Meet Mr. Capital -- and Learn to Avoid Him

Mr. Capital loves fat profits. Among Mr. Capital's problems is that he doesn't think logically or in terms of cycles. In fact, there's scant evidence that he even considers the long term. If there is easy profit to be secured, Mr. Capital will unleash his largesse in wholesale pursuit of it -- and damn the consequences.

In the last cycle, capital flowed in torrents to underwrite anything and everything related to the tech/telco Internet revolution. In a typical cycle, capital will flow to companies that have been profitable in the hope that additional profit will be generated. But the most recent cycle was different. Little, if any, profit was made at most of the Internet-related companies that were seeking capital. But there was plenty of fat, easy profit to be made -- by the brokers, investment banks and venture capitalists.

The Sieve of Competition

The great leveler in business is competition: It's the sorting mechanism through which winners and losers are determined. Capital flows distort the effect of this sieve. Investors can profit today -- if they're able to recognize current inefficiencies caused by capital flows.

Excess Capital Flows: There is still too much capital in the technology sector. As I routinely wade through one set of financial statements after another, I'm surprised by what I find in tech. Too many marginal companies with suspect business models are flush with capital and almost no debt. While I realize that many astute value investors are now attracted to tech, I find the enhanced staying power of these asset-rich companies to be cause for concern.

Consider the recession/depression that occurred in the airline sector several years ago. Many well-known airlines from that era are now long gone, either put out of business or merged with stronger rivals; examples include Pan Am, PSA, Eastern, Western and Braniff. Because the airlines were saddled with debt at the time, many were unable to survive a downturn, unlike the tech sector today, where balance sheets are pristine.

It will take longer than it should to ferret out the weak links in technology because of the distortion caused by excess capital flows in the last cycle.

It's still possible to make money in technology if you have an edge (or if you're lucky), but that is a difficult and crowded road to take. When two roads diverge in the wood, to paraphrase poet Robert Frost, my preference is to avoid the difficult road every time.

Inferior Capital Flows: For most of the 1995-2000 cycle, investment capital had an easily identifiable mantra: all tech, all the time. Left behind, then, was much of the rest of the economy, consisting of what I like to call "real" companies.

How many IPOs in the last cycle can you remember from the chemical, auto-parts or home-appliance sectors? How many billions did the venture capital community ante up for start-ups in defense, retail or air transport?

I said in an earlier column, after quoting baseball legend "Wee Willie" Keeler, that success in investing is about hitting them where Wall Street ain't. By extension, the same is true with respect to capital. Where flows are rampant, increased competition begets lower margins. And where capital flows are negligible, expect margin-expansion opportunities to abound.

It's Time to Get Real, Baby!

All 23 stocks I've highlighted in RealMoney.com columns were about finding value in "real" companies. In my most recent column, I initiated a new rating system on my year-end picks. I've noted buy ratings on the stocks that I'm still buying at today's prices.

While these recent picks' performance has slipped recently -- because of weakness in the airline stocks and at Kmart (KM Quote) -- the return is still positive in a tough environment, not to mention well above that of the S&P 500.

Picks and Performance Here's how my 2001 highlights have fared so far this year and how they look now
	Rating	Date of Pick	Price at Pick	Aug. 27 Close	Total Return
Safeco (SAFC:Nasdaq)	Buy	1/26/2001	$24	$30.29	26.21%
Delta Air Lines (DAL:NYSE)	Buy	3/30/2001	39.50	40.44	2.38
Centennial Bank (CEBC:Nasdaq)	Buy	3/30/2001	7.75	8.51	9.81
Northwest Airlines (NWAC:Nasdaq)	Buy	4/17/2001	23.50	21.85	-7.02
Liz Claiborne (LIZ:NYSE)	Neutral	4/24/2001	44.50	52.75	18.54
Kmart (KM:NYSE)	Neutral	5/2/2001	10.40	10.65	2.40
Ameritrade (AMTD:Nasdaq)	Neutral	5/9/2001	7.55	6.08	-19.47
York International (YRK:NYSE)	Buy	5/10/2001	30.44	37.64	23.65
Textron (TXT:NYSE)	Buy	6/5/2001	58.97	54.71	-7.22
Continental Airlines (CAL:NYSE)	Buy	7/12/2001	50	44.30	-11.40
Toro (TTC:NYSE)	Buy	7/24/2001	43.26	47.60	10.03
Manpower (MAN:NYSE)	Buy	8/7/2001	31.77	31.78	0.03
Average Return					6.88%
Avg. S&P Return					-4.58%
Note: The average return is not an absolute average; it's weighted by time. Source: Alsin Capital Management