I created my article repository site (also known to some as a blog), ContrarianEdge.com, in 2004. When I was trying to pick its name I did a lot of soul searching. I was thinking, what’s the common thread among all of my articles? I realized that it’s my willingness to disagree with a popular opinion if my research leads me to a contrary conclusion. Thus Contrarian Edge.
That doesn’t mean I disagree with the common opinion all the time, not at all. It’s just that when I agree with one – which happens often, actually –there is little value in it: Love, hate, or indifference is already priced into the stock.
A lot of times I won’t have an insight into a business because I don’t understand it or because it’s too complex. GE is a great example today. I’m a value investor; I should be all over this stock that is making a generational low. Not at all. I looked at GE a half a dozen times over the years, and every single time I walked away without understanding the business or what it is worth.
To make things worse, despite GE’s being one of the most-admired companies in the US, I have always hated its culture. Jack Welch went into the corporate history books as the best American CEO ever. I’d argue that this history needs some serious rewriting. Welch built a company with a “beat this quarter” culture. Jack’s GE was not in the business of building moats and investing for the long run; he was in the business of beating quarters. In his book, Welch raved that from the early 2000s GE always beat Wall Street estimates. He was proud of how managers of one division were able to “come up with” a few more cents of earnings if another division fell short of its forecast. I kid you not – reread that sentence, three times. If I was at the SEC I’d investigating GE’s accounting.
GE played games with their earnings for a long time, but the reality that its cash flows couldn’t cover its dividend, which was supposedly half of its earnings, is what triggered a wake-up call for investors. GE is another reminder that it is incredibly dangerous to own a stock just because you like the dividend. Consistency of recurrence of dividend payments creates an optical illusion that the dividend will always will be there. Just think about it: GE’s dividend of 96 cents was half of what the company was expected to earn and it still couldn’t afford to pay it.
I’d argue that Welch is on the opposite end of the spectrum from Jeff Bezos. Bezos doesn’t even know how to spell quarterly earnings. In one of his interviews Bezos explained that Amazon makes decision years out. So the current quarter’s report reflects decisions Amazon made several years ago. I don’t want to own companies that are run by the likes of Welch, but we own a few that are run by the likes of Bezos. When I hear management praise their ability to beat last quarter’s earnings, I run.
GE was ultimately destroyed by enormous capital misallocation. They assumed anything they touched with Six Sigma, independent of the price they paid, would turn to gold. So they didn’t care how much they paid for acquisitions. (I’ll discuss the topic “death by acquisition” next week in part two of this article.)
There is another lesson for me here. We always look for simplicity and transparency. If a company’s business is complex and opaque, we move on. One of the most important things in investing is what you do in between buying or selling a stock. After you buy it is just a matter of time before your initial assumptions come under fire. Maintaining rationality throughout your ownership of the company is paramount, and to do that you need to understand the business well. Thus (at least for us) the business cannot be opaque or overly complex. (We set an upper limit to the IQ required of us to understand the business.) So that’s why I have no opinion on GE shares today.
Once in a while, after we’ve done extensive research on a business we understand, I may have an opinion that is contrary to the market’s. In those few situations you can drive a truck between the stock price and what we believe the company’s value is, and this is when we dig in and become contrarians. Today’s article is about one of those instances.
Finally, I implore you, don’t let this article be the end point of your research. I talk to a lot of perspective clients whose portfolios are assembled based on “compelling” articles they’ve read on MarketWatch, Yahoo Finance, Motley Fool, or even in my emails (articles). This article represents our thinking today, not forever. If facts change, I’ll change my mind, and you may or may not find me writing about it (unless you are IMA client, then for better or worse you’ll get a fifteen-page quarterly letter).
This may sound harsh – I’m sorry – but I rarely reply to emails that ask, “What do you think about this company now?” There is only so much time in a day, and I’d be answering these emails all day long. We never make a decision based solely on someone else’s research; that is always just a starting point for our own research. You should do the same. (You can read about that in this article.)
Vitaliy Katsenelson, CFA
Student of Life, CEO
I wrote two books on investing, which were published by John Wiley & Sons and have been translated into eight languages. (Even in Polish!)
In a brief moment of senility, Forbes magazine called me “the new Benjamin Graham.” (They must have been impressed by the eloquence of the Polish translation.)
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