ON INVESTING

Time to go bargain hunting

In an emotional market, a sharp pencil and a hard head can yield exceptional buying opportunities

Deirdre McMurdy March 26 2001
ON INVESTING

Time to go bargain hunting

In an emotional market, a sharp pencil and a hard head can yield exceptional buying opportunities

Deirdre McMurdy March 26 2001

Time to go bargain hunting

ON INVESTING

Deirdre McMurdy

In an emotional market, a sharp pencil and a hard head can yield exceptional buying opportunities

If there’s one irony the average equity investor needs to grasp, it’s this: stocks always generate the most excitement when overvalued and in hot demand. But when they’re cheap, investors tend to steer away from them, consistently failing to capitalize on the pessimistic sentiments of others. That means that for those who can overcome the irrational, emotional tone in a jittery market, a sharp pencil and a hard head can yield exceptional opportunities for bargain hunting.

In the erratic environment that now prevails, investors are dithering, intent on finding “the bottom” of the market— even though most veterans maintain that’s never apparent until at least a year after the fact, as with market crests. Significant rounds of North American interest-rate cuts, and the expectation of more to come in months ahead, have failed to whet a hearty appetite for stocks. The recent exhortations to beef up equity holdings from, among others, influential portfolio strategist Abby Joseph Cohen of Goldman Sachs, haven’t budged that reluctance. Neither has the point that much of the economic data being used to take the cooling temperature of the North American economy is focused on past performance, rather than future prospects.

Instead, everyone is concentrating on the trillions of dollars in wealth that have been obliterated as the tech-heavy Nasdaq exchange has lost 63 per cent of its value over the past year.

For a more relevant and contrary view, consider this: last week, several leading economists, including a panel of advisers to the cabinet in Ottawa, repeated their call for continued economic growth this year—albeit at a slower average pace of about 2.5 per cent. Activity, even in the battered manufacturing and technology sectors, is forecast to pick up in the second half of this year. That said, the recent string of corporate profit warnings is a legitimate deterrent for jumping into the market with both feet. Even the financial services sector, which usually flourishes when interest rates decline, has been stalked by mounting concern about the banks’ loan portfolios.

But there are still scores of companies—many in the ranks of the neglected Old Economy—that have at least three appealing elements: a dominant market position, strong cash flow and limited debt. Last year, Warren Buffett, the legendary U.S. billionaire investor, earned a 114-per-cent profit on the portfolio of assets held by his company, Berkshire Hathaway, even though they’re exclusively in low-glamour, low-tech sectors. In his annual letter to investors, Buffett wrote, “We have embraced the 21st century by entering such cutting-edge industries as brick, carpet, insulation and paint. Try to control your excitement.”

Investors should feel excited about several events now taking

place. First, the inflated price-to-earnings ratios commanded by high-technology shares are coming down. According to fund managers, it’s important to realize that the “burn-off” of those premiums has contributed greatly to the volatility in the tech sector, obscuring some of the attractive new valuations that are gradually coming to the surface. “Tech stocks aren’t cheap but they’re inching back into the realm of reality, compared with a year ago,” says Bruce Murray, a growth fund manager with McLean Budden of Toronto. “And there’s lots of healthy undergrowth.”

Another positive for the sector is a new level of understanding about what sort of technology and applications are commercially viable—and which ones are just marketing hype. That means that most companies that do survive the shakeout, especially at the junior or start-up level, are much more sturdy. “The frenzy of the gold rush is over now,” says Kevin Restivo, an industry analyst with IDC Canada. “The wildcatters and the prospectors are giving way to the pros who just want to do business.” Bernie Grybowski, a veteran venture capitalist and

president of HDL Capital of Toronto, adds that “the Internet is now viewed for what it has been all along—a tool. Anything that attracts capital now is very application-specific, very much geared to changing the way things are done at a fundamental, not a novelty, level.”

Regulators are also doing their part to increase the long-term investment appeal of high-tech companies. Last week, the Ontario Securities Commission announced there is a need for “a significant improvement in the nature and extent of disclosure” in high-tech financial statements, specifically the manner in which they measure revenue. Ultimately, more transparent accounting and tougher, uniform guidelines will help people to make better-informed investment decisions.

Another promising development is the return of improved balance and breadth to equity markets. Grybowski’s admission that it has become more challenging to attract new funds to the technology sector is welcome news for operators in parts of the economy that have been languishing. The mining industry, for instance, has been starved of capital for new exploration and development initiatives, because so much was siphoned off for technology investment.

Last week, as markets were roiled again by corporate earnings revisions and anxiety about the Japanese economy, opportunities abounded for bargain hunters. The only thing missing from the equity equation was investors’ willingness to stock up.