Evening The Odds

Back in 1967, after finishing language school and security training, I was driving with an Army buddy and his wife from Chicago to Oakland, California to ship out to Okinawa. I had enjoyed my leave, and had spent just about everything I had in the pursuit of that enjoyment. This wouldn’t be a problem when we got to Oakland, but in the meantime, I had exactly 78 cents to eat on when we got to Reno, Nevada.

Reasoning that even an entire dollar wasn’t enough to buy anything anyway, I decided to put the money into the slots, just so I could say I hadn’t gone through Reno without doing any gambling. And voila! I got a $12.00 payoff from my last dime. I ate well on that win!

I wasn’t tempted by my good fortune to jump in with both feet. I’ve never had a lot of luck gambling, and that one exception didn’t change my mind about how little sense it makes to keep betting when the odds are against you.

So, every time I go to Las Vegas, I wind up walking around watching other people gamble, which gives me a much better return ratio. I’ll put all my pocket change and a $20 bill or two into the slots, but I guess my temperament just isn’t made for gaming. I can’t stop thinking that my money could buy a nice book! Hardly the ideal thought pattern for a successful gambler.

More and more I’m convinced that investing in stocks is also a matter of temperament. If I invested the way I gamble, I’d be a big holder of U.S. Treasuries and of value stocks. But I genuinely enjoy finding out more about companies and I have a feeling that the more I know the more I’m able to push the odds slightly in my favor. I still get killed occasionally, but – like the MIT group that figured out how to successfully count cards at the Blackjack table – I know that it takes only a slight advantage to make me a winner. That’s exactly what the casinos in Las Vegas know, too; if they have an edge of just a couple of percentage points, the more you gamble, the more they make.

The ideal growth investor isn’t content with just a series of small wins – you have to have enough risk tolerance to take on some stocks with big potential. But when it works, it can make you feel great … just as much as if you’d made a point at the craps table.

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During the first week of October, Cabot Publisher Tim Lutts and I drove over to Vermont, where we attended the Contrary Opinion Forum. Tim, who has been going for years, has already reported some of his experiences in his Cabot Wealth Advisory. But this was my first time, and I was fascinated by the mix of people who had laid out good money to come listen to experts talk about the economy, stocks, and methods of analysis.

You might think that the beautiful setting on Lake Champlain, the golf course 100 feet away and the sumptuous meals may have had something to do with it. But conference attendees weren’t much seen on the links, and, despite the unusually warm sunshine outside, the conference hall was filled for every speaker. Plus, the good weather was something of a surprise to the people I talked to, many of whom had endured rain, gloom and storms in previous visits. All of which is just to say that the people really were there to hear Contrary Opinions about investing.

“Contrary to what?” you may be asking, and it’s a question that came up early in the conference. One of the first speakers weighed in by remarking that he had always thought that contrary opinion just meant thinking for yourself. I responded – under my breath – that it might mean just thinking, period. But maybe that was a little snarky.)

Anyway, the speakers were an interesting cross section of the professional investment community, including four economists, two mining/metals analysts, two fundamental money managers and one technical stock analyst.

And what, you may be asking, did these assorted gurus, grey-beards and eager intellects conclude? Mostly it was that the enormous wad of bad mortgage debt generated by the subprime crisis is going to take a long time to digest, and eventually someone is going to have to pay for it. Lots of those bad mortgages were used as the basis for asset-backed bonds, and the bond-holders will have to be paid off whether the mortgages are or not. The only alternative is for the issuer to default on the bond, which takes the money out of the bond-holder’s pocket.

It’s also possible that the government could step in with another Resolution Trust Company, which was founded in 1989 to deal with a similar problem resulting from the failure of many Savings and Loans. But many people then saw this as letting the responsible (or irresponsible) parties off the hook, and there is just as much disagreement about who should foot the bill this time around. If you suspect that it won’t be the fat cats who made tons of money from making all those bad loans, I suspect that you may be right. Stay tuned.

There is a doom-and-gloom quality to much of the talk about the subprime crisis. The reasoning is that this wad of bad debt is hanging like an enormous boulder over the stock market highway, and that when it falls, the world as we know it will essentially end. In this regard, it’s a lot like assertions that the U.S. national debt (or current account balance or poor educational system or declining manufacturing base, etc.) will ruin everything forever.

As a technical stock analyst, I can look at all these dire predictions with a certain detachment. If charts show me stocks that are going up, I buy. If charts (and the broader market) are going down, I sell. It’s not that I don’t care what’s happening in the real world; it’s just that anticipating what will happen doesn’t do me any good, and thus doesn’t interest me much. Technical investing gets me out of the business of predicting (and worrying about) the future, and that may be one of the biggest benefits of all.

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The investment idea I have for you needs some explaining. As a growth investor, the stocks that interest me need to stand out in some way. I want to see a unique product or a killer competitive advantage to go along with a pattern of healthy growth in revenues and earnings, and, to top it all off, I want to see a rising chart that shows that investors are signing on. It’s the classic trifecta: story, earnings and chart.

Comp De Saneamento (SBS) doesn’t have what I’d call a unique product, but it’s a very important one. It’s a Brazilian utility that supplies water and sewage services to almost 23 million customers in more than 368 municipalities in the Brazilian state of Sao Paulo as well as in the metropolitan area of Sao Paulo itself. The government of the State of Sao Paulo is the main shareholder.

While it may not be dramatic, the importance of providing clean water and processing sewage and industrial wastewater is hard to overestimate. The company, which calls itself Sabesp (an acronym for the company’s complete name, which translates to something like Basic Sanitation Company of the State of Sao Paulo), performs 147,000 water analyses a month at its ISO-recognized laboratory centers.

Brazil is a fast-growing region, and this has meant good business for Sabesp. Q2 results showed earnings up 80% and sales up 24% from the previous year. The after-tax profit margin of 20.4% and forward P/E ratio of 11 are also attractive. The chart shows a stock that has been in an uptrend since the middle of 2004 and that pulled out to a new price peak in late September, completing its recovery from the mid-August meltdown.

SBS used to pay a dividend, but hasn’t declared one since late December 2006. This is likely a sign that the company is building cash for either capital projects or a takeover war chest.

SBS isn’t a heroic stock that’s likely to fly to the moon. But with markets acting a little grouchy and leading stocks sailing along at extended valuations, there’s something attractive about the slow-but-sure advance of a well-run utility in a country that’s growing twice as fast as the U.S.

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Editor’s Note:

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Paul Goodwin

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