Un-bear-able Deals: When Bears Turn “Bullish”

by | Jul 31, 2002 | POLITICS

For years, Grant’s Interest Rate Observer was noteworthy for being both exceptionally witty and consistently wrong. Times have changed. The newsletter, edited by James Grant, who has written wonderful books on such topics as the life of Bernard Baruch and the history of credit in America, is now both witty and right. Or as Grant […]

For years, Grant’s Interest Rate Observer was noteworthy for being both exceptionally witty and consistently wrong. Times have changed. The newsletter, edited by James Grant, who has written wonderful books on such topics as the life of Bernard Baruch and the history of credit in America, is now both witty and right. Or as Grant put it in his July 5 newsletter: “Before this publication became profitably bearish, it was unprofitably bearish. It was unprofitably bearish for a very long time.”

One of Grant’s readers, Frederick E. “Shad” Rowe, who describes himself as a “recovering short seller,” suggested to the editor recently that the newsletter, in Grant’s words, “should turn bullish, just to be able to say we did it.” But, Grant said, “We think we will wait.” Why? The falling dollar, accounting scandals, a “political climate [that] is turning chilly toward enterprise,” and prices that are even now “not cheap.”

And yet, and yet. . . .

In the past month, Grant’s has run two articles that are shockingly optimistic about stocks — specifically, about e-commerce companies and biotechs. Some of Wall Street’s most prominent bears in the 1990s — including Barton Biggs of Morgan Stanley — are acknowledging that with bargains multiplying and the U.S. economy recovering, it’s time to buy. Even Barron’s, which warned during the go-go years that stock prices were getting out of hand, told readers last week in a headline that it was “Time to Stock Up.” Andrew Barry wrote, “Sober investors fortunate enough to be sitting on cash now have the opportunity to invest in stocks at valuations that look pretty reasonable by historical standards.”

Most remarkable of all, however, is the changed attitude of Jonathan Cohen, who manages a hedge fund and a tiny mutual fund. Never heard of him? Grant’s reminds us that Cohen is the guy who wrote in December 1998 that Amazon.com was “probably the single most expensive publicly traded company in the history of the U.S. equity markets.” At the time, the stock was trading at $58 a share (adjusted for splits). A year later, it was over $100. The advice may not have endeared Cohen to his employer, Merrill Lynch & Co., and soon he had a successor — Henry Blodget, technology’s Bull of All Bulls. Times have changed. Amazon now sells at $12.49 a share and Cohen was vindicated, while Blodget, now also gone from Merrill, is the target of lawsuits.

The surprise is that Cohen is buying technology stocks. The mutual fund he manages is Royce Technology Value. In the six months after its launch in January, it beat the average fund in its category by more than 30 percentage points. But don’t get too excited. One reason Cohen has done so well is that he took his time deploying his cash into stocks and, even so, he’s down 23 percent since the fund’s inception. Far more important than Cohen’s short-term performance is his upbeat view on technology stocks — or, at any rate, on some of them.

“I wish everything we owned was an absolutely hugely compelling value,” he said. “Some of them are merely quite good values.”

That’s a start. In selecting tech stocks, Cohen looks not at projections of a company’s profits but at its here-and-now balance sheet. Grant’s notes, “He attaches more weight to the tangible net worth of an investment candidate than to anyone’s guess of its three-to-five-year earnings prospects.” Cohen wants to own companies that not only have good ideas and good management but that have a good chance of being around for a while. For that, they need cash.

One of his favorites is United Online Inc., a low-cost Internet service provider that, in the most recent 12 months, lost $45 million on $113 million in revenue. But United has $132 million in cash and short-term investments and has no debt. The stock price is up about two-thirds since January. The largest holding in Cohen’s portfolio is LendingTree Inc., an Internet marketplace that brings borrowers and lenders together. LendingTree is losing money, but it is also rapidly increasing its revenue and cutting its quarterly deficits. Over the past year, the stock has risen by about three-quarters.

Cohen owns, among bigger techs, E-Trade Group Inc., the online investment service, which has a cash hoard greater than its market capitalization (meaning its value in the stock market, based on its price). E-Trade stock has dropped 37 percent over the past 12 months, but the circumspect Value Line Investment Survey gives the stock its top rating (“1”), an accolade shared by only 100 companies out of 2,000. The latest Value Line write-up concluded: “These volatile shares are timely. The stock’s three-to-five-year appreciation potential is also very attractive, though somewhat speculative at this juncture.”

Another holding with a strong balance sheet is Adaptec Inc., which sells products that store computer data. The company has $8 per share in cash and short-term investments and no debt. On Friday, it closed at $6.01. Yes, the company is losing money, but it’s got a business and real assets as a safety net. The stock doubled between September and January but has been on the skids lately.

Grant’s said: “Cohen was right in 1998 — just early. Our hunch is that he is right, and early, again.”

Last week, Grant’s featured another portfolio manager who was actually buying stocks: Dan DeClue, vice president of SF Investments, a Chicago money-management firm. DeClue, Grant’s said, “is bullish on scientific orphans, and we are bullish because he is bullish.” Specifically, DeClue likes biotech stocks. In the past, they were hot items. In 1998 and 1999, Amgen Inc., the largest biotech, soared sixfold in price. While the rest of the technology sector crumbled, biotechs held up through late last year, then succumbed. Today, as Grant’s puts it, “though scientists continue to labor at their benches, the former bulls have developed the kind of laryngitis for which medicine will never find a cure.”

This is precisely the environment in which to be buying biotech. And some people are — including, significantly, insiders at biotech firms themselves. Meanwhile, Wall Street analysts are dropping coverage of the companies, and the companies are so cheap that they are becoming obvious takeover targets. Meanwhile, few doubt that biotechnology discoveries will dominate medicine in the decades to come.

Like Cohen, DeClue searches for companies that can stay the course because they have solid balance sheets. Consider Sonus Pharmaceuticals Inc., which is developing a cancer therapy. It has $25 million in cash and short-term securities and just $100,000 in debt. That’s about $2 a share in net cash for a stock trading at $2.39 (down from $8.30 in January). Of course, Sonus does not yet have a profitable product, but it’s getting there. The idea is to own a lot of stocks like Sonus — DeClue lists Synaptic Pharmaceutical Corp., Pharmacyclics Inc., Corvas International Inc., Titan Pharmaceuticals Inc. and CuraGen Corp., among others — in the expectation that some will come up with winning drugs or get bought by bigger firms.

The point about these companies is not that they are much more likely to become successful than they were a year or two ago, but that the risks are lower because the prices are lower. Could prices go lower still? Of course — and in that sense, Cohen’s high-techs and DeClue’s biotechs aren’t much different from the rest of the stock market.

A lot of stocks look cheap. For example, International Business Machines Corp., the world’s largest technology company in terms of sales, now trades at about 16 times last year’s earnings — or less than two-thirds its typical valuation.

One quick-and-dirty calculation that points to values is to find a company’s earnings per share in a peak year, multiply it by 10 and compare it to the current price. Apply that formula to Hewlett-Packard Co. and you find that peak earnings were $1.73 in 2000 for a target price of $17.30. On Friday, the company, having merged with Compaq Corp. and gained a new symbol (HPQ), closed at just $11.66. In other words, based on its profits in 2000, Hewlett trades at a price-to-earnings ratio of less than seven.

Smart investors with the discipline and long-range perspective to continue buying stocks find themselves with a tough choice: Should they buy tried-and-true brand names that have been whacked, such as Coca-Cola Co., which has dropped nearly 20 percent in the past few weeks? Or speculative techs and biotechs, many of which have fallen much more?

The simple answer is to own both, but to own the more volatile stocks in mutual fund portfolios. Royce Technology Value itself has some drawbacks, including a high expense ratio and, according to Morningstar Inc.’s Brian Lund, the fact that “Cohen has little money-management experience.” In addition, Royce, which is a respected fund family with a leaning toward small-cap value stocks, is not known for its prowess in technology. But then again, hardly anyone else stands out these days either, and Cohen’s relatively fresh eyes may be a good bet.

My favorite mutual fund picker, Sheldon Jacobs of the No-Load Fund Investor, gives high marks to Firsthand e-Commerce and Firsthand Technology Leaders. The funds have lost 44 percent and 40 percent, respectively, since the start of the year. (Ouch.) Turner Healthcare and Biotechnology, another of his recommendations, is down 24 percent in 2002. Another pick, Ryder Biotechnology, requires a $25,000 minimum investment. It’s down 50 percent this year.

But that’s the whole point. With the carnage piled high, so are the deals. At least, that’s what some erstwhile bears are now beginning to think.


Ambassador Glassman has had a long career in media. He was host of three weekly public-affairs programs, editor-in-chief and co-owner of Roll Call, the congressional newspaper, and publisher of the Atlantic Monthly and the New Republic. For 11 years, he was both an investment and op-ed columnist for the Washington Post.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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