John Templeton started his investment career in 1939 by buying every stock on the New York Stock Exchange trading under a dollar. He argued that you wanted to buy securities at what he called, “the point of maximum pessimism.” Still reeling from the depression and with war looming in Europe, he certainly found a point of pessimism. Additionally, he noted that “If you can see the light at the end of the tunnel, it is probably too late.”
Templeton’s philosophy and maxims can be summarized as buying into severe contentiousness. When the common stock of a meritorious company falls deeply out of favor, it is easy and obvious to point out the negatives. This makes a purchase of shares hard to do for psychological reasons. We argue that these psychological situations and the information which surrounds them are one of the main weaknesses of the efficient market theory.
While it may be true that everyone in the internet age has the same information (a point for the efficient market folks), it is also true that the ability of market participants to “be greedy when other are fearful” is not improved by the democratization of information. Turnover ratios and individual investor trading statistics clearly suggest that access to information breeds impatience.
Our job at Smead Capital Management is to sort through quantitatively wonderful companies that go on sale, and determine if the problems are permanent or won’t be remembered in three to five years. The history of what we do rests on the contentiousness of the original purchase and the long-duration wealth creation of the underlying businesses we own.
We will discuss some of today’s most contentious industries and feature one of our common stocks which could gain in the future if folks can’t remember three years from now what was bothering investors today.
One theory, which is very popular on Wall Street, is that new technology will eliminate the need for TV networks and network-affiliated TV stations. Currently investors pay approximately 72 times 2016 EBITDA (earnings before interest, taxes, depreciation and amortization) to buy Netflix (NFLX). They may love NFLX, but we’re happy to buy Tegna (TGNA), which owns 46 network-affiliated TV stations, Cars.com, CareerBuilder.com and trades for 4.25 times 2016 EBITDA.
Tegna has multiple attractions for us. First, little known to popular belief, 55% of news consumed by adults in the U.S. today comes from watching local TV stations. Local stations dominate news on public safety, politics, community affairs, local sports, traffic and weather. We believe these numbers will only go up when our largest population group (23-35 years of age) become home buyers and dwell with their family.
Second, Tegna has a consistent and successful business online. Cars.com is the Zillow of auto dealers and Careerbuilder.com serves the needs of millennial resume builders. Third, Tegna is a very large owner of coveted cellular spectrum via their TV stations. The Federal Communication Commission is begging TV station owners to sell them their spectrum to meet the streaming needs of Netflix and YouTube, which use 54% of all the data and existing cellular capacity. We think the need for cellular spectrum will only grow.
Let me share some personal history to help you understand why folks overestimate the value of new, exciting technologies and distribution methods. My wife and I were married in late 1981 and moved into an apartment. We ordered cable for the first time and I began to watch my favorite songs played visually on a network called MTV (Music Television). I became addicted for about three years and watched for as many as three hours per evening. Men at Work, Huey Lewis, Dire Straits, and other music came alive on my TV screen.
What eventually stopped me from watching was the birth and aging of our first couple of children. I had no interest in their little ears and eyes being fixated on the lyrics and images I was absorbing. It was assumed at the time that this new station would kill radio and some TV programming because of its hold on young men and women.
Viacom bought MTV and ultimately morphed it into a series of TV shows designed to lure 15-25 year olds, giving up on their main channel even playing music videos. Today, Viacom’s stock is languishing. In our opinion, one of its biggest problems is how irrelevant MTV is in music and popular culture.
If there is a more despised and ridiculed industry in the U.S. than banks, we haven’t found it. Regulators scrutinize the banks as if the next 1930’s depression is right around the corner. Politicians demonize the banks and use their populist message to seek power. Lawyers feast on both sides of bank-related issues, sucking potential profits out of the companies as the sins of 10 years ago are punished. Too bad the executives and employees from back then are long gone.
The nation’s largest banks are the main transmission system of the economic engine which drives our nation. They match up savers and borrowers. They guide investors, fund business growth and borrowing needs. They are the largest mortgage lenders and credit card issuers. At some point, regulators will normalize their scrutiny, politicians will demonize another industry and lawyers will feast on another carcass.
In the meantime, Bank of America (BAC) sells at tangible book value, 11 times 2015 profits and has the largest deposit base in America. They are the bank of the average American household and stand to gain more from the emergence of our largest population group to form households, buy houses, and cars which fit car seats. Even if interest rates are slow to return to historical levels, it is easy to visualize normalized earnings of $2.50 to $3.00 per share by 2019 and dividends of $1.00 to $1.50 by 2020. At a P/E ratio of 12, this would mean a $30-36 dollar stock and dividends for today’s buyer of 6-9% in five years.
Although it is not as contentious as it was in 2011, when it was left completely for dead, the health sciences world is back in the populist doghouse. A needed correction in the stock prices of the raciest biotech and pharmaceutical participants turned into a debacle as the presidential election cycle revved up. Candidates on one side of the aisle are threatening to socialize another part of the healthcare system and cap medicine prices.
We had been concerned one year ago that too much popularity had entered the sector and we trimmed our ownership of healthcare-related stocks from a peak of 29% of our portfolio down to 18%. Now it appears that others are afraid to tread in the area which could be a bit of a political football for the next year.
Merck (MRK) looks very intriguing at around $50 per share. It trades for 13.3 times First Call Consensus 2016 earnings estimates, pays a 3.6% dividend and has been a historical leader in the development of medicines and vaccines. Its CETP inhibitor, Anacetrapib, has been left for dead by numerous respected heart doctors after Eli Lilly gave up on a similar CETP test on October 9th of 2015. We could get a better feel by the end of the year when they give us an interim report on the REVEAL study of Anacetrapib. When the pricing fears subside and a very favorable era for new product introductions play out the next three years, Merck could surprise the investing crowd.
John Templeton proved over a long and illustrious investing career that buying stocks which are contentious can produce market beating results. We would argue that the memory of the 2007-09 financial meltdown, the recent market adjustment and isolated difficult circumstances in specific industries give opportunity to bargain hunters today.
The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Bill Smead, CIO and CEO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.
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