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Friday, 24 October 2008

Think Big: This Mega-Bear Will End

ByArne Alsin, RealMoney.com Contributor


Who will be the biggest losers over the next three to five years? Surprisingly enough, it will be investors afraid of losing. Those who squirrel away cash in T-bills or CDs in an effort to get safe are not, in fact, safe. Chances are good that they'll be losers two different ways.

The first way is through diminished buying power. If you accept a 1% to 2% after-tax rate of return in safe investments, chances are good that over the next three to five years, you'll be a net loser after adjusting for inflation.

The second way ultra-cautious investors will lose is brutal -- more likely than not, they're cautious because they've been ravaged by the recent market debacle. They may have lost 50% or more in stocks. And so rather than endure more uncertainty in equities, they've opted out. It's been the biggest "fright flight" in history: After pulling $72 billion from equities in September, $57 billion more came out in the first two weeks in October. These investors will pay dearly, as they'll miss out on likely rebound gains of 50% or 100%.

Context, as they say, is everything. History says that the market doesn't go down and stay down. It has always snapped back, retracing 50% to 100% of the decline within two years of the low.

Since World War II, we've had only two "mega-bear" declines in the Dow Jones Industrial Average -- defined as a slump of 40% or more -- the 1973-1974 drop of 45% and the 2007-2008 decline of 40%.

Investors ran for the hills in 1974. They not only had to watch stock prices plummet, they also saw daily headlines about OPEC's oil embargo, the Watergate scandal, and a spike in inflation to 11%. It's too bad investors were scared out of stocks, because adjusted for dividends, the market retraced the entire decline in two years' time.

If we go back 100 years, we can find three more mega-bear markets. Following the 47% drop that ended 1921, the market retraced two-thirds of that decline over the next two years before reaching new highs shortly thereafter. And following a 52% bear market that ended in 1942, the market also retraced two-thirds of the decline over the next two years before going on to new highs.

And then there is the mega-bear to end all mega-bears: From 1929 to 1932, in the midst of the Great Depression, the Dow fell from 381 to 41, an 89% decline.

Don't listen to the fearmongers who say we're headed for a repeat performance. It's not going to happen. Unlike in the current market, the Dow was absurdly overvalued in 1929. Fueled by speculation and 10% margin requirements, the Dow soared 497% from 1921 to 1929.

A more reasonable run from the low of 64 in 1921 would have taken the Dow to 120 or 150 in 1929. While the low in 1932, at 41, is still quite a drop from 120, look at how fast it rebounded: The Dow rebounded 165%, to 109 in 1933, less than 12 months after reaching the low of 41. The five-year mega-bull market that started in 1932 saw the Dow reach 194 in 1937, a 372% gain off of the 1932 lows.

You shouldn't worry about whether the next 10% move in the market will be up or down. Think big. The next 100% move in the market is up. Your portfolio should be designed so it captures the biggest possible gain in the upcoming retracement while providing plenty of staying power.

The companies I named in my last column will soar in the upcoming retracement, plus they've got staying power. Dell , Boeing , Expedia and Tecumseh Products serve end markets that are not going away, they're loaded with cash, and they are tops in the sectors in which they compete. Here's another idea.


IDT Corp.: A Spectacular Opportunity
Normally, I would never recommend a stock trading below $1 a share. But the current market is light-years away from normal. There are a handful of companies trading at minuscule stock prices that have been mistakenly tossed into the trash heap. IDT Corp. is an excellent example. Trading at 63 cents a share, down from $9 a share at the end of 2007, it has net cash of well over $2 a share. The market says the whole company's worth $48 million. Even in the context of a vicious bear market, this stock never should have dropped to anywhere near its current quote.

The core telecom business, with $1.8 billion in annual sales, has undergone an impressive transformation over the last year. The profitability of the telecom business is masked by one-time charges and the closure or sale of unprofitable businesses. Now that the hard work is done, you'll see free cash flow in the current fiscal year (that started Oct. 1) of $20 million.

This is the type of nugget you can only find in a mega-bear market -- a company valued at $48 million that generates $20 million in free cash flow and has $150 million in net cash on the balance sheet.

In addition to the telecom business, IDT owns several businesses in energy and media. Over the years, the company has developed and sold many businesses -- Net2Phone is one of many success stories. While there is tangible evidence that these businesses have considerable value, even if you assume they're worth zero, the stock is still a bargain.

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