November 13, 2003
Is the Wish List’s Latest Success Indicative of an Oversaturated Market?

As work progresses on the upcoming 2004 Christmas Wish List report, an unexpected announcement crossed the wires yesterday: GE Healthcare Financial Corporation will acquire Wish List company HSBC Inc. for $14.50 a share in stock ($72.4 million). This takeover prices HDR shares at nearly 60% above Tuesday’s closing price (or more than 80% above HDR’s price when it was originally selected for the Wish List on December 26, 2002). Accolades aside, the takeover announcement also means that after beginning the year with 8 company selections – all of which we purchased or had already owned from previous years – total Wish List selections outstanding will soon be down to two.  Even steadfast bears stock piling gold and ammunition should be able to find more than two companies to invest in…

The reason why is obvious: we do not believe that stocks are, by and large, undervalued. However, there have been other factors at work in 2003, including Bush’s reduction of dividend taxes and an unrelenting rush into gold stocks.  Quite frankly, despite some missed momentum opportunities we still elect to tread carefully. While the sustained rally in quality dividend and gold companies may by no means be over we refuse to allow it to transform us from investors into price chasers.

In addition to the evaporation of opportunity caused by the rally in U.S. stocks, the global equity landscape is becoming equally parched. To be sure, the boom in Asia complexifies an in-depth investigation of beaten down opportunities, and even the two cheapest major markets in the world on a forward P/E basis – found in Paris and Germany – have followed the upward trajectory of the U.S. markets.  This global melt-up in stocks has undoubtedly left behind some undervalued companies, yet finding these companies has become increasingly difficult when considering that central banks may have just ended their concerted attack on interest rates.  To be sure, a nearly 2% yield today - say on Siemens AG – looks attractive…but if central banks begin raising interest rates a 2% dividend yield is barely worth mentioning. 

Taking the flipside, central bank ‘reflation schemes’ are supposed to bring with them a sustainable up-tick in economic activity and corporate profits – thus, when dividend yields become less attractive compared to bonds investors will begin focusing more on capital gains.  This rosy theory makes sense – until you discover that companies like Siemens have already more than doubled in share price since October 2002, and valuations (forward P/E of 20) are optimistic to say the least.  

Regardless, we are not in full mourning over the arid opportunity environment just yet.  Rather, since inception the Wish List has yet to make a single losing equity selection, and now that HDR is being acquired this counts as two companies (Newmont’s takeover of Franco Nevada being the first) that have been de-listed for hefty profits. Sometimes blessed with luck, and other times capable of discovering underappreciated companies, our agenda and selection methodology remain the same. With total Wish List returns to date approaching 85% over the last 3 years, we hope to sustain the 3-year winning streak to 30-years and beyond…

In sum, we carry a great deal of skepticism when it comes to the price GE paid for HDR.  However, we are not complaining about success, only noting our fear that the drying up of opportunities could turn into a drought as the hunt for undervaluation continues.

Notwithstanding this, we have dug even deeper and in the process have found a number of potential investment opportunities that we will share in the flagship December 26, 2003 report.

We have sold some HDR shares already, and do not intend to add GE to the Wish List following the acquisition. HDR will be officially removed from the Wish List in the run-up to the acquisition’s completion.

Sincerely,

Brady Willett & Todd Alway
 

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