This Expected Returns cover story from April 2009 underscores the things that really matter during bear markets, corrections and recessions.  We were reminded at the time to focus on high-quality opportunities with vigilance for upstart, promising companies ratcheted up.  If you’re curious about our work at Manifest Investing and the resources we provide for long-term investors, and interested in a FREE 90-day test drive, let me know via markr@manifestinvesting.com … for now, may your investing brackets be “nothing but net.”

The stock market madness of early March has given way to a rally that at least delivers welcome respite from the cascading decline we’ve experienced for several months.

Triple Play: A Measure of Opportunity. History suggests that the discovery of companies poised with Triple Play characteristics can lead to rewards. We’ve leaned on Nicholson’s Triple Play concept often since the 4th quarter of 2008, citing potential impact on our shopping efforts. Finding companies with the prospects of potential profit margin and P/E expansion seems prudent. Combining that potential with high-quality companies exhibiting out-sized PARs could deliver a measure of success and shining moments for our portfolios going forward.

 

March Madness now extends into April as the NCAA basketball championships bring the current season to a close. And the stock market madness of early March has given way to a rally that at least delivers welcome respite from the cascading decline we’ve experienced for several months. In the movie ‘Hoosiers’, there’s a classic scene where Gene Hackman, coach of the underdogs from a very small town, leads the boys into the championship venue for their pregame practice. He hands a tape measure to the anxious players and urges them to confirm that the hoop is 10 feet above the floor … just like home … and the free throw line, 15 feet … just like home.

From “Just Like Home” …

As many of you know, we’ve discovered that NAIC/BI co-founder, the late George Nicholson, focused his attention on “the next bull market” during the dreadful bear market of 1973-74. As we studied his writings at the time, we learned that he looked back to the lessons of the 1937-38 bear market — days when he was launching a successful career and lifetime of successful investing.

He believed that the challenges and opportunities of 1973-74 were similar to conditions last seen in 1937-38 complete with year-over-year 50% declines in automobile sales (sound familiar?) and a variety of economic ailments related to scarcity of commodities and mischievous behavior in the banking and investing sectors, etc. He developed a set of criteria — intended to seek opportunities just like “home.”

Although we can’t be certain, I can imagine that he saw it as a sort of antidote to the poisonous paralysis that afflicts so many of us as stock prices decline. In fact, Nicholson “pleaded” with investment clubs to commit to decisions during early 1975 — citing a recent 80% gain in Coca-Cola over a span of less than six months as evidence that prices could and often do, move in sudden spurts. (The stock price of Coca-Cola proceeded to languish for the next 5-6 years.) If you missed the autumn 1974 opportunity to own the Real Thing and waited a few months before committing, your experience was considerably less rewarding.

… to “Shining Moments”

CBS Sports features the song ‘One Shining Moment’ to encapsulate the highlight reel celebrating the coronation of this year’s champion.

Nicholson shared that some of the best shining moments of a lifetime of successful investing could be traced to the elements of his Triple Play concept. Here are the three features that qualify a stock for Triple Play status: (1) A depressed stock price. Think elevated projected returns. (2) A potential for P/E expansion over a 5-year time horizon and (3) A potential for profit margin expansion. Such stocks are most frequently found at the end of a long bear market.

“I have been investing in Triple Play situations during 1973-74 in preparation for the next bull market. If past performance is any guide, the performance should exceed [stock market returns] by a wide margin.” — George Nicholson.

Triple Play Candidates. This listing of study candidates was shared with the attendees at the Better Investing regional conference in Lansing, Michigan on April 3-4, 2009. Our database was screened for companies with PAR>21%; Quality>60; EPS Stability > 60; and Financial Strength > 70. A large number of companies are poised for P/E expansion (not shown) and the screening results shown here are sorted by annualized net profit margin (%) expansion in descending order. Note Solomon Select company, Mettler-Toledo, and the other precision instrument companies.

Bear Down, Regularly

There’s an insurance company commercial running on television where the celebrity sponsor (President Palmer for ‘24’ fans …) shares that we’ve been through twelve recessions over the last 50 years or so. All of them ended and a period of economic expansion ensued.

During a recent seminar, Steve Sanborn, retired director of research for Value Line, and I shared that — in his wealth of investing experience — all bear markets have ended. In that seminar, we explored the history of bear markets and underscored the similarities between 1938, 1974 and 2009 as supported by the accompanying graphic.

The lessons of history suggest that it’s probably time to think less about poisonous paralysis — avoid remaining unduly mired in yesterday’s quagmire — and focus a whole lot more on an effort to engage tomorrow’s prosperity. The table displays a listing of companies with depressed stock prices and the potential for profitability and P/E expansion. Many of these companies were mentioned multiple times by some pretty effective stockpickers and educators at the regional conference in Lansing, Michigan on April 3-4.

The list includes some community favorites, a few newcomers and a few Solomon Select legacy features.

Growth by Recession

It’s probably time for a reminder that our emphasis on focus on size diversification includes a healthy nudge. That nudge entails the continuous pursuit of companies with higher top line growth expectations. It also includes an increased focus or emphasis during periods when we may be approaching the end of a recession.

Bear Market Comparisons. As shown here, the bear markets of 1937-38, 1973-74 and 2007-2009 exhibit some similarities when compared versus all of the bear markets that have come and gone before. No, Virginia, we’re not seeing conditions like the Great Depression (see 1929-32) yet. Nicholson seized the moment in 1973-74, seeking Triple Play candidates to ready his portfolio for the next bull market.

You’ll hear some pundits, rhinos and talking heads continuing to encourage blue chip companies and we’ll nod and agree that this pursuit should be continuous, too.

That said, we also heed the advice of Peter Lynch. The Magellan maestro suggested that small companies can be more nimble and recover more quickly coming out of recessions. This reality is one of the things that leads to frustrating periods where blue chip languish while “garbage companies” seem to flourish. An investor over-concentrated in slow-growth blue chips last experienced this during the 2003 bull market.

Dial up shopping efforts and maintain overall portfolio sales growth at the high end of your comfort range. Languish a little less.

I have a small confession. Much like Jim Surowiecki, I’m sometimes conflicted with doubts about how much this “quality stuff” really matters. After writing The Wisdom of Crowds, Surowiecki shares several experiences where he doubted the wisdom of a gaggle of chefs in some “predictive kitchen” only to discover that the collective wisdom held up well … again, despite and in deference to any doubt.

And every time I check, I’m stunned by the reinforcement and rediscovery that comes with it.

2-Year Annualized Returns for Low-Quality Companies. The companies shown represent approximately (20) of the lowest quality ratings as of March 2007. The average annualized loss for this group of companies is 60%. Yes, 60% … and that doesn’t count three companies no longer “on the board” because they’ve gone bankrupt and no longer exist. In a word, Ouch.

The accompanying graphic is from a couple of slides presented at the regional conference — updating a look at bear market performance for low-quality companies versus high-quality companies. Yes, we’re talking about the current bear market.

And yes, the contrast is stunning. And it hits a little close to home as we watch companies like General Motors (GM) drop from $29.27 to $1.94 over a period of two years — an annualized loss of 74% (per year!)

Nicholson’s Legacy Continues

The companies shown in the accompanying graphic are often found on subscriber dashboards and rank among the most commonly-held and widely-followed by our Community. We’re proud, yet humbled, that companies like Solomon Select feature Strayer Education (STRA) tops these charts, compelling us to continue our quest.

2-Year Ann. Returns for Highest-Quality Companies. In sharp contrast, the highest-quality companies combined for an average return of -19% versus a stock market down -27%. Note that three companies (including a couple of community favorites and a Solomon Select alum) managed positive returns!

 

Nicholson strongly cautioned avoiding lower quality companies as bull markets raged. In our vernacular and interpretation, we’d translate that to: “periods where MIPAR is historically low” as our measure of bull market condition.

Where’s your “investing tape measure?” In the spirit of Hoosier coach Norman Dale (Gene Hackman), we continue to urge that seeking Triple Play Candidates and heeding the repeating lessons of Quality are pretty good yardsticks to honor.

Just like home … Indeed.