Opinion and Investing Column

SKARBECK: Gain fortitude by knowing what companies you own

October 8, 2011

Ken SkarbeckTo weather these difficult market periods, investors must realize that the stocks they own are not just commodities that hop around daily in price, to be bought and sold on the whim of market emotions. It is essential to understand that shares of stock represent the fractional ownership of an operating business.

Once that concept is engrained, the daily gyrations in stock prices—and the superficial opinions given for these volatile short-term swings—tend to serve more as a source of amusement than as information that needs to be acted upon. Underlying intrinsic business values just don’t change as sharp movements in stock prices would indicate. More important, for the prepared investor who has the basic tools to value businesses, these zigs and zags occasionally offer up buying opportunities.

A shareholder of Johnson & Johnson (JNJ) likely knows he owns one of the world’s largest, diversified health care businesses. Yet that fact alone may not be enough to keep him from selling after being bombarded with pessimistic economic and political headlines.

On the other hand, a diligent investor—viewing JNJ as an operating business—would recognize the company is modestly valued at 12.5 times expected earnings of $4.97 per share, has strong cash flow that amply covers capital expenditures, and allows for a 3.6-percent dividend.

That investor might have noted that, in 1999, when JNJ’s earnings per share were $1.49, investors were happy to pay 35 times EPS, or $53 a share. Now that price-to-value relationship has turned around dramatically.

While over that time JNJ’s stock price has risen a measly 9 points, to $62, earnings per share have more than tripled. Profits have grown 10.5 percent a year for more than a decade while the stock price has hardly budged. Investors buying JNJ stock today clearly are receiving good value on fractional ownership of this high-quality business.

And while a few of the 57 countries in which JNJ operates are in Europe, a thinking investor knows the continent’s banking crisis will have a minimal effect on the company’s intrinsic value. Shares still may drop, but that value could help the stock hold up better than the market. And even if JNJ shares were to take a larger hit, the savvy investor would buy more, comfortable knowing he is getting even more bang for his buck.

Similar conclusions could be reached about companies like Kraft, Microsoft and McDonald’s. And several Indiana firms pay generous dividends and should see their stock prices perk up once the economy improves—which eventually will happen. Among those: Hillenbrand, Haynes, Hurco, Kimball, Celadon and Kite Realty.

Unlike market environments where prices were high and bargains were few (1999 and 2006-2007 come to mind), today we find it difficult to sit on the sidelines when cash pays nothing and reasonable values can be found.•

__________

Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
 

ADVERTISEMENT

Recent Articles by Ken Skarbeck

Comments powered by Disqus