The Turnaround Letter originally published "A Whole New World" in its November 1987 (Volume 2, Number 5) issue. Revisiting "Blast from the Past" articles like this one offers historic insight and the opportunity to utilize lessons from the past to uncover potential turnaround profit in the future.
A Whole New World
What a difference one day makes—at least when it’s a day like October 19, 1987. The 500 point drop in the Dow Jones average that took place that day has sharply changed both investment values and investor perceptions. There is no need to panic in response to these changes, but there will be need for caution and patience.
Nervousness, among all types of investors, that had been building for months turned into panic. The panic was probably set in motion by a combination of factors: concern over the 100 point drop in the Dow the preceding Friday; unsettling world news, particularly the U.S. retaliation in the Persian Gulf; and that old nemesis, “program trading.” Once in motion, nothing but the closing bell could stop the selling.
As the sell orders mounted, buyers disappeared, and many stocks went into a free fall. This was especially true for many of the less actively traded or less well known stocks, including a number of our own previous recommendations. When buyers finally did reappear, the stocks bounced back somewhat, but nowhere near their previous levels.
What Does it All Mean?
For at least the time being, there has been a “flight to quality,” or perhaps more accurately, a flight to known quantities. Many investors are heading for what they perceive as safety in government bonds and money market funds. Those who are staying in the stock market are focusing principally on the “big name” or “blue chip” stocks.
The rules for valuing stocks have also changed. Price-to-earnings ratios that were considered acceptable a few weeks ago are now viewed as much too high. And investors who were willing to anticipate future earnings now want solid, undisputable current earnings.
Over the short run, these conditions do not favor turnaround stocks. Our stocks tend to be less well-known, have little or nothing in the way of current earnings, and have somewhat uncertain futures—not exactly what the market is looking for right now.
But for the long term, there are some tremendous values among turnaround stocks, particularly among those we have previously recommended. It may take longer for the value to be reflected in the stock price because most investors will wait until the turnaround is absolutely certain before jumping into a stock. But when the turnaround does become evident to mainstream investors, the appreciation could be greater than ever because of the low present levels of many turnaround stocks.
What do Do Now?
This is still a time for caution. The dust has not yet settled from the recent upheavals, and we may see some after-shocks. (In fact, prices are still dropping as we write this.) It will also take some time for Wall Street to establish new rules for valuation and a new “market psychology” with which it is comfortable.
Generally, we think this is a time for cautious buying and not selling. Because of all the uncertainty in the market, we recommend sticking to those stocks you know best and increasing yoru holdings of those that look like the best values.
Consistent with that approach, we have reviewed all of our previous recommendations in light of the new market conditions. We are not making recommendations on any new stocks in this issue. For those with a long term perspective, the recent price collapse will create some good opportunities. It should shake out some of the speculative excesses that we have been seeing in the market for the last year or so. There should now be more good values in the marketplace, particularly in the turnaround area. We hope that the flight back to binds and blue chips will return turnaround stocks to the relative obscurity that they have historically enjoyed. There is nothing like a nice obscure and inefficient niche for finding good value!
Read the November 2012 issue, which references "A Whole New World."