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Posted 9/15/2000
Niederhoffer & Kenner
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18 stocks for adventurous investors
Today's market rewards risk-takers, not bystanders. So those who dare to invest in companies that are losing money today may very well get the biggest payoff.
By Laurel Kenner and Victor Niederhoffer
"I was leaving for a new world, new ways of living. Was I the fool? Was I leaving a certainty for a chance?" Louis L'Amour, To the Far Blue Mountains
The Nasdaq 100's ($NDX.X) 11% decline in the six days after Labor Day cut 10% or more off 50 of its members. It is well to remember at such times that the spirit of adventure that drove Europeans to cross the Atlantic in search of fortune, that inspired Prometheus to upset the gods by giving fire to men, that helped Hercules persist through a dozen trials, and that guided Odysseus through the perils of storm and shipwreck is the same one that rewards investors.
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The fear of losing everything will keep most people at home. The riskier a venture is perceived to be, the greater the reward for undertaking it.
In the new millennium, the people reaping stock-market rewards are generally not the ones who succeeded in the 1930s, the 1950s and the 1970s. In the 1930s, the winners were those who overcame their memories of the Great Crash by limiting their purchases to companies trading below book value. In the 1950s, they were the ones who didn't succumb to the fear that, once wartime spending was over, the economy would slide back into depression. In the 1970s, when the Nifty Fifty collapsed and many stocks lost 70% to 80% of their value after inflation, investing in companies that were trading below book value once again paid off.
Those investors of the past -- the Warren Buffetts and Ben Grahams -- earned enough cachet through their successes to permit them to live on their reputations until now. But like a lot of elderly citizens we know, at some point many of them stopped being curious. Ben Graham stopped investing when he couldn't find any more stocks below net liquidating value. Warren Buffett was saved from obscurity almost by accident because he had the foresight to buy an insurance company. Academic studies, based on the past rather than present, confirmed the wisdom of their methods, offering investors exactly the wrong strategy even as the old investors fell further behind the form.
Rewards go to the adventurers
In the 1980s, a new spirit captured the market. It is the Promethean spirit of growth, of exploration, of developing tools for conquering the all-too-difficult slings and arrows of life. This spirit has been amply rewarded -- but the prizes haven't gone to the investing stars of the 1950s and 1970s. The old-hearted stars responded to the change by sneering at the newcomers and rejoicing when market crashes, such as the one that occurred in March and April of this year, seem to bear out their opinions; but a glance at their portfolios shows their pathetic nature.
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What the old men love most is to say, "This company trades at a sky-high P/E (price-to-earnings ratio), because the idiotic public has driven up the market price." America Online (AOL, news, msgs) is a prime example. True enough, profits didn't start to take off until the fourth quarter of 1998. But the stock rose 2,500% in four years, to a chorus of pooh-poohs all the way up
Were AOL investors stupid? Let's call them adventurous. They had faith that the company would eventually go from red to black, because of something above and beyond the balance sheet. The naysayers, for all their smarts, remind us of the 15th century Chinese, who despite possessing compasses, advanced shipbuilding technology and maritime charts, passed laws against sailing abroad even as European sailors explored the world.
(We'd like to make plain that a person can be old in years while maintaining curiosity and sense of adventure. The image of the old gentlemen in "The Pickwick Papers," who could hardly resist a game of leapfrog while on a brisk evening walk, comes to mind. Our 80-something friend Edwin Marks, who has racked up a 32% average return over 35 years of investing, is not averse to buying companies such as Ariad Pharmaceuticals (ARIA, news, msgs), which has a negative P/E. It may help that Ed reads five books at a time and that he's on the board of Cold Springs Harbor Laboratories, which is the research center in New York run by Nobel prizewinner Jim Watson.)
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Dare to look at money-losing companies
While an adventurous company could be defined in many ways, we decided to zero in on those that actually lost money in the last 12 months, but were valued above $500 million by the market. After all, if these companies continued to lose money, they would go out of business, and this prevents many institutions and investors from buying because of legal restrictions and fear of total disaster.
A further burden on the flimsy support for such stocks is the incessant pounding by the financial press. In a recent issue of Barron's, for instance, lead columnist Alan Abelson inveighed upon Emulex (EMLX, news, msgs), the victim of a hoax that drove its stock down as much as 62% during the Aug. 25 trading session. "When it hit 43, the stock still seemed more than a tad overpriced at upward of 40 times projected earnings," the columnist wrote. "But hey, on Friday, the P/E was back over 100, which automatically anoints Emulex as a premier growth company and therefore cheap at any price."
Niederhoffer & Kenner
Victor Niederhoffer has traded stocks, currencies and futures worldwide for the past 40 years; he is the author of "The Education of a Speculator." Laurel Kenner is a trader and former Bloomberg markets editor. In a special series of weekend columns for MoneyCentral, they'll assess the past week's Wall Street performance and next week's prospects. Let us know what you think in the Start Investing Community.
To profit from a company that is losing money, its financial picture must change from revenues below expenses to revenues above expenses. When we combine this need for change with a rich valuation, the purchaser must be high in hopes, resolution and resilience.
As previously mentioned, we have grave doubts about the validity of academic studies of stock performance. Most of them suffer from the bias of retrospection. At its simplest level, this bias stems from choosing companies based on data that would not have been available at the time these companies were chosen. To avoid this defect, we chose our sample of companies in alphabetical order, starting with "A," from a source that was printed and available on a contemporaneous basis: the Standard & Poor's Stock Guide for 1995 and 1996. The earnings reported in this publication had all been announced before press time. For example, the first company that we chose for our 1995 portfolio was Alliant Techsystems (ATK, news, msgs). In the 12 months ending Sept. 30, 1995, it had a deficit of $4.92 a share, and its market value was $655 million, based on year-end prices.
Unlike most studies, which conveniently delete companies that did not report continuously during the period, ours followed the sample through merger, acquisition or delisting. For example, in 1995, five of the 20 companies in our universe were acquired and one was delisted, for an average return for the six of -4.2%.
The results of our study of just the companies starting with As and Bs for those years -- a statistically valid method of sampling -- indicate that investment in adventurous companies of this nature is amply rewarded. The average change for the stocks in our 1995 Adventurous Portfolio to date has been a gain of 176%, vs. 143% for the S&P 500. The 1996 Adventurous Stocks rose 169%, vs. 99% for the S&P 500.
Not every stock made money. Acquired companies weren't always bought at a premium. Shares of the Mexican construction company Bufete had lost 99.9% of their value since 1995, while in the 1996 portfolio, AOL rose 2,586%.
Taking account of the variability of the results, there is a 95 in 100 chance that the superior performance of the Adventurous Portfolios was due to systematic, non-random factors.
The Adventurous list
The current list of Adventurous companies -- the first 18 As, Bs and Cs found in this screen on Sept. 13 -- is as follows:
ACLARA BioSciences (ACLA, news, msgs)
Aether Systems (AETH, news, msgs)
American Home Products (AHP, news, msgs)
Akamai Technologies (AKAM, news, msgs)
Amazon.com (AMZN, news, msgs)
AirNet Communications (ANCC, news, msgs)
Ariba (ARBA, news, msgs)
Aventis (AVE, news, msgs)
Aviron (AVIR, news, msgs)
Avanex (AVNX, news, msgs)
AT&T Wireless Group (AWE, news, msgs)
Bell Canada International (BCICF, news, msgs)
BEA Systems (BEAS, news, msgs)
British Sky Broadcasting (BSY, news, msgs)
Clear Channel Communications (CCU, news, msgs)
CacheFlow (CFLO, news, msgs)
Clearnet Communications (CLNT, news, msgs)
Comcast (CMCSK, news, msgs)
We caution that, because of the extreme variation in the stocks' performance, the elimination of just one company from each of our samples would have brought the results down to random. Therefore, investors should consider these stocks as a group rather than picking and choosing a stock, or handful of stocks, that looks ideal. Companies that look absolutely the worst in portfolios like this often end up with the most attractive returns.
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Encapped in these Adventurous Stocks is the Western idea of making hypotheses about the future and using principles to analyze and explain. Egyptian surveyors knew about right triangles, but the Greeks were the ones to explain the relations of the sides with the Pythagorean theorem. The tendency to pay heed to practical precepts without regard to underlying principles reminds us of today's value investors. For example, nobody has ever been able to explain what "intrinsic value," the key to value investing, really is.
One of the principles at work in an Adventurous Portfolio is that it costs a business more money to develop a customer than will come from the first sale. It's true not only in business, but in all walks of life, including romance. The cost of establishing that first relation is always high. If you're developing a lot of customers, or courting a lifelong partner, you're probably losing a lot of money and spending a lot of time. Eventually, with repeat business, the rewards will come. What people who don't understand computers or electronics can't comprehend is that with the number of people using the Internet increasing by, say, 50% a year, companies riding this wave are bound to lose money as they fish for customers among these users.
Rather than obeying the rickety precepts of past decades, today's investors will succeed by venturing forth. The emergence of this sort of person between the 15th and 17th centuries was admirably described by Richard Tarnas in "The Passion of the Western Mind": "Curious about the world, confidence in his own judgments, skeptical of orthodoxies, rebellious against authority, responsible for his own beliefs and actions, enamored of the classical past but even more committed to a greater future, proud of his humanity."
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