Sometimes, the Discounts Aren't Right

 | Jun 10, 2014 | 1:56 PM EDT  | Comments
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When it gives you a chance, do you take it? That's what I think to myself every time we have a mini-swoon or a drop in prices of a certain sector.

Take this morning. I am coming out of the Exchange after "Squawk on the Street" and going in at the exact same time is Stephanie Link, the co-portfolio manager of Action Alerts Plus, my charitable trust. She sees me and, while we pass each other, she asks, "What do you think of the decline in aerospace here?"

I said I thought it made no sense, as we know business is terrific. She couldn't think of any reason for the weakness, either.

Maybe it's the failed sale of BE/Aerospace (BEAV) I posited, a company that makes the interiors to many aircraft, including seating and galleys. Not long ago the company decided to explore options to bring out value. There's been tremendous takeover activity these days so when I read this morning that BE is going to split itself up rather than sell itself, I figured that maybe someone is saying that the aerospace cycle has slowed down. BE was down about 5% when we saw each other and it did reflect poorly, momentarily, on the airline biz.

She then asked about buying some United Technologies (UTX), which was down with the sector.

I said, "Great idea, it shouldn't be off a buck and change, especially given the rest of its book of business, which includes a ton of non-residential construction and heating ventilation and air conditioning that is, at last, turning around. Stephanie had already opined that HD Supply (HDS) , a very good barometer of construction in this country, reported this morning that business steadily improved throughout the quarter. Plus, architectural billings, another good judge of construction, have stayed strong and China cut its reserve requirement ratio last night, which could boost stimulus.

So we bought some more United Technologies.

What's important about this exercise? I think these days, it's pretty novel. We like to explain our moves in real time to subscribers of Action Alerts PLUS, and we laid out this logic pretty much as I just described it before we pulled the trigger. It helps a great deal to do so. Typically, though, I see the opposite happen in this market. People want to buy United Technologies when it's hot, not when it's not. They don't want to use the price break to scoop some shares up. They usually believe it is the beginning of some horrendous move and they will be coming in at what seems like a discount, only to be followed by a still bigger discount tomorrow.

Let me say that's certainly a possibility. Our rational for United Technologies may not play out. Or perhaps there is something wrong. Maybe we catch a downgrade tomorrow by some firm and it leaked today, which, sadly, has been known to happen.

Let's just say the whole mentality of the buyers since this market bottomed in 2009 can be summed up in these words: Every decline is a selling opportunity. People simply don't believe that a discount is worth taking.

I hate this kind of thinking. If you believe the thesis is intact, you should be a buyer. There might be whole instances where some stock or sector has gone out of fashion. We know, for example, that the Software-as-a-Service businesses got too high. They were then clocked by insider selling, as well as a deluge of new companies posing as SaaS companies. These companies were all valued relative to each other, not the overall market, which means that there's always the possibility of a real hammering.

However, when you are buying stocks of high-quality companies that aren't that expensive, you do get your opportunity, and I think you start to buy.

I use the same kind of logic for United Technologies pretty much every day in this market. I look for price breaks that the market provides and run to them, not away from them. Don't buy all at once. I would love to scoop up some United Tech even lower than it is today to get a good basis.

But it might not go down, and I might not get more in. So be it.

Sometimes these discounts can be painful and the buys torturous. For example, we started buying General Motors (GM) too early for the trust, thinking the worst was over. But we always left some room in case it wasn't. When the stock got down to $34 I came out hard telling everyone to buy it because I figured the terrible incidents that the defective switches caused were being discounted by a lower stock price, one that brought its yield all the way up to 3.5%. Believe me, though when I say, that every time I saw CNBC's Phil LeBeau come on about GM, I had to cringe. I know the papers don't stop hammering the company, and the lawsuits will be ugly, no doubt about it. But unless you think that these suits are going to be like asbestos was to many of those makers (and I don't think they will), or like Macondo was to BP (BP) (which I also don't think is a good comparison), that was your chance. Maybe it comes around again. Maybe it doesn't.

You can't always nail the bottom. I like Rite Aid (RAD) very much, but when it had its poor earnings preannouncement last week I said to keep buying it. The stock still hasn't settled down, but that doesn't bother me. It is a long-term story. Yet, I think, judging by my Twitter feed, many are mad that it hasn't stopped going down. You have to ask yourself if you are in it for a quick pop or for a bigger haul. I like it for the latter.

Some declines are particularly horrendous but still buyable. I was faithful to Facebook (FB) all the way down after what was a terrific quarter. I was faithful because while many Internet stocks had become very expensive, this one simply isn't when you look out a couple of years. Facebook is quite different, say, from AthenaHealth (ATHN). Remember, when you are evaluating growth stocks you have to look at the estimates of how they are going to do a little further out than this year. AthenaHealth, for example, sells at about 70x 2016 numbers even after its huge decline. Facebook, on the other hand, sells at about 25x 2016 numbers. Given that Facebook has far superior growth to Athena and a host of other Internet, e-commerce and SaaS plays, I wanted to buy it and did. Others, though, kept telling me, "There's something really wrong here." To me there wasn't. Doesn't mean there won't be, but, again, I wanted that price break to do some buying.

There will be plenty of times where the discount is a harbinger of something worse to come. But the vast majority of the times since 2009 have been the exact opposite. Remember that. Sometimes the discounts aren't right. The market overreacts, especially in an era where the futures and the exchange-traded funds are way too powerful. If they give you a chance, maybe, just maybe, it's worth taking.

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