Discovering Value


Make Money Off Mixed Market Messages

Whitney Tilson
John Heins

Investors torn between wanting safety and craving yield have created a market filled with wonderful opportunities both to own stocks and sell them short.



In their fascinating book, Mistakes Were Made (But Not by Me), psychologists Carol Tavris and Elliot Aronson describe a mid-20th-century doomsday cult. The cult, led by one Marian Keech, believed a flood was going to destroy the Earth on December 21, 1954. Many of Keech's followers disposed of their belongings and joined her on December 20 to await the flying saucer she promised would whisk them to safety before the end of the world.

As midnight passed, even the most fervent believers started to become anxious. At 4:45 a.m., however, Keech had a new vision: Because of the unsurpassed faith of her followers, God had spared the planet! You would think at this point that her followers would have seen Keech for the charlatan she was, packed up their spacesuits and left.

But instead, the mood shifted from despair to exhilaration; the belief of Keech's followers in her mystical abilities actually grew. Such enhanced faith makes sense given the power of cognitive dissonance. Here's how Tavris and Aronson describe it: "It is a state of tension that occurs whenever a person holds two [ideas] that are psychologically inconsistent, such as 'Smoking is a dumb thing to do because it could kill me,' and 'I smoke two packs a day.' Dissonance produces mental discomfort, ranging from minor pangs to deep anguish; people don't rest easy until they find a way to reduce it."

Investment Paradoxes

Today's investment climate is among the most dissonant we've ever seen. In fixed-income markets, a flight to safety has driven Treasury-bond yields to near all-time lows. At the same time, investors are pouring money into emerging-markets and junk-bond debt at a record pace. Investors are torn between wanting safety and craving yield.

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In the stock markets, investors are torn between their disgust at the lousy returns of blue chips over the past ten years and their expectation that stocks should outperform other investments. As a result, many of the least-risky blue-chip stocks are extremely cheap, while the shares of some firms with less-predictable or speculative prospects are expensive. We consider investors' contradictory stance toward risk in stocks to be great news. Everywhere we look, we see wonderful opportunities both to own stocks and to sell them short. (See Our Favorite Short Sales.)

Focusing just on the long side, blue-chip bargains include many we've mentioned over the past year, such as Anheuser-Busch InBev (symbol BUD), Kraft Foods (KFT), American Express (AXP), Berkshire Hathaway (BRK-B), Microsoft (MSFT) and Pfizer (PFE).

American Express is among the bluest of the blue chips in the financial sector, with one of the world's most powerful brands. We bought it after the stock had been cut from $40 to $20 during the meltdown in late 2008. It then fell another 50% by March 2009. That was hard to take emotionally but, convinced the company would survive the crisis, we doubled down and have since been well rewarded. The stock now trades at $40 (all prices are as of September 10). While we've taken some profits, we still hold a position in American Express because we believe its future prospects are bright and the stock is still cheap, trading at only 12 times average earnings estimates for 2010 and 11 times 2011 estimates.

A more recent purchase is Exxon Mobil (XOM). The company boasts an extra-ordinary long-term record of creating value for shareholders and is one of the few companies that still has a top credit rating. We rarely invest in energy companies because profits are too dependent on unpredictable energy prices, but Exxon Mobil's stock is cheap enough that we're comfortable owning it. How cheap? At about $60, the shares trade at a mere 11 times this year's earnings estimates and nine times 2011 estimates. Plus, the stock yields 2.9% -- better than a ten-year Treasury, with a comparably low risk of default.

Columnists Whitney Tilson and John Heins co-edit Value Investor Insight and SuperInvestor Insight. Funds co-managed by Tilson own shares of all stocks mentioned.



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