Something does not add up! (page 1 of 3)

Of course, I found many horrible recommendations as well as a few timely calls. Thus, a well-meaning journalist could put together a list of wonderful recommendations, while someone who was out to discredit me could compile a lengthy list of disastrous forecasts. But this is not the issue I want to discuss.

All of us in the investment business made some good, as well as bad calls, and took great investment decisions and bad ones, which we later bitterly regretted. What, however, struck me is that in the 1970s, 1980s and early 1990s, there were again and again some real bargains around in the financial markets amidst economic fundamentals, which either looked favorable or which had the potential to improve significantly. Today I find it hard to find valuation jewels given the systematic risks in the financial markets. Let me explain.

One of the recommendations I made in early 1982 (Dow Jones hovering around 800) was to buy US automobile stocks, which were then terribly depressed. Chrysler, Ford and General Motors were all lower than they had been 20 years earlier. From their highs in the late sixties, General Motors had declined by 70%, while Chrysler was off 95%!

At their 1982 lows, GM and Ford had dividend yields of over 6%, whereby the dividends had already been cut. But this is not all, if one took inflation into account, which had been high between 1964 and 1982, the auto sector was down from its high, adjusted for inflation, by more than 90%. At the same time the entire US financial market was extremely depressed.

Consider the following: The US dollar had in the 1970s lost about 70% against the Deutsch Mark and the Swiss Franc. US long dated treasury securities were yielding close to 15%. In the late 1970s and early 1980s bond prices had totally collapsed. The Dow Jones had a P/E of less than seven, and a dividend yield of over 6%. Sentiment among investors was horrible and the economy was in the midst of one of its worst recessions, with unemployment having shot up to above 10%.
Even so called 'safe' stocks, whose earnings are less cyclical than the profits of auto companies sold for extremely depressed prices. Clorox traded with a yield of 7% from 1980 to 1982 and sold for as little as six times earnings and three times cash flow. Colgate-Palmolive sold for a P/E in the six-to-eight range and at 30% of sales, while Proctor & Gamble traded around eight times earnings.

I hope you get the point. In 1982, the economy was depressed and the world's economy did not look particularly promising. But stocks in the US were incredibly cheap, after having declined by an inflation adjusted 70% between 1964 and 1982. Thus, the risk/reward looked enticing.

Sure, the economy might not have rebounded. Sure the US dollar might have continued to decline. Also the rate of inflation could have risen again. But at least you bought into a very depressed asset class at a time the economy was already in a deep recession and investors' sentiment extremely bearish.

The overall level of bearishness was evident from the fact that investors had been liquidating equity mutual funds throughout the seventies and, in 1982, equity mutual fund assets, at just $40 billion, were no higher than they had been in 1970! Thus, while buying US stocks and in particular the auto companies in 1982 was an opportunity that did entail some risk, the upside potential was huge in the case the economy and corporate profits were going to recover.

Or consider some other examples of low valuations.