Streetwise for Sunday August 3, 2008

Streetwise

Lauren Rudd

Sunday, August 3, 2008

Volatile Markets Have Opportunity

Wall Street reminds me a little of the weather here in Florida, volatile. It is either dry as a bone or you are engulfed in water. Although I can probably predict the weather with the same degree of accuracy as the stock market, I believe the markets will remain volatile throughout the remainder of this calendar year.

Now, before you sigh in resignation, consider some comments made by Warren Buffett at the annual Berkshire Hathaway shareholders meeting last May. He said, “If a stock I own goes down 50 percent, I would look forward to it. In fact, I would offer you a significant sum of money if you could give me the opportunity for all of my stocks to go down 50 percent over the next month.”

The point being that when the shares of quality companies go on sale you don’t cry, you go shopping. It does not matter whether you already own the stock or not. Quality is quality and a sale price is always temporary.

Yes, I have read your letters about the performance of the equity indexes over the past several years. However, you will notice that I did not say anything about buying index funds or mutual funds or any of a host of other more exotic instruments. We are talking about investing in vanilla stocks of specific companies whose returns you believe will outperform the general market and still meet your risk requirements.

And I also did not say anything about investing in companies that some parasitic investment letter or TV performer or commission sales person says will outperform the market. Believe me if they really knew what stocks to buy, they would be buying them and not living off subscriptions, advertisers and commissions.

There is nothing wrong with reading about or listening to investment ideas, especially when you are not paying for the privilege. It is when you act on those ideas without doing your own proper due diligence that you book tax losses no t profits. There is no promise of a rose garden on Wall Street. Act imprudently and the market will resemble one of Florida’s renowned alligators...and you a hot lunch.

Unfortunately, in an effort to counteract the ills of today’s economy, investors are chasing after phantom opportunities in a relentless search for profits beyond the norm. This is especially true as they try to tap into the rising oil and energy markets.

While investing in the energy sector is an excellent strategy, never neglect the requirement for a stable history of positive earnings and cash flow growth. Consider, for example, Transocean, a company I discussed here a year ago whose share price is up 30 percent since then.

Transocean is the world's largest offshore drilling contractor and the leading provider of drilling management services worldwide. The company's fleet is considered one of the most modern and versatile in the world due to its emphasis on the technically demanding segments of the offshore drilling business.

Yet, as I said last year, there is also a strong warning label accompanying this selection. Due to the nature of the business, profits in offshore oil drilling are volatile and that volatility can quickly spill over into a company’s share price. Therefore, do not allow yourself to become blinded by the share price performance.

The intrinsic value of the shares is also close to being unbelievable. Using a discounted earnings approach and with a 15 percent discount rate and an 11 percent earnings growth rate, yields an intrinsic value of $203. The more conservative free cash flow to the firm approach produces a value of $202. The shares recently traded at $141.83.