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You're obsessed about it. Nothing else matters. Your investing day begins and ends with worry about this particular risk. Since it is an objective measure, there is not a scintilla of room for negotiation -- a dollar is a dollar, right? To you, then, this risk trumps all others.
What is the risk I'm referring to? I call it quote risk. Quote risk is the risk that the price quote for your stock might go down. Quote risk is a worry for investors that attribute too much meaning to quotes. The typical investor puts $10,000 into a stock; when the quote drops by 30%, he announces with certitude, "I've lost $3,000."
To a value-centric investor, a price quote is a bid, an offer. That's all it is. A price quote tells you the dollar amount you can secure
you sell your property today. If you buy stock at a discount to value, it doesn't make sense to sell your property just because the offer price declines.
If you own the local car wash and someone offers you 75 cents per dollar of value, does it mean you've lost 25%? Do you call your spouse and say, "Honey, we've lost 25% of our business value today." Of course not. You received an offer. That's all. The bid doesn't come attached with a detailed appraisal of value. If you own the car wash and you're rational, you know that full and fair offers occur infrequently. If you're interested in selling the car wash, you know that you'll likely have to wait several weeks, or even several months, before you get an offer that approximates value.
To a long-term value investor, quote risk is irrelevant. I paid 40 cents per dollar of value, or $17 a share for
Class A shares last year. A few weeks later, the quote dropped by one-half. I didn't look at the quote and exclaim, "I've lost 50% of my money!" I didn't lose anything, because I wasn't about to play giveaway. I wasn't about to accept an offer that was a tiny fraction of value.
While price eventually migrates to value, anything can happen in the short term. Chalk it up to quote risk.
To Play the Market, You Must First Understand It
The purpose of the market is to facilitate liquidity: The market does not provide valuation analysis. It tells you price. It does not tell you value.
Price does not equal value: All stocks are mispriced, some by a little, some by a lot. The value-centric investor, naturally, seeks to buy stocks where value exceeds price by a wide margin.
-- As covered in "Understanding the Stock Market: Tecumseh, Office Depot."
Plus, To Play the Game, Understand This: Price Change Exceeds Value Change
If the market is going to provide cash offers each and every day, then you can't expect prices to be stable. Prices will fluctuate in a wide range. It should come as no surprise that prices oscillate by more 50% per year for the average stock, while value changes by less than 1% per month. Sophisticated investors seek to arbitrage the spread between the change in price and the change in value.
Here is an example of such an opportunity:
. While the business value has changed by slightly less than 1% per month, the stock price has ranged from $67 to $118 over the last year. Lately it traded at $72. And it's worth at least $150 a share.
Let's start with the obvious: Business at Whirlpool is lousy. Demand has declined in concert with an escalation of costs. For investors who seek to buy assets at a discount, it doesn't get any better than this. A stock like Whirlpool gets priced as if demand will never come back and as if costs will never be corralled. It's nonsense, of course. The current cycle will end in the not-too-distant future, and when it does, the stock quote will dramatically improve.
For evidence of Whirlpool's undervaluation, look to the comparable business at
. GE is trying to sell its appliance business, with $7.2 billion in sales, for $5 billion to $8 billion. A comparable range for Whirlpool amounts to $195 to $310 a share. Why is GE trying to sell its appliance business? In part, it's because GE can't keep up with Whirlpool. Whirlpool has a much better appliance business than does GE. Whirlpool is easily the No. 1 brand in the U.S. (GE is No. 2) and it's far out in front of GE internationally as well.
Whirlpool's undervaluation is also seen in its robust free cash flow. Even though the company is struggling at a cyclical nadir, free cash flow yield is still robust, at 10%.
Should you own Whirlpool stock for many years to come? Not necessarily. When operations rebound and analysts are once again lavishing praise and platitudes on the company, the stock price will be much higher. If price approximates value, it will be time to take profits. That's because the good times, like the bad times, won't last.
This column was originally published on
on May 28, 2008 at 7:35 a.m. EDT. For more information about subscribing to
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At time of publication, Alsin and/or ACM was long Tecumseh, although holdings can change at any time.
Arne Alsin is the founder and principal of Alsin Capital Management, an California-based investment advisor. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback;
to send him an email.