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>> i think value is a very core value investing is taking advantage of the market ‘s emotions, so i think you’re looking for a company that is inexpensively valued, that looks cheap on the basis of earnings or cash flow or the asset values, but in addition to which it’s out of favor, so there’s a big discount that the market is giving it, an emotional discount in there. so that if the asset value recovers, the cash flow and earnings recover and you get a butter multiple on that over the next one to three years, you could have a much better price.
>> some stocks go out involuntarily and come back up. some stocks go down permanently. how do you differentiate between a stock that is undervalued and a stock that will continue to lose value?
>> every company has a bit of a different story, and just to address what barbara was saying about value investing, in general we don’t follow the value investing criteria she would use like a warren buffett, we follow the garp investing theory, growth at a reasonable price. we’re looking for companies that have a decent p/e-to-growth rate and free cash flow, but those aren’t necessarily the primary criteria we would use.
>> david, if we talk about value in this market , you’re a known hunter of companies that may be overvalued, so i guess we can flip things around for you. how do you find companies that, when you look at them, you say this company is trading well above where it should be?
>> well, to echo some of what barbara said, looking at it from the opposite side, when expectations are really high and when everyone is in love with a company, these companies tend to be too highly priced. we’re looking at high-price to book value company, companies selling at high p/e ratios, where people are assuming everything’s going to go right. and where there’s uniform optimism nearly all buy recommendations coming from wall street, no sell recommendations, and then you still have got to analyze fundamentally what’s going on inside the firm and if the bull case assumes everything to go perfectly where you see some flies in the ointment where there could be problems out there.
>> barbara, how do you define a badly priced company and just a bad company?
>> well, by badly priced i think you’re saying mispriced.
>> exactly. overdone, oversold.
>> and actually, that is the hard part because a lot of companies are cheap for good reasons. you know, they fall out of favor, you look at an eastman kodak and xerox sort of lost their way. and if you were just to look in the rear-view mirror, you’d say, gee, if this company were to regain the luster, it could be valued much more highly but you look at the company over the next one to three years on the horizon. i spend 90% of the final trying to figure out the catalyst or sequence of events over the next one to three years that will return that company to cash and earnings and a much better valuation as the reputation comes back. that’s the hard part, making sure you’re investing in companies that can have a change of fortune.
>> and what do you look at specifically? cash flow? reversal of fortune?
>> yes. companies are out of favor because they create their own missteps or their business or industry cycle misstates them. if you can identify a series of events over the next one to three years, the company will perhaps sell off noncore assets. sometimes the management has to change. if you can outline a series of events over the next one to three years, a specific story for that company that can restore the value, and monitor that, you have a good investment.
>> mike, would you rather buy the stock of a company that’s in a declining industry but the company has something going special for it or buy stock of a company that is en in an advancing industry but has fallen on short-term issues of its own?
>> i think―it’s not an easy answer, but both are equally important. xerox, for example, is an interesting name. it’s been in the news quite a bit in the last few quarters. there was the s.e.c. investigation and liquidity questions but we’ve warmed up to the stock over the last six months.
>> why? for xerox they’re a copier business and they’re in digital imaging but america things of xerox as a copier company, are they not in an industry that may be maturing and is that a risky bet? what do you like about xerox?
>> the growth rate of the industry itself is slowing. you’re right about that. it’s not a fast-growing industry of 30% to 40%. but we like the liquidity problems have disappeared from the company. those questions whether they would survive at all. the management has actually changed. there’s a new c.f.o., a new c.e.o. the company has brought out a number of new product lines over the several last quarters, they’re producing a tremendous amount of cash flow to pay down debt. despite the fact the industry is growing slowly, they’ve gained market share. you want to look at the industry. obviously, if it’s in difficult times, for example, the tire industry and goodyear we wouldn’t go near, but in this case, we think it’s sufficient.
>> david, are the majority of retail investors almost always wrong?
>> i would say, joe, yes. individual investors tend to misunderstand the concept, something you mentioned before as far as the bad company versus a bad stock or a good company versus a good stock. you could have a great company and it could be a bad investment. you could have a bad company and it could be a good investment. and that’s very important for investors to look at, that if you have a relatively bad company with very low expectations, that has a very low stock price, that is making some changes, making it better, then that could be a good investment. or you can have a great company that everybody loves selling at a very high stock price but unfortunately more competition is coming in and it’s not going to be as good as what everyone thinks and that’s a bad investment. so, i think that’s the place that individual investors make the biggest mistake.
>> david, if you’re short or long, how many stocks out there are good investments?
>> well, we’re, of course, known to have a dismal market view currently, so there’s not many companies in our view that are good investments out there.
>> even as a short, though? as a short as a good investment? either way to make money.
>> well, there’s always lots of opportunities if you’re looking at the ability to go either short or long. however, it’s a very tricky ballgame, that’s for sure, and it’s not even easy to find good shorts today with the market environment like it is, where bad stocks are going up.
>> ok. david, we’ll come right back to you after the short break. we’ll be back with david tice, barbara marcin, and michael sheldon on this special edition next.
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