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Posted
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The Speculator
Recent articles:
• Higher
dividends are no magic bullet, 10/17/2002
• What dividends
say about a stock, 10/10/2002
• The earnings
gimmicks roll on, 10/3/2002
More...
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The Speculator
5
genuine buys on a Street of impostors
These days, a lot of bad
stocks fool investors by sending just the right signals. We found
five S&P 500 names whose stories hold up. Plus, four ways to
spot a scumbag.
By Victor
Niederhoffer and Laurel Kenner
Rewards have never been greater for those able to
discern truly superior investment opportunities. Yet favorite buy
signals such as buybacks and insider buying too often turn out to be
misleading in individual cases. In the words of our favorite science
fiction novel, "Invasion of the Body Snatchers," more than one
company that seemed to fit our criteria "only looked, talked and
acted" like one that really thought its stock was a good value.
We have
designed a new system to weed out impostors and used it to pick five
stocks from the S&P 500 ($INX)
that we think are genuine buys: Albertson's (ABS,
news,
msgs),
Analog Devices (ADI,
news,
msgs),
Dell Computer (DELL,
news,
msgs),
Paccar (PCAR,
news,
msgs)
and Xerox (XRX,
news,
msgs).
Here's how we arrived at those choices.
We started by
considering impostors in life and nature. The story of 1890s
adventurer Louis de Rougement proved particularly inspiring. As told
by Sarah Burton in her entertaining book, "Impostors: Six Kinds of
Liar -- True Tales of Deception," de Rougement claimed to have
survived 30 years in the vast Australian outback by convincing the
cannibals that he possessed supernatural powers. Eventually, he
found his way back to London and sold his tale to Wide World
magazine.
The first installment of the story created a furor.
De Rougement's account of riding sea turtles was widely ridiculed.
"I have caught and handled some thousands of turtles," wrote an
Australian, "and I never yet saw one which when afloat and when
touched anywhere on its body did not sink almost vertically." An
admiral weighed in on de Rougement's side: "I have considerable
experience of turtle-catching, and know of a midshipman who got on a
turtle and enjoyed a 10 minutes' ride before he brought the animal
to a standstill." In 1906, the self-proclaimed cannibal chief rode a
sea turtle at the London Hippodrome, disproving the naysayers. By
then, however, investigative reporters had unmasked de Rougement as
an imaginative former valet named Louis Grin.
They get what they want
On reading de
Rougement's story, we realized we needed more than a mere sea-turtle
test to avoid being fooled. This point was driven home when we read
about the outrageous high-stakes frauds perpetrated by seemingly
innocent plants.
European orchids not only look like bees,
they smell like sexually receptive female bees -- all to seduce male
bees into carrying pollen. A bee, after excitedly crawling all over
an alluring flower and attempting union, quickly learns to distrust
the fraudulent scent -- but 100 other types of orchids practice
similar shams.
"After visiting four or five different plants,
he has learned his lesson -- the whole lot that smell in this
general way are useless and he visits them no more," writes David
Attenborough in "The Private Life of Plants." "But by that time, he
is likely to have done what the orchids required of him."
So
it goes with investors. They are attracted by companies that buy
back their stock, or have insider buying, only to be surprised, as
in the case of WorldCom (WCOEQ,
news,
msgs)
by disclosures of secret debts, vaporous earnings or magic-trick
accounting for acquisitions. After a few encounters with such
impostors, investors may be ready to give up on stocks entirely. But
by then, they'll have made their contributions to the
market.
Some plants practice deadlier deceptions, pretending
to be food for a predator and then making the predator their prey.
The pitcher plants of Southeast Asia are shaped like beakers,
flagons, decanters and champagne flutes. Using copious amounts of
nectar, they lure insects inside -- and then dissolve their trapped
victims in digestive acid.
To avoid being fooled, seduced or
eaten alive by our stock selections, we decided to require multiple
signals before buying. Our evolutionary grounds for doing so are
that no life form (and hopefully, no company) would expend the
energy necessary to give off multiple false signals.
Three-signal monte
For most of this
year, we have been writing about various signals emitted by
companies. We've looked at buyback announcements, changes in
inventory and accounts receivable, and changes in dividend yields,
among other things. Now it's time to start putting some of these
signals together.
We settled on three signals that we feel
have been particularly efficacious:
- Buyback announcement
- Big decrease in inventory
- Big decrease in accounts receivable
As we reported in
our column
of April 18, companies that announced buybacks from year-end
1999 through March 2001 outperformed the S&P 500 by some 30
percentage points in the year after the announcement. We updated the
study on Oct. 3 and found that the difference had diminished to a
still-significant 6 percentage points.
Our Sept. 19
column reported on a 1970-1997 study by Jake Thomas and Huai
Zhang showing that companies that report big decreases in inventory
outperform those that report big increases by some 10 percentage
points in the next year. For accounts receivable, the difference was
5 percentage points. We updated the Thomas-Zhang study and reported
Sept. 26 that the five Dow Jones Industrial Average companies in
1998 and 1999 with the greatest inventory decreases outperformed
those with the greatest increases, with the difference averaging out
to some 10 percentage points.
To choose these signals, we
conducted many tests that could be classified as negative studies.
The buyback companies perform so well that additional criteria are
not overly helpful. For example, we found that the percentage of
shares bought back as well as insider buying within this group does
not add significantly to the returns during 2002.
Our
exploratory work shows a slight edge for the 93 companies that
announced buybacks so far in 2002 and also reported the greatest
decreases in inventory and accounts receivable. Buyback companies
with the 10 largest decreases in inventory have beaten the S&P
500 by three percentage points year to date; those with the 10
largest increases in accounts receivable by one percentage
point.
Only three companies displayed all three signals (a
buyback announcement and membership on the top 10 lists for largest
decreases in inventory and accounts receivable). Those three
companies were Analog Devices, Paccar and Albertson's. Xerox and
Dell were among the 10 companies with the largest drops in inventory
and also had substantial decreases in accounts receivable, so we
added them to the list.
Altogether, five companies met three
tests indicating that they are not impostors. We will be buying them
after the first substantial drop in the market that occurs after our
column is published, as we are writing at an S&P 500 level of
900 and are waiting for a decline.
Final note
David Rosen, a very smart
Chicago trader, spent many hours developing a profile of "the
scumbag/user type" of impostor. Whenever he observes the following
traits in someone, he says, "I know to run the other way." It seems
to us that these characteristics could easily be applied to
corporations, so we reprint them in full.
- He is very fashionable/trendy. This includes everything he
owns: Car, clothing, even his address has to be in the trendy part
of town. This also includes where he likes to spend his time. He
can't just hang out at "Bob's Bar," he has to be seen at the most
fashionable spots in the city. He'll usually live above his means.
He takes great effort to maintain his image, because image is all
he has.
- He is always looking for conquests. If he's married or has a
girlfriend, he's cheating on her left and right. Whenever any
attractive female passes by him, he is compelled to comment on her
beauty to any men he happens to be with. This is often accompanied
by a graphic description of what he'd like to do to her.
- He refuses to admit possibility of failure. When making his
investment/business pitch, he enthusiastically gushes on about how
it can't possibly fail. The worst that can possibly happen is that
you'll only make a little money on the deal.
- He's your best friend right away. You've just met the guy, and
he seems so happy to be around you and listens intently to
everything you have to say. He acts like he's your new best buddy;
in fact, he'll even literally call you "buddy" a lot to drive the
point home.
"Beware of these four traits in anybody you're
considering doing business with!" Rosen wrote. "Just one of these
traits is enough to repulse me, but you'll often see the con man
display three or even all four of these 'red flag' traits at once.
Knowing how to accurately profile people is a skill worth
fortunes."
Kindly send your thoughts about impostors and our
column to us at request@dailyspeculations.com,
and we will send you the complete list of buybacks classified by
changes in inventory and accounts receivable.
At the time
of publication, neither Victor Niederhoffer nor Laurel Kenner owned
or controlled any of the securities mentioned in this
article.
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