Investing in Uncertain Times

Amid the subprime mortgage fallout, the U.S. housing market has seen a marked drop in demand, higher levels of unsold inventory, and an increase in foreclosures. Media coverage of these events seems to emphasize that the fallout is unclear, that conditions may worsen, and that the total impact will not be known for some time.

These are precisely the conditions to engage in contrarian investing. At this point of the investment cycle, the valuations of select companies are very attractive, meaning that their current market valuations are trading below their intrinsic values. Examples abound in the financial sector, pharmaceutical sector, auto sector, and food sector. It's understandable for Clients to wonder whether purchases in these areas are "too early", given the potential for continued deterioration, especially in currently unpopular sectors of the economy. How can we determine fair values for companies when the total impact of such current events may be still unknown?

In difficult times stock prices tend to exaggerate the prevailing uncertainties. Opportunities are created where individual stock prices fall below a rational assessment of business worth. Keep in mind that an assessment of business value is conservative and not precise; intrinsic value estimates are dynamic. Often it is best to describe intrinsic value estimates as a "neighborhood", not as specific address. Reversion to the mean allows us to take advantage of short-term price declines that can create long-term opportunities. When the relative difference between stock price and assessed fair value is great enough, the investment decision is not dependent on precision.