Can companies be undervalued even if the market is overvalued? We've had a monster run since the bottom in the second week of February. It's been unstoppable - and today's no different.
There have been a ton of reasons why the market has moved up. We hear them all of the time: The Fed's on hold, the dollar's become a little weaker, the stress in the oil patch seems to have let up -- perhaps saving billions in loans from going bad. Still, all those do is allow the market to be revealed for what it is: thousands of stocks of companies with different prospects -- and different valuations for those prospects.
I think that a lot of this move has to do with the fortunes of individual companies, and how much more their stocks may be worth than their companies are currently valued.
Take this tussle over Starwood Hotels & Resorts (HOT), the hotel chain with 1300 properties all over the globe. Just a few months ago, Marriott bid $11 billion for Starwood -- a bid that I thought so low that I was astonished the company would sell out for so little. But the Board was under tremendous pressure from short-sighted activists who were in a strong position to demand a sale.
Hotels have had disappointing valuations ever since the advent of AirBNB. I love that scrappy outfit, which is probably now worth more than Starwood and Marriott combined. Nevertheless, the idea that AirBnB can saturate a market where there are so few new hotels being built is absurd, so absurd that I bet the people at AirBNB have to be considering buying hotels, they are so cheap.
It is pretty ironic that at the eleventh hour, it took a state-owned Chinese insurance outfit, Anbang, to figure out that Marriott International (MAR) was buying this fabulous property so cheaply because activists were demanding a quick sale, and the Starwood Board didn't have time to negotiate a better price. So Anbang came in with that higher bid, topping the old Marriott bid by as much as $2 billion. Then this morning, Marriott came back with a $13.6 billion offer for Starwood. Now you are talking about a deal that's $2.6 billion more than Marriott's own first offer.
You would think that if Marriott were overpaying, its stock would be hammered. But it's barely down. What does that tell you? To me, it says that Starwood should never have been so low to begin with. That the stock market was just wrong. Anbang's owners, China's Communist Party, saw it, aided by the fact that the Starwood Board had made it easy for another company to come in with a deal that allowed for a higher price from outside -- without too much of a penalty -- and woke us up to the real valuation.
Last week on Squawk on the Street, we interviewed Herb Kelleher, the man who founded Southwest Airlines (LUV). It was fascinating, just incredible. Why? Because he said he had never seen the airline business be more lucrative and the prospects so bright and the costs so low, yet the stocks are being given away, as they are selling at about a third to a half less than the average stock in the S&P 500.
The airline stocks have been on the move since then, but Kelleher's takeaway was simple: There have been so many times that the airline business was horrendous, and all the companies, except Southwest, were losing money. Now it is the opposite - and yet the stocks are trading as if the whole shebang were about to collapse when that's pretty impossible to envision. I have heard Herb talk about how the rest of the industry didn't have its act together. But this miracle of profitability is happening at the exact same time that valuations are the lowest he can recall.
Of course, we don't have a Chinese government-owned entity to come in and buy American Airlines (AAL) to give it a more accurate price. But I think if someone were going to launch a bid for an industry that already has too much consolidation, the stock would be dramatically higher.
Or let's take Caterpillar (CAT). Last week, the company announced that it would report a quarter that would be far below what Wall Street was looking for. Although it kept its yearly earnings forecast intact, the preannouncement made it clear that the company's current businesses are all running well below plan. Yet, after an initial decline, the stock took off and has stayed up since then. You can say that's just technical: So many people were short it that there was no way it could be down.
But what if the thesis were stood on its head? What if we just said that CAT should never have been as low as it was, and the announcement of its weakness simply quantified that its dividend wasn't in jeopardy, and the company is realistic about how well it is doing, but the stock was unrealistically priced. Unrealistically low. It's not just Caterpillar. Cummins (CMI), another huge engine company, has seen its stock go from $85 to $110 pretty much in a straight line. Again, there's technical in play: big funds were underinvested in cyclicals. However, I think the better way to say it is the stock got too cheap.
Then there's Valspar (VAL), the paint company. Last Friday it stood at $83, having come off a weak quarter. Now it's at $104 because a rival coveted it - not for this quarter, which was hurt in part because of market share loss to Sherwin Williams (SHW), but with the idea that the company's existing stock price was just too little, given the opportunity it presented for Sherwin Williams.
In other words, the rights to the profits that Valspar makes were being improperly valued by the market given the opportunity. Does that mean that the stock market should have been valuing Valspar higher? Yes. Definitely. I want you to be sure, though, that while the stock's not going to reflect the full price of a takeout, the huge premium to the price from Friday says a great deal about how wrongly valued the stock was.
Or how about the media companies? It wasn't that long ago that this market determined that cord cutting and expensive programming are two headwinds that couldn't be recovered from. We had decided that Disney's (DIS) ESPN numbers were all that mattered to that company, and its stock plummeted from $120 to $89 in three months' time. It ticked at $100 last week.
We heard the death knell of Time Warner (TWC) because of its stale programming back when it was at $60. Now it's at $72. CBS (CBS) went down to $42. After a solid analyst meeting, it is now at $54. Did those negatives get washed away by the hit Disney movie Zootopia, or the March Madness on Time Warner, or the possible sale of CBS radio? Or should the stocks never have been that low?
Finally, let me give you the saga of two of the best performers in the Dow Jones averages: Wal-Mart (WMT) and McDonald's (MCD). Wal-Mart's stock was at $66 when it announced a giant shortfall and traded down $10 over the next month. It was shattering for a stock that doesn't trade in a wild fashion. Now it's $2 above where it announced that shortfall. How about McDonald's? It was in the low $90s, a year ago when it got a new CEO, Steve Easterbrook. Now it's at $123 after just a couple of good quarters. Maybe neither stock deserved to be as low as they were.
Why isn't all of this clear to people? I think it gets obscured by the bigger backdrop of the Fed, the politics of this country and the weakness in the world. At any given time we have had a rolling bear market in so many different sectors. Right now, because the drug companies have been the whipping boys of the presidential election, they've been in their own bear market. Perhaps it ended today with the change of management at Valeant (VRX), which has had some serious headwinds, with a series of restatements and musical chairs at the top. Or maybe it's just a respite.
Here's my point: When the smoke of what we call the macro picture clears, you see the companies for what they are worth -- and so many are worth a heck of a lot more than what they are currently selling for.