Oct. 13–On Friday, I was skimming the morning’s research, when a headline from Deutsche Bank made me drop my mouse. “Texas Instruments — Throwing in the Valuation Towel — Upgrade to Hold.”
TI was at $24.99. The analyst said its fair value was in the mid-teens, and was selling at pre-bubble levels. So why would he chuck his valuation models and upgrade a stock he thought was too expensive? The stock was already up 60 percent. No one wanted to listen to his sell recommendation. So he might as well capitulate to the market. The same analyst also raised Intel to a “buy” with the headline, “If you’ve gotta own one.”
His position was that Intel was selling close to pre-bubble levels. He justified his upgrade by noting it was cheap relative to other chip stocks, and that “the market’s sensitivity to valuation is low.” In other words, if investors aren’t going to care about valuations, why should he?
I’m worried when I see an analyst recommend a stock, because “you’ve gotta own one.” I’ve never thought I had to own a semiconductor, retail, or real estate stock. I try to own stocks I think will go up. If all chip stocks are too expensive, why should I own any?
I also don’t care about the valuation of one stock relative to its peers, unless I’m planning to buy that stock and sell its competitor. This was the type of thinking that got everyone in trouble during the bubble. Analysts were pushing new Internet stocks because they were cheap relative to old Internet stocks. Then, the market proved they were all overvalued.
Finally, no one should ever buy a stock because the “market’s sensitivity to valuation is low.” The market always cares about valuation. Sometimes it has temporary amnesia, but it always remembers in the end. Only investors forget.
That’s not to say the market is going to start falling. There are lots of reasons to be bullish in the short term. The economy’s improving. Inventories are low. Earnings will surprise on the upside. Retail sales in September were the strongest in years, giving retailers a great start to the fall season.
Returns on alternative investments, like bonds and money funds, are lousy, meaning investors should keep putting money into stocks. Hedge funds are still underinvested and underperforming. They’ll buy more to salvage their year. All this suggests a continuation of the rally.
But this run won’t go on forever, and the first real sign of excess is that more investors are ignoring valuations. Read almost any report on a tech, Internet, or biotech. Analysts talk about improving earnings, but less about fair valuation.
This is becoming a game of chicken. One day in December or January, the market will suddenly remember valuations do matter, and high flyers will hit big time air pockets. I’m not smart enough to pick the top. So I’m trying to stick to my value discipline by reducing my exposure to stocks I think are fully valued, and looking for names I think have been ignored.
Friedman’s is a jewelry retailer, selling at $12, which should earn $1.70 next year. TMM is a Mexican railroad, selling at $3.34. If it wins its tax case, it’s worth $10. If it loses, it’s worth $2.50. Bon Ton is a Pennsylvania department store chain whose shares are selling for $11.62. With a new acquisition, it can make over $2 in 2 years. I own all of them.
I’m not throwing out my valuation towel. Neither should you.
Peter Siris ([email protected]) is a New York hedge fund manager.
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