Value Library

The following is an excerpt from the ABC Perspective - October 2000 - Pg. 12

Running the Gauntlet

Needless to say, the present investment environment is perilous. The stock market is fraught with revenue shortfalls, missed cash flow projections and debt repayment concerns. Corporate earnings warnings are numerous and growing.

And yet, despite increasing investment uncertainty, investor complacency is rampant. As a result, the incredible and increasing share price volatility has grown in crescendo, contributing to an emotionally-charged, fickle stock market. Moreover, with the reported investor margin debt at all-time highs and rising interest rates, the general investment horizon appears to be flashing amber.

Now this is not to be interpreted that we are bearish or negative on the securities market. On the contrary, we believe that a certain class of stocks will outperform, namely out-of–favor equities that are extremely undervalued and are ripe for merger, restructuring, privatization, or takeover. However, the equity market is dichotic, as the undervalued, unloved value stocks are the polar opposite of the power-charged and grossly overvalued high technology, new economy stocks.

These seemingly turbo-powered high tech equities have been trading at astronomical valuations, high price to book and sales multiples and triple digit price to earnings multiples. In many cases they have gargantuan cash burn rates and the only way they survive is through perpetual equity financings. But this hasn’t, up until recently, bothered investors. There remains considerable investor optimism that these technology stocks will recover and that sky-high valuations will charge upward once again. Maybe so, but the risks are increasing and these stocks are now running the gauntlet.

As a value investor, I must admit that it has not been an easy time. Basic "Investment 101" tenets are disregarded and snubbed by the marketplace. Underpriced old economy stocks are trading at inexplicably low prices. Clients incessantly ask, why? All I can reply is that it is very difficult to explain. However, I do believe that the incomprehensible over-valuations are vulnerable and that value investing will triumph in the end.

Strangely enough, we believe that we now detect an early stage investor switch back to the basics. This flight to quality toward terra firma, old economy stocks started with the Canadian banks, insurance companies and utilities. They have done remarkably well. While it is still a little early to definitely state that this trend could become an investment groundswell, we are heartened and encouraged.

We suspect, however, that the end result will be a continued shift back to the relative safety of balance sheet, cash flow, and price to earnings analysis. This rotation, we believe, will be the ultimate catalyst toward value stock success and exceptional performance.

Irwin A. Michael, CFA