Being Decisive in the Market, and in Life, Pays Off

At the end of 2007, I was invited to serve as president of the homeowners association where I live in Florida.  This came as a complete surprise.  I had been on the Board of Directors for a couple of years, but I thought that I had kept a low enough profile by offering opinions only when necessary.  I told the board that I would get back to them.

So I did some soul searching, eventually deciding our association needed some new blood.  I accepted the Board’s generous offer (I will get paid $100) upon the condition that they help me out whenever I need assistance, which is most of the time.

Now this may not sound like a big deal, but presiding over 365 homeowners is no easy task.  With so many varied interests and personalities, people are bound to have problems from time to time.  I quickly learned that the old adage, “You can’t please all of the people all of the time” is very true, indeed.  At the same time, I have found that if people believe you are trying your very best, eventually they will treat you with respect.

After a few months of getting my feet wet, I enjoy being president of our homeowners association.  Attendance to all of our social functions has risen noticeably.  Why?  Maybe because I made it clear that I expected everyone to stop squabbling, to treat their neighbors with respect, and to do their part to make our community a better place in which to live.  My forthrightness was a shock to some, but after a few months, I’m beginning to see some progress toward a cohesive, friendly community.

Being Decisive Pays Off

What have I learned so far from my venture?  Most importantly, I can easily make a new friend by simply reaching out and treating each person as a unique individual.  I have learned a lot of other lessons, too.  I have had to make a lot of decisions quickly.  I tend to be a procrastinator, so learning to make decisions expeditiously has not come easily.  But, I am learning (the hard way).

How does this tie into the stock market?  When making decisions in the stock market, procrastination can become your enemy.  One delayed decision will only lead to another delay, and before you know it, a mini-disaster is at hand.  I know, because I’ve been there.  Most often, my initial thoughts about whether to buy or sell a particular stock turn out best.  That is, of course, after the proper amount of research has been completed.

Words of Wisdom: Be decisive, both in life and your investments.  The outcome will become far better than what is achieved by delaying action or doing nothing at all.

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Bubbles occur when crowds of people (including investors) behave irrationally.  It has spelled trouble throughout time.

The first recorded financial bubble occurred in 1636 when tulip mania hit the Netherlands.  Tulips became a luxury item and status symbol because of their vivid mosaic coloring.  Demand increased rapidly, pushing prices up to foolish heights.  Futures contracts were developed to enable buyers to buy next year’s crop.  Tulips began trading on exchanges. Speculators–not growers–bought bulbs and tulips expecting to resell them at higher prices.  At the top, one tulip bulb could fetch the equivalent of 20 years of wages for a skilled craftsman.

But in 1637, buyers for tulips disappeared.  Owners and investors could attract no new buyers at such lofty heights.  The ensuing crash in prices sent the Netherlands into a recession.   Sound familiar?

Tech Bubble Bursts

At the end of the last decade, investors bid up tech stocks to dizzying heights.  Price to earnings ratios were abandoned, because “this time was different.”  If a company had fast-growing sales, not earnings or cash flow, its stock was soaring in price.  New companies were welcomed to stock exchanges and experienced an immediate run-up in their stock price.  A tech stock with a good story could fetch more than 100 times sales.  The Nasdaq Composite Index skyrocketed from 1,000 to more than 5,000 in less than four years.

But in 2000, buyers for technology stocks disappeared.  During the next three years, the Nasdaq plummeted 78%, back to 1,100.

More Bubbles

Most recently, we all know what has happened with real estate in the U.S. and in other parts of the world.  Crowds of people behaved irrationally.  Now we are in a re-adjustment period, attempting to bring supply and demand back in balance.  Prices are falling while supply exceeds demand.  Eventually, balance will be attained and a new price level will be reached.

The current run-up in commodity prices, such as oil, corn, etc., is ongoing.  Are we near the top in prices?  I honestly don’t know.  And I doubt that investors or economists know, because there are too many variables.  It’s too hard to pick the tops of bubbles. As a conservative investor, however, I know my system will work regardless of the trend in commodities because I can continue to focus on lower risk investment opportunities.

My recommendation is to avoid stock sectors that have been bid up to dizzying heights.  For every hyper-inflated stock, there is an undervalued stock with a low price to earnings ratio, strong balance sheet and a solid outlook.

Here’s a stock that fits that bill.

Hewlett-Packard Co. (HPQ) manufactures computers, servers and printers and provides technology services and support.  The company is the leading maker of personal computers in the world.  Nearly 70% of sales are derived from foreign operations.  Sales of laptops and printer ink are providing strong growth and high profitability.

New management is providing renewed growth and higher profits at HPQ.  An increased sales force and aggressive expansion into emerging markets are also boosting results.  Emerging markets, such as China, India and Brazil, continue to grow rapidly.  I forecast 15% annual EPS growth during the next 12-month and three-year periods.

HPQ will acquire EDS, the former Electronic Data Systems, for $13.9 billion in cash.  The purchase will double HPQ’s services business and provide massive cost cutting opportunities.  HPQ’s strong balance sheet will enable the purchase of EDS without incurring insurmountable debt.

HPQ shares sell at 11.7 times forward 12-month EPS, which is lower than many technology stocks.  The company’s dividend yields only 0.8%, but HPQ is using excess cash to buy back shares.  I fully expect HPQ shares to advance to my Minimum Sell Price of 60.36 within one year, fueled by cost savings and rapid foreign expansion.

Sincerely,

J. Royden Ward
Analyst and Editor of Cabot Benjamin Graham Value Letter

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