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gameguru (34.54)

My Favorite CAPS Picks



December 15, 2006 – Comments (3)

I don't have nearly as many CAPS picks as some other players - I've only made 18 picks since I started back at the end of August 2006. That's only about 5 picks/month. With so few picks, each one is a call I've thought about, committed to, and ultimately believe in. Yet, I can look back and easily pick out a few calls as being my favorites of them all. The three picks I would name as my favorites (COF, LUK, and FUN) share many common traits. They were all made on the same day (8/31/06), making them my first 3 picks, and they are all losing to the market. That's right, the stock calls I would name as my favorites are not my timely calls on EBAY or CRYP, or my steady gainer AB, but are net losers so far. Why do I love these stocks and my CAPS calls on them?

First, I'm personally invested in them - I own shares of each of these stocks.

Second, these are stocks that I believe in the longer-term will not just beat, but crush the market. So what if they're losers over 3 and 1/2 months? I'm patient when I have high confidence. (Feel free to hold this statement against me in 3-5 years.) Why am I so confident? Because even though all three stocks have made modest (<10%) gains since my calls, they are still currently priced at substantial discounts to my estimates of their intrinsic value. On an earnings basis, here are my estimates of intrinsic value (IV):

Ticker IV range Price Discount to IV

COF $120-130 $77.25 55-68%

LUK $35-38 $27.54 27-38%

FUN $30-34 $27.88 8-22%

[I consider all of these to be conservative estimates of the intrinsic value, so the discounts to value may in fact be much higher. As I said, I already own these three stocks, so I might wait for even lower prices before purchasing more (especially on FUN).]

That was a long-winded second reason. Moving along...

Third, they are all undervalued on a number of other metrics. They all have a Market Cap that is at or below Enterprise Value, and they have Operating Cash Flows that are higher than Net Income.

Fourth, they all provide the anchor of paying a dividend. In the case of COF and LUK, the yield is modest (tiny in COF's case!). For FUN, a substantial part of the total returns will come from dividends (so I can't wait for CAPS to start recognizing this important part of performance!).

Fifth, they all have what I consider to be outstanding and long-standing management teams that think like owners and look toward future possibilities. They all want their companies to become more than they currently are. You can see this in COF's transformative acquistions of traditional bankers, in LUK's continued emphasis on under-valued buy-out opportunities, and in FUN's recent acquistion of the Paramount properties. I think the market has mis-priced the companies because it fails to see the accretive nature of these acquistions. For example, all the market sees is the debt burden on FUN, without seeing the possibility that it can add value to those new properties based on its well-established operating principles.

Sixth, when I look at the major institutional holders of these companies, I find that I'm in good company. Take a tour of the major holders on Yahoo Finance, and you'll see a veritable who's who of value investors and value funds. Such validation isn't necessary to my stock picking, but it certainly doesn't hurt.

Seventh, even though they are all losing to the market, they are down, but not out. They each lag the market by less than 5%, meaning they've stayed well within striking distance. I think this is primarily because their discounts to value keep attracting investors and will ultimately shine through. But, the important point is that I see the downside in each as being very limited.

Eighth, I was relatively early in making each of these picks. Only about 20 other Fools picked COF and LUK before me, while I'm about the 50th to pick FUN (which is pretty amazing given that it is one of the Fool newsletter picks, I believe). I suppose it helped that I was already invested in these stocks, so I didn't have to go digging around to find them - I'd already done that work. Admittedly, this is a very superficial reason, but in a system where thousands of other people are picking stocks, I take a small measure of pride in picking an under-exposed company.

Finally, they all share a completely silly commonality. They all have phonemically meaningful ticker symbols (I want to say that they are onomatopoetic, but I don't think that is quite right) - Cough, Luck, and Fun.

Anyway, these are my favorite picks, and I look forward to following them through the years. Maybe this will help you appreciate them too, or inspire you to look over your own picks and bond with a few. What are your favorite CAPS picks?

3 Comments – Post Your Own

#1) On December 15, 2006 at 11:31 PM, JrnymanInvestor (81.88) wrote:

Nice post.

I took a quick look at Capital One, Leucadia and Cedar Fair (names close if not exactly right, I hope). I haven't yet put in the effort to start figuring my own estimates of intrinsic value / discounted cash flow, but I hope to develop the ability and patience to do so sometime in the next several months to a year. Interesting that your IV estimates for COF, LUK, and FUN are so attractive, as it's true there are lines in the stat sheets of all 3 that would tend to make me shy away from these. Any hints as to an efficient method for estimating intrinsic value? I've read about it some and downloaded one or two Excel files, but it still looks like a cumbersome (while valuable and necessary) exercise.

Looking over my CAPS picks, my favorites are the ones I've learned from. I have an ended outperform and an active underperform on Delta Airlines DALRQ.PK. Hit the outperform on merger interest from U.S. Air and then proceeded to really learn about bankruptcy proceedings when I'd had only a vague notion previously. So, I closed that stupid losing pick -- and when the stock popped above 1.50 and was pickable again I put in an underperform. Also picked Northwest NWACQ.PK to underperform and have had my CAPS score suffer greatly in the short term. But as you said of yourself, I'm patient when I'm confident I'll eventually be well rewarded.

I also like my ended SVI pick, as I learned about the concept of a "blank check" company when I stumbled on this one making picks for 5STARsmallCAPS. I figured it would go up on news announcements around the time of their acquisition of Jamba Juice. Got a nice 13 score points, banked some accuracy, and learned something too. (Plus I'd never heard of Jamba Juice before. Now I'll go there and get a smoothie some time when I'm in an area where they have stores.)

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#2) On December 19, 2006 at 3:34 PM, gameguru (34.54) wrote:

Calculating IV is often a company-specific exercise. You can do a quick and dirty estimate if you know the TTM earnings, long-term (5-year) estimated growth rate, and the discount rate you want to apply (I use the long-term market return - unadjusted for inflation - which is in the 10-12% range, depending on your source's time frame). You can get a better estimate if you break out free cash flow or owner earnings, and this usually requires knowing something about the line items for each company. If you want to learn more about intrinsic value calculations, one of the best and easiest to understand sources (the examples will be outdated now, however) I can recommend is The Warren Buffett Way by Robert Hagstrom.

CAPS clearly provides a learning experience, and so I think most users would list their favorites as those picks they've learned the most from. Thanks for sharing yours!

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#3) On December 20, 2006 at 3:12 PM, TMFSpiffyPop (99.36) wrote:


Great blog post. Fool on! --David Gardner

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