The Bailout Plan: Now’s The Time To Buy Stocks
Like Warren Buffett
by Floyd G. Brown, Advisory Panelist, Investment U
Wednesday, September 24, 2008: Issue #859
In today’s semi-political investment environment, it starts to become a little hazy whether we’ve turned the corner or whether we’re still headed for an even worse market crash. Press reports have praised the work of Treasury Secretary Henry Paulson and Congress for diverting the economy from a new version of the Great Depression.
The only problem is that their bailout plan has not been adopted. It still must run the gauntlet of the U.S. Congress. Anyone who knows something about politics understands that trying to get a bill passed is like playing a grown up version of telephone - you may not get out what you put in.
Here is what we know so far. While the bailout plan has been dubbed the “son of RTC” - referencing the independent Resolution Trust Corporation that bought the assets of failed savings and loans in the 1980s - it will be very different from the RTC.
While the RTC took the assets of defunct savings and loans, wiping out shareholders, the Paulson process is looking to protect Wall Street. The U.S. Treasury Department will buy as much as $700 billion in toxic assets from institutions that are still solvent. Shareholders in the bailout firms will have their equity cut, but not destroyed.
Unfortunately, this will protect the same corporate dynasties that ran many of these firms into the ground with excess leverage. It also moves these depreciating assets onto the balance sheet of the U.S. government.
But there is something important that investors need to take away from this current meltdown…
The Bailout Plan Distracts From The Bigger Long-Term Picture
The bailout plan, while important and publicized, is distracting many from the bigger long-term picture. And that’s opened the doors for us to score some great bargains.
By holding “reverse auctions,” the Treasury plans to buy these loan portfolios from multiple banks. But the greatest danger is government officers buying assets that no one understands. How much they are really worth? Banks could offload non-performing assets with larger risks than currently disclosed.
When risks are divorced from investments, you naturally have an increased opportunity for fraud.
In my opinion, the wholesale nationalization of much of the mortgage market and many banks sets a bad precedent. And the plan’s insuring of money-market funds guarantees managers taking more risks will climb and the due diligence of the buyers will fly out the window. Before long, all of Wall Street will be selling bad assets here.
America has over 200 years of bankruptcy law that should be governing these transactions. If managers who accumulated too much risk by not adequately qualifying lenders are allowed to continue in their jobs, we are doing a disfavor to the intelligent managers who accepted lower returns for more prudent lending practices.
I believe the shareholders and executives at these mismanaged firms should be wiped out. These investments have clearly failed, and management is to blame. It’s the risk we all take, and the risk of investing. It allows new managers and companies to fill the void. This type of creative destruction - however painful - always strengthens the economy in the long run.
The Bailout Plan Brings A Silver Lining Of Consumer Benefits
The silver lining of the bailout plan is that many of these investments may come back to benefit the consumers. In the final review of the Savings & Loan bailout, U.S taxpayers saw a net gain from their “purchases.” And the simple reason behind it was that assets were purchased for less than they were worth and sold at a profit when their value was realized.
It’s the very principle behind deep-value investments.
The current mess has created lots of imbalance in stock prices. As thousands of financial “professionals” worry about their job prospects, stock prices are getting hammered. But that doesn’t mean that all of these companies deserve this mistreatment. There are solid businesses out there that have been completely undervalued by the market.
I’ve long been a proponent of contrarian investing and buying assets on the cheap. It delivers superior long-term returns and uncovers portfolio “superstars.” And it seems that I’m not the only one beating the pavement for deep values…
Now’s The Time To Buy Like Warren Buffett
Warren Buffett just took a $5 billion stake in Goldman Sachs (NYSE: GS), with the ability to buy another $5 billion more. And MidAmerican Energy, one of his subsidiaries, just bought Constellation Energy (NYSE: CEG) shares for half of what they were trading at earlier this month.
Clearly Buffett has been using the liquidity crisis to grab some phenomenal bargains. And we should be on the lookout for the same. The market’s recent fluctuations have been offering investors some tantalizing buys. (Take a look at today’s crib sheet for 3 ideas.)
So keep a level head and invest with caution in the current environment. The rules of the game are changing and short-term relief could be replaced with higher inflation and a longer bear market.
But that doesn’t mean there are some great values out there.
Good investing,
Floyd
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Today’s Investment U Crib Sheet
Here are three firms that recently caught Floyd’s attention…
- Qwest Communications (NYSE: Q) is trading at $3.46. This telecom firm gets no respect. It is the product of the ill-fated merger of long distance provider Qwest and the old regional Bell firm US West. As the firm loaded up on debt for the merger, the business swiftly changed. It has been plagued by the cancellation of landlines. In addition, its core business is shrinking. If its customer base stabilizes, and if it’s able to leverage its network, its debt will go down. Without a mountain of debt to dig out from, shareholders should see profits hitting the bottom line, and their wallets.
- 3COM Corp (Nasdaq: COMS) is trading at $2.21. Last year, the Chinese and Bain Capital tried to take this computer-networking firm private. The Pentagon blocked the sale because of national security concerns. Why? The technology this firm controls is vital to national security in everything from handheld devices to networking applications. Security personnel are currently watching over the Olympic Games via IP-based surveillance cameras, thanks to networking provided by 3Com. Quarterly earnings at 3Com are improving, and the share price action is more the result of the broken leveraged buyout than the state of the company.
- American Shared Hospital Services (AMEX: AMS) is trading at $1.99. This firm helps hospitals acquire the Gamma Knife equipment used in advanced radio surgical and radiation therapy services. This company was known for paying a healthy dividend. But late last year management decided to cut the dividend to reinvest the cash in growing the company. Shares were punished as income investors fled. The AMS Chairman, Ernest Bates MD, is bullish on the future saying in the last company conference call that earnings results “show how our strategy to use AMS’ creative financing solutions to make proton beam radiation therapy (PBRT) systems, Leksell Gamma Knife PerfexionTM systems, IGRT systems and other next-generation devices for radiation oncology delivery available and affordable to our clinical partners and their patients has put us on the path for long-term growth.”
For more ideas on investing in undervalued companies, learn more about Warren Buffett’s Investment Strategy, and nine companies Berkshire Hathaway loves loading up on.
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