by Peter Lynch
There’s the perfectly-good-company-inside-a-bankrupt-company kind of turnaround, such as Toys “R” Us. Once Toys “R” Us was spun out on its own, away from its less successful parent, Interstate Department Stores, the result was 57 bags.
There’s the restructuring-to-maximize-shareholder-values kind of turnaround, such as Penn Central. Wall Street seems to favor restructuring these days, and any director or CEO who mentions it is warmly applauded by shareholders. Restructuring is a company’s way of ridding itself of certain unprofitable subsidiaries it should never have acquired in the first place. The earlier buying of these ill-fated subsidiaries, also warmly applauded, is called diversification. I call it diworseification.
I’ll have more to say about diworseification later—most of it unflattering. The only positive aspect is that some companies that diworseify themselves into sorry shape are future candidates for turnarounds. Goodyear is coming back right now. It’s gotten out of the oil business, sold off some sluggish subsidiaries, and rededicated itself to the thing it does best: making tires. Merck, having washed its hands of Calgon and a few other minor distractions, is once again concentrating on its ethical drugs. It has four new drugs in clinical trials and two that have passed FDA approval, and the earnings are picking up.
THE ASSET PLAYS
An asset play is any company that’s sitting on something valuable that you know about, but that the Wall Street crowd has overlooked. With so many analysts and corporate raiders snooping around, it doesn’t seem possible that there are any assets that Wall Street hasn’t noticed, but believe me, there are. The asset play is where the local edge can be used to greatest advantage.
The asset may be as simple as a pile of cash. Sometimes it’s real estate. I’ve already mentioned Pebble Beach as a great asset play. Here’s why: At the end of 1976 the stock was selling for 14½ per share, which, with 1.7 million shares outstanding, meant that the whole company was valued at only $25 million. Less than three years later (May, 1979), Twentieth Century-Fox bought out Pebble Beach for $72 million, or 42½ per share. What’s more, a day after buying the company, Twentieth Century turned around and sold Pebble Beach’s gravel pit—just one of the company’s many assets—for $30 million. In other words, the gravel pit alone was worth more than what investors in 1976 paid for the whole company. Those investors got all the adjacent land, the 2,700 acres in Del Monte Forest and the Monterey Peninsula, the 300-year-old trees, the hotel, and the two golf courses for nothing.
Whereas Pebble Beach was an over-the-counter stock, Newhall Land and Farming was on the New York Stock Exchange and very visible while it went up well over twentyfold. The company had two significant properties: the Cowell Ranch in the San Francisco Bay area, and the much larger and more valuable Newhall Ranch, thirty miles north of downtown Los Angeles. The Newhall Ranch has a planned community complete with an amusement park, a large industrial-office complex, and it is developing a major shopping mall.
Hundreds of thousands of California commuters drive by the Newhall Ranch every day. Insurance appraisers, mortgage bankers, and real estate agents involved in the various Newhall deals certainly knew of the extent of Newhall’s holdings and of the general increase in California property values. How many people owned houses in the areas around the Newhall Ranch and saw the great escalation in land values, years ahead of any Wall Street analysts? How many of them considered researching this stock that has been a twenty-bagger from the early seventies and a fourbagger since 1980? If I’d lived in California, I wouldn’t have missed it. At least, I hope I wouldn’t have.
I once visited a mundane little Florida cattle company called Alico, run out of La Belle, a small town at the edge of the Everglades. All I saw there was scrub pine and palmetto brush, a few cows grazing around, and perhaps twenty Alico employees trying unsuccessfully to look busy. It wasn’t very exciting, until you figured out that you could have bought Alico for under $20 a share, and ten years later the land alone turned out to be worth more than $200 a share. A smart codger named Ben Hill Griffin, Jr., kept buying up the stock and waiting for Wall Street to notice Alico. He must have made a fortune by now.
Many of the publicly traded railroads such as Burlington Northern, Union Pacific, and Santa Fe Southern Pacific are land rich, dating back to the nineteenth century when the government gave away half the country as a sop to the railroad tycoons. These companies have the oil and gas rights, the mineral rights, and the timber rights as well.
There are asset plays in metals and in oil, in newspapers and in TV stations, in patented drugs and even sometimes in a company’s losses. That’s what happened with Penn Central. After it came out of bankruptcy, Penn Central had a huge tax-loss carryforward, which meant that when it started making money again, it wouldn’t have to pay taxes. In those years the corporate tax rate was 50 percent, so Penn Central was reborn with a 50 percent advantage up front.
Actually Penn Central might have been the ultimate asset play. The company had everything: tax-loss carryforward, cash, extensive land holdings in Florida, other land elsewhere, coal in West Virginia, and air rights in Manhattan. Anybody who had anything to do with Penn Central could have figured out that this was a stock worth buying. It went up eightfold.
Right now I’m holding on to Liberty Corp., an insurance company whose TV properties are worth more than the price I paid for the stock. Once you found out that the TV properties were worth $30 a share, and you saw that the stock was selling for $30 a share, you could take out your pocket calculator and subtract $30 from $30. The result was the cost of your investment in a valuable insurance business—zero.
I wish I’d bought more shares of Telecommunications, Inc., a cable company that sold for 12 cents a share in 1977 and $31 ten years later—up 250-fold. I had a very small position in this, the largest U.S. cable company, because I didn’t appreciate the value of the assets. The earnings were poor and the debts were worrisome, so on the traditional measures, cable was an unattractive business. But the assets (in the form of the cable subscribers) more than made up for these negatives. All the people with an edge in the cable business could have known it; and so could I.
Regrettably, I never took more than a piddling position in the cable industry, despite the urging of Fidelity’s Morris Smith, who periodically pounded on my table to convince me to buy more. He definitely was right—for the following important reason.
Fifteen years ago, each cable subscriber was worth about $200 to the buyer of a cable franchise, then ten years ago it was $400, five years ago $1,000, and now it’s as high as $2,200. People in the industry keep up with these numbers, so it’s not exactly esoteric information. The millions of subscribers to Telecommunications, Inc., made it a huge asset.
I think I missed all of this because cable TV didn’t arrive in my town until 1986 and in my house until 1987. So I had no firsthand appreciation of worth of the industry in general. Somebody could tell me about it, just as somebody could tell you about a blind date, but until you are personally confronted with the evidence, it has no impact.
If I’d seen how my youngest daughter, Beth, loves the Disney channel, how much Annie looks forward to watching Nickelodeon, how my oldest daughter Mary appreciates MTV, how Carolyn takes to the old Bette Davis movies and I take to CNN news and cable sports, I would have understood that cable is as much of a fixture as water or electricity—the video utility. It’s impossible to say enough about the value of personal experience in analyzing companies and trends.
Asset opportunities are everywhere. Sure they require a working knowledge of the company that owns the assets, but once that’s understood, all you need is patience.
HIGHFLIERS TO LOW RIDERS
Companies don’t stay in the same category forever. Over my years of watching stocks I’ve seen hundreds of them start out fitting one description and end up fitting another. Fast growers can lead exciting lives, and then they burn out, just as humans can. They can’t maintain double-digit growth forever, and sooner or
later they exhaust themselves and settle down into the comfortable single digits of sluggards and stalwarts. I’ve already seen it happen in the carpet business and in plastics, calculators and disk drives, health maintenance and computers. From Dow Chemical to Tampa Electric, the highfliers of one decade become the groundhogs of the next. Stop & Shop went from being a slow grower to a fast grower, an unusual reversal.
Advanced Micro Devices and Texas Instruments, once champion fast growers, are now regarded as cyclicals. Cyclicals with serious financial problems collapse and then reemerge as turnarounds. Chrysler was a traditional cyclical that almost went out of business, became a turnaround, then got turned around and became a cyclical again. LTV was a cyclical steel company, and now it’s a turnaround.
Growth companies that can’t stand prosperity foolishly diworseify and fall out of favor, which makes them into turnarounds. A fast grower such as Holiday Inn inevitably slows down, and the stock is depressed until some smart investors realize that it owns so much real estate that it’s a great asset play. Look what’s happened to retailers such as Federated and Allied Stores—because of the department stores they built in prime locations, and because of the shopping centers they own, they’ve been taken over for their assets. McDonald’s is a classic fast grower, but because of the thousands of outlets it either owns or is repurchasing from the franchisees, it could be a great future asset play in real estate.
Companies such as Penn Central may fall into two categories at once, and Disney, over its lifetime, has been in every major category: years ago it had the momentum of a fast grower, which led to the size and financial strength of a stalwart, followed by a period when all those great assets in real estate, old movies, and cartoons were significant. Then, in the mid-1980s, when Disney was in a slump, you could have bought it as a turnaround.
International Nickel (which became Inco in 1976) was first a growth company, then a cyclical, and then a turnaround. One of the old-line companies in the Dow Jones average, it was one of my first successes as a young analyst at Fidelity. In December, 1970, I wrote a sell recommendation on Inco at $47⅞. The fundamentals looked bleak to me. My argument (nickel consumption slowing down, increased capacity among producers, and high labor costs at Inco) convinced Fidelity to sell the large position it held in the stock; and we even accepted a slightly lower price in order to find a buyer for our big block of shares.
The stock went sideways into April, when it still sold for $44½. I was beginning to worry that my analysis was faulty. Around me were portfolio managers who shared my concern, and that’s putting it mildly. Finally reality caught up with the market and the stock fell to $25 in 1971, $14 in 1978, and down to $8 in 1982. Seventeen years after the young analyst recommended the Inco sale, the older fund manager bought a large position for Fidelity Magellan as a turnaround.
SEPARATING THE DIGITALS FROM THE WAL-MARTS
If you can’t figure out what category your stocks are in, then ask your broker. If a broker recommended the stocks in the first place, then you definitely ought to ask, because how else are you to know what you’re looking for? Are you looking for slow growth, fast growth, recession protection, a turnaround, a cyclical bounce, or assets?
Basing a strategy on general maxims, such as “Sell when you double your money,” “Sell after two years,” or “Cut your losses by selling when the price falls ten percent,” is absolute folly. It’s simply impossible to find a generic formula that sensibly applies to all the different kinds of stocks.
You have to separate the Procter and Gambles from the Bethlehem Steels, and the Digital Equipments from the Alicos. Unless it’s a turnaround, there’s no point in owning a utility and expecting it to do as well as Philip Morris. There’s no point in treating a young company with the potential of a Wal-Mart like a stalwart, and selling for a 50 percent gain, when there’s a good chance that your fast grower will give you a 1,000-percent gain. On the other hand, if Ralston Purina already has doubled and the fundamentals look unexciting, you’re crazy to hold on to it with the same hope.
If you buy Bristol-Myers for a good price, it’s reasonable to think you might put it away and forget about it for twenty years, but you wouldn’t want to forget about Texas Air. Shaky companies in cyclical industries are not the ones you sleep on through recessions.
Putting stocks in categories is the first step in developing the story. Now at least you know what kind of story it’s supposed to be. The next step is filling in the details that will help you guess how the story is going to turn out.
8
The Perfect Stock, What a Deal!
Getting the story on a company is a lot easier if you understand the basic business. That’s why I’d rather invest in panty hose than in communications satellites, or in motel chains than in fiber optics. The simpler it is, the better I like it. When somebody says, “Any idiot could run this joint,” that’s a plus as far as I’m concerned, because sooner or later any idiot probably is going to be running it.
If it’s a choice between owning stock in a fine company with excellent management in a highly competitive and complex industry, or a humdrum company with mediocre management in a simpleminded industry with no competition, I’d take the latter. For one thing, it’s easier to follow. During a lifetime of eating donuts or buying tires, I’ve developed a feel for the product line that I’ll never have with laser beams or microprocessors.
“Any idiot can run this business” is one characteristic of the perfect company, the kind of stock I dream about. You never find the perfect company, but if you can imagine it, then you’ll know how to recognize favorable attributes, the most important thirteen of which are as follows:
(1) IT SOUNDS DULL—OR, EVEN BETTER, RIDICULOUS
The perfect stock would be attached to the perfect company, and the perfect company has to be engaged in a perfectly simple business, and the perfectly simple business ought to have a perfectly boring name. The more boring it is, the better. Automatic Data Processing is a good start.
But Automatic Data Processing isn’t as boring as Bob Evans Farms. What could be duller than a stock named Bob Evans? It puts you to sleep just thinking about it, which is one reason it’s been such a great prospect. But even Bob Evans Farms won’t win the prize for the best name you could give to a stock, and neither will Shoney’s or Crown, Cork, and Seal. None of these has a chance against Pep Boys—Manny, Moe, and Jack.
Pep Boys—Manny, Moe, and Jack is the most promising name I’ve ever heard. It’s better than dull, it’s ridiculous. Who wants to put money into a company that sounds like the Three Stooges? What Wall Street analyst or portfolio manager in his right mind would recommend a stock called Pep Boys—Manny, Moe, and Jack—unless of course the Street already realizes how profitable it is, and by then it’s up tenfold already.
Blurting out that you own Pep Boys won’t get you much of an audience at a cocktail party, but whisper “GeneSplice International” and everybody listens. Meanwhile, GeneSplice International is going no-where but down, while Pep Boys—Manny, Moe, and Jack just keeps going higher.
If you discover an opportunity early enough, you probably get a few dollars off the price just for the dull or odd name, which is why I’m always on the lookout for the Pep Boys or the Bob Evanses, or the occasional Consolidated Rock. Too bad that wonderful aggregate company changed its name to Conrock and then the trendier Calmat. As long as it was Consolidated Rock, nobody paid attention to it.
(2) IT DOES SOMETHING DULL
I get even more excited when a company with a boring name also does something boring. Crown, Cork, and Seal makes cans and bottle caps. What could be duller than that? You won’t see an interview with the CEO of Crown, Cork, and Seal in Time magazine alongside an interview with Lee Iacocca, but that’s a plus. There’s nothing boring about what’s happened to the shares of Crown, Cork, and Seal.
I already mentioned Seven Oaks International, the company that processes the coupons that you hand in at the grocery store. There�
�s another tale that’s guaranteed to shut your eyes—as the stock sneaks up from $4 to $33. Seven Oaks International and Crown, Cork, and Seal make IBM seem like a Las Vegas revue, and how about Agency Rent-A-Car? That’s the glamorous outfit that provides the car the insurance company lets you drive while yours is being repaired. Agency Rent-A-Car came public at $4 a share and Wall Street hardly noticed. What self-respecting tycoon would want to think about what people drive while their cars are in the shop? The Agency Rent-A-Car prospectus could have been marketed as an anesthetic, but the last time I looked, the stock was $16.
A company that does boring things is almost as good as a company that has a boring name, and both together is terrific. Both together is guaranteed to keep the oxymorons away until finally the good news compels them to buy in, thus sending the stock price even higher. If a company with terrific earnings and a strong balance sheet also does dull things, it gives you a lot of time to purchase the stock at a discount. Then when it becomes trendy and overpriced, you can sell your shares to the trend-followers.
(3) IT DOES SOMETHING DISAGREEABLE
Better than boring alone is a stock that’s boring and disgusting at the same time. Something that makes people shrug, retch, or turn away in disgust is ideal. Take Safety-Kleen. That’s a name with promise to begin with—any company that uses a k where there ought to be a c is worth investigating. The fact that Safety-Kleen was once related to Chicago Rawhide is also favorable (see “It’s a Spinoff” later in this chapter).
Safety-Kleen goes around to all the gas stations and provides them with a machine that washes greasy auto parts. This saves auto mechanics the time and trouble of scrubbing the parts by hand in a pail of gasoline, and gas stations gladly pay for the service. Periodically the Safety-Kleen people come around to remove the dirty sludge and oil from the machine, and they carry the sludge back to the refinery to be recycled. This goes on and on, and you’ll never see a miniseries about it on network TV.