Great Expectations

 | Oct 10, 2011 | 10:02 AM EDT
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When much is expected, and those expectations are not met, it's downright painful. On Friday night, the Phillies season ended prematurely -- in my view anyway -- at the hands of the St. Louis Cardinals in Game 5 of the National League Division Series. Despite putting together one of the best pitching staffs in the game, and setting a franchise record for wins in a season, the Phillies came up short as the team's usually potent offense fell asleep. A World Series appearance (at minimum) was my expectation -- and many others' as well. We expected too much and were bitterly disappointed by the outcome.

Of course, similar situations routinely occur in the equity markets, but there's a lot more at stake -- when your favorite team loses, it's typically not accompanied by a loss of capital. Look at what happened to Illumina (ILMN) last week. Late Thursday, the company preannounced third-quarter revenue of $235 million, more than 15% lower than consensus estimates of $278 million. And this was no small consensus, as there are 20 or so analysts covering the company. On Friday, shares fell nearly 32%, cutting away about $1.6 billion of market cap. Ouch!

As a value investor, I tend to avoid high-expectation situations, preferring instead those names where little is expected. I don't focus solely on little-known small- or micro-caps, though -- there are certainly opportunities in bigger names that the market has decided to shun. A perfect example of this is eBay (EBAY), a name that I never thought I'd own. It certainly did not fit the profile of what I'd normally take a position in, especially during the heady growth days when it traded at 50x, 60x or 100x earnings. But at 9x earnings in 2009, it seemed like a steal, and it remains in my portfolio. I bought it during a time of very low expectations. At this writing, despite running up 130% since my initial position, it is still inexpensive at 13x 2012 consensus estimates. Once again, fairly low expectations for a former highflier.

Very little is expected of former media giant Gannett (GCI), parent company of USA Today. Since dodging bankruptcy fears in early 2009, the company has been putting up some pretty decent numbers, more often than not exceeding expectations. But the specter of being involved in the newspaper business has scared away many investors despite the fact that there's more to the company, and Gannett currently trades at less than 5x trailing earnings and about 4.5x 2012 consensus estimates. In the trailing 12 months, the company has generated $2.59 in free cash flow per share. With the recent dividend increase, Gannett now yields 3.1%, and after cutting the dividend in early 2009, I can't imagine that management doubled it without very careful consideration. While the company may not be in a great industry, especially in this economic environment, this still seems like a ridiculously low valuation.

Gannett will report third-quarter earnings next Monday, Oct. 17, and the consensus is calling for revenue of $1.27 billion, and earnings per share of $0.44.

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