Never Mind the Guesswork

 | Dec 12, 2011 | 10:36 AM EST
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One of the oldest rules of thumb in investing is that you are buying a stock today not for what the company has done but what it's likely to do. Understanding a company's past performance and overall history can help you develop thoughts on its potential.

It's a tough concept for the average investor to grasp, and it's not made any easier by looking at algebraic expressions online or premade spreadsheets for discounted cash-flow modeling. I have become very skeptical of the typical ways of doing things in investing. The entire manner in which information is fed to us and the lightning-fast time it takes for it to be reflected in a stock's valuation is telling me that I have to continue changing my approach to valuation.

If you're a home gamer, you must either evolve or lose money.  A complicated, multi-factor model that soothes one ego with a tidy output may be outdated as soon as the research is published.

Wall Street just loves to make forecasts. Trading desks try to position clients ahead of those expected outcomes. As the outcomes bear fruit, the stock is likely sold. (This is a broad-stroke statement, as Apple (AAPL) would suggest, but have you ever seen a stock sold on a seemingly great earnings report and guidance? Of course you have.) And when a stock is upgraded on research, it will likely run up, but not as much after financial results are reported. Wall Street reminds me of weathermen. Their predictions are rarely correct, yet they continue to collect a check while clients wonder where 10% of their life savings went. I dare you to find me a research note in December 2010 that outlined the following events and their associated market reactions:

  • Inflation spike
  • Surprising resilience in consumer spending
  • U.S. rating downgrade
  • Basically another year of E.U. inaction

It was next to impossible to predict these events! Even if one were some kind of Wall Street rainmaker with access to all sorts of detailed information, the market's reaction to these events would be a wild card, because X number of other events are being rationalized as well. Complicated stuff, I know. That is why, as we round the bend and zoom into 2012, I am not putting out one of these "2012 Predictions" notes. I used to do it as my old shop, but what is the value other than to pat myself on the back if a prediction is correct by December 2012, likely because of nothing that I outlined from the start? I can make soft or general predictions on the future, but I would rather invest on the basis of factors that have more certainty attached to them.

One set of assumptions that I am growing comfortable with revolve around food. Because of price spikes in 2011, farmers ramped up plantings of corn, wheat, soybeans and sugar. Although many of these products are still characterized as being in short supply relative to global demand levels, price gains in 2012 should be slower than in 2011 as a result of better quantities.

Importantly, though, prices for these products are currently well removed from the peaks established in 2011, so as food producers rebuild their inventories, their profit margins should benefit. For brand names in the marketplace, the dynamic should be quite intriguing, and the investment thesis should be that much more powerful. Costs are off their 2011 peaks, prices are higher at the stores after structural package changes, and consumers are trading up a bit.

I normally would go best-in-breed, as the food industry overall is very competitive. But I wanted to guide you toward something a little spicier than General Mills (GIS). The name of choice is Fresh Del Monte (FDP), which trades 14% below book value in an industry that is shedding assets to maximize shareholder value or seeking deals to improve economics of scale. In other words, performance is not the only reason the stock piques my interest. Fresh Del Monte is obviously a branded player in the supermarkets and convenience stores, and it has been successful in raising prices in 2011 (meaning volume hasn't nose-dived).

Other areas of interest:

  • An improved trade cycle has helped the company meaningfully reduce its debt load from what it had in the fourth quarter of 2009.
  • The company is generating greater sales per unit of inventory.
  • The customer base is expanding in the high-margin prepared food business (convenience stores are a factor here).
  • The company is now focused on its core businesses and continues to remove expenses from its operating model.



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