once the annual reports began to come out.

So, here we are today and the market has spoken. As this post's title says, "The Market is Whacko!" At least, I believe that I can make a very sound case to prove that it is. Let's see if you will agree.

On the day of the spin-off, HSP had a market Capitalization of $4.694 Billion based on the number of shares outstanding then. The reason that I say this is the number of shares has jumped significantly due to the new management taking options that they have awarded to themselves, but you have to read the HSP SEC filings to find this out.

Meanwhile, on that same day in May 2004, ABT had a Market Cap of $64.16 Billion...less HSP's Market Cap leaves $59.466 Billion ($39/share). But, remember, the low price was primarily due to the problems at Hospira and they were being put out to pasture that day. Sure enough, ABT's price began to rise and HSP's began to fall until it reached about $26/share. But, for some reason, the price has taken off since then and has been as high as $49/share...a CAGR of 27.8% from the IPO price and 37.3% from the lows of 2004. Abbott Labs stock has risen to $46.50/share in the same time period...a CAGR of 9.2%. And, it was below $39/share just a few months ago...a zero percent 2-year CAGR. Does that make any sense?

Today, HSP carries a P/E Ratio of 29:1 while ABT has a 21:1 P/E. Obviously, HSP is the superior stock and the fastest grower. Or is it?

Please tell me what is so desirable about this stock...or the company for that matter? It has grown earnings at about 5%/year, it is in a very competitive business and revenues are hardly growing at all. HSP pays absolutely no dividend and they have huge debt that they owe to Abbott Labs to buy themselves from ABT. How can Mr. Market award a high P/E to this stock? Can anyone explain this to me?

But, what about ABT?

The parent company is growing earnings at 18%/year and surprised to the high side again this week, driving the price up from about $42/share. ABT's market cap is $71 Billion while Hospira's is $6.68 Billion. That is $2 Billion up from the spin-off.

Without the spin-off, ABT would be worth $50.89/share today. But because they unloaded one piss-poor division, the stock is worth just $46.50/share. Abbott has been penalized by $13.54 Billion since May of 2004 for doing a smart thing. How can this make any sense to an investor? Heck, ABT had been penalized $26 Billion before the spin-off that was supposed to solve the problem. So much for sound logic on the part of management. Check out ABT's history:

Without HSP. ABT's actual performance have soared while HSP's numbers have shown nothing to be excited about. But, after two years, Mr. Market is still penalizing ABT for something that HSP actually did back in 2002. The market is definitely whacko. It rewards the inept and penalizes the mighty because no one is really paying attention. Mr. Market can be manipulated for extended periods for no good reason. I think that I have just proven that fact.

Today, I would not pay a dime over $18/share for HSP which should carry a P/E of about 12. And, the real earnings are suspect because of those management options. At least, they show the true earnings figures in their SEC filings. In truth, I do not want to own any HSP at all. Someone bought all of my shares at about $45 each...why? I have no clue.

I used the proceeds to buy more Abbott Labs because I know exactly why I want to own them...and I already owned enough shares already. But, I could not pass up a great buy no matter what. ABT at under $40/share is nothing short of theft. But, it is legal theft.

But, that is merely my opinion. You will need to make up your own mind. But, if you think the market is rational or that all information is priced into the market at all times, you are more whacko than the market is. I hope that I have helped to prove that the market is not rational and that all information is obviously not being considered in pricing many stocks. The key is for us to know what we are buying and, more importantly, why we are buying it.

We must teach ourselves how to shop for real bargains in the market. That is what the BMW Method does for me.

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