With this article, Seeking Alpha introduces Arne Alsin of Alsin Capital Management. A longtime successful money manager and prolific author, Arne manages focused value-centric portfolios for investors with an investment time horizon of two to three years. Arne welcomes your comments and feedback.
I’ll make it crystal clear, in no uncertain terms: The asset class to own right now - for the rest of this decade, even – is stocks. Not only are investors set to earn multi-fold gains over the remainder of this decade, but those gains are achievable with low risk.
That’s not to say it’s easy to get excited about stocks. Investors have yet to regain their footing after a brutal secular bear market that lasted from March 2000 to March 2009 - a cycle that began with the bursting of the tech-stock bubble, and ended with the nastiest plunge in stock prices since the Great Depression.
And, as if investors weren’t already disgusted enough with gyrations in stock prices, volatility over the last few months has been ratcheting higher, to levels that most investors find gut-wrenching. How do you lose $10,000 in stocks? Well, apparently, all you have to do is invest $50,000 and wait a week.
The consequent stain on investor’s psyche is deeply embedded. And it isn’t going to fade anytime soon. Not until several years pass. Not until several thousand points are tacked onto the Dow Jones Industrial Average.
It’s always been the case: Enthusiasm for any asset class swells after-the-fact. Investors will gradually warm to stocks as the Dow Average climbs to 20,000 during the next few years, while widespread enthusiasm is not likely to grip the masses until the Dow closes in on 30,000 near the end of the decade.
Ingredients for a Secular Bull Market
The two prime ingredients for a secular bull market are firmly in place: Extreme pessimism coincident with material undervaluation. To recognize the extreme sentiment against stocks, look no further than what the data say investors are doing with their cash. Even though stocks have gone up substantially since the secular bear market ended in March 2009, investors have been making sizeable and consistent net withdrawals out of stock funds ever since – over $150 billion at last count.
This illustrates investor loathing for stocks as much as anything: Rather than own stocks, investors are pouring money into money market funds that pay near-zero yields. In prior bear markets, at least, investors had decent alternatives. During the 1987 Crash, investors were enticed away from stocks by 7% yields on cash. Today, cash yields hardly constitute an enticement. They’re more like an embarrassment. But investors gladly clutch onto those tic-tac-toe-sized yields; anything, it seems, is preferable to owning stocks.
To the undervaluation issue: You simply can’t find a historical precedent for the current situation. That is, you can buy premier, best-in-class companies at 10 times earnings and at dividend yields that are double the 10-year-treasury bond yield. It hasn’t happened before (and it likely won’t happen again). You can compare things like the long-term average PE ratio (use the 100 year average or the 200 year average, it really doesn’t matter), or you can employ a wide variety of cash flow metrics. As long as the metric you’re using is reasonable, it’s likely to agree with me on this: The market can rise immediately by 25-35% and still be considered cheap by historical standards.
What’s really impressive about this market is not that it’s cheap in the aggregate. Most exciting is the story within the story; or, more precisely, the market within the market. It’s a stock picker's dream come true: It’s easy to distinguish stocks that offer modest potential upside (10-30%), like Johnson & Johnson (JNJ), from those that offer true, wealth-building opportunities, with profit potential of 100% and above, like General Electric (GE), a company I highlight below.
Top Ten List for 2012
My Top Ten List for 2012 is comprised entirely of stocks from the latter group (100%+ profit potential). I’ll post the entire list in upcoming columns, but to get the ball rolling, here is my first pick for the Top Ten:
1. GENERAL ELECTRIC (GE)
Ten years ago, when GE traded at $40 per share, I recommended selling the stock in a column for TheStreet.com (GE’s Priced for Perfection, 11/29/2001). It was hardly a heroic call, given the issues it was facing at the time, not the least of which was an excessive (by a factor of two) PE multiple of 30.
Ten years later, the opposite recommendation is an easy call to make: Buy General Electric. By this time next year, I expect this $15 stock will trade close to its intrinsic value of $26-27, or 70-75% above today’s quote. By next year the annual dividend will be $.85, and for 2013, I’m estimating a $1 annual dividend. If you buy GE today, then, you’ll be getting a 7.5% yield ($1 dividend on a $15 outlay for stock) in slightly more than a year from now, a yield that’s likely to grow substantially for the remainder of the decade.
My projection of a doubling in GE’s stock price is based on nothing more than simple common sense. It’s certainly not heroic, no more heroic than my critique of the stock in 2001 when it traded at $40. Anyone can do the math, as long as they have the right assumptions in place. Those assumptions are predicated on a simple question: What is normal?
What is normal?
It’s the most important question you can ask when the market environment is extreme. Note that the question applies at either end of the spectrum, whether the market is extremely good (1997-1999) or extremely bad (2008-2009). The smart analyst views extreme periods for what they are: outliers. More specifically, they are outliers that should be given very little weight, since it is highly unlikely they’ll be repeated anytime soon.
The worst thing you can do as an investor is to extrapolate non-normal conditions (again, whether it is good or bad) in a linear fashion into the future. Listen, I fully recognize certain inevitabilities: GE is going to have a lousy year (or two) before the decade is over. It’s also going to have an unusually good year (or two) before the decade is out. Both are dangerous to the investor when given too much weight (which is to say, any weight at all).
The smart analyst focuses on “normal.” Let other analysts forecast calamity. Predictions of calamities (like a credit meltdown in Europe) don’t always pan out. Normal always pans out. Normal is inevitable, even if we have to wait a bit longer than we’d like. And when a return to normalcy translates into easy 100% gains, like I’m suggesting for GE stock, maybe waiting isn’t such a big deal, after all.
So when I analyze GE’s operating metrics, my objective is to build a model around normal, or near-normal. And on this topic, I have happy news for GE shareholders.
The factors that served to depress GE earnings to subnormal levels - such as the capital overhaul and business reconfiguration at GE Capital - are fading remarkably fast.
Normal is right around the corner for GE, and when it occurs, the earnings power in this particular operating model will surprise a lot of observers. Here’s just the start: $2 in annual earnings and a $1 annual dividend – both metrics were surpassed in years past, by the way, back when GE was a less efficient, less valuable company. An earnings stream approaching $2 per share may happen as soon as next year, on a rolling basis (not on a calendar year basis), perhaps beginning as early as the third quarter. ($2 EPS from Q3 2012 to Q2 2013).
The timing of $2 earnings/$1 dividend is much less important than the inevitability itself. It’ll happen and soon. That’s all investors who are staring at GE’s $15 stock quote need to know.
More stocks ideas coming…
In the coming days, look for additional posts from me, as I unveil the rest of my Top Ten List for 2012. I’ll be recommending stocks where value exceeds price by a wide margin, and where catalysts are in place to drive price appreciably higher.
Disclosure: I am long GE, JNJ.
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