Our Best Calls of 2008
There were some bright spots in a dismal year.
By all accounts, 2008 was a dismal year for most investors. We made our share of mistakes last year, several of which we highlighted in this article. We also learned a lot of lessons that will improve our analysis going forward. Of course, the market has offered opportunities to learn these lessons many times in the past, but it often takes a crisis to bring them clearly into focus. And investors--no matter how experienced--often forget to be prepared for the worst even when things are going well.
Although we certainly should have done better with some parts of our coverage universe, 2008 wasn't all bad. In fact, our aggregate performance in 2008 was slightly ahead of the market, as we reported in our recent performance update. We did particularly well with our 1-star calls, which on average fell 67% versus a 37% decline for the S&P 500.
Notwithstanding 2008's pandemonium, our belief in the value of bottom-up, fundamental analysis remains unshaken. Following the teachings of Benjamin Graham and Warren Buffett, we continue to believe investors will do best to think like owners, ignoring short-term price movements caused by the market's caprice and focusing instead on the fundamental value of the underlying business.
Below, we present some examples of our best calls of 2008. These are examples where our thesis has been playing out and our valuation appears to have been on the mark.
Apollo Group (APOL)
Current Rating: 4 stars*
We've long been fans of wide-moat education company Apollo Group. We held to a $76 fair value estimate for most of 2008, as the stock fell from around $80 to as low as $38 because investors became concerned about slowing enrollment growth and the possibility that students would be unable to get loans. We thought slowing growth was the result of temporary issues and saw plenty of opportunity for both enrollment growth and margin expansion in the future. In the second half of the year, enrollment growth rebounded sharply, helped by workers returning to school to bolster their resumes, and margins again began to benefit from operating leverage. Lending concerns subsided as the government increased federal loan limits; private lending was always a small source of revenue for Apollo. The stock rallied to the mid-$70s, and our fair value estimate got a boost to $90 toward the end of the year. We raised our fair value estimate again in January to $109, with the stock trading around $80.
Joy Global (JOYG)
Current Rating: 3 stars
We were always wary of mining-equipment manufacturer Joy Global because of its severe cyclicality and exposure to commodity prices. We started 2008 with a $37 fair value estimate on the company, with the stock trading around $65. We raised our fair value estimate only once during the year, to $40 (our fair value estimate currently sits at $22). In the meantime, Joy's stock ran up as high as $90 by June and spent the first half of 2008 with a 1-star rating. As the commodity bubble burst, the outlook for demand of Joy's original equipment fell off a cliff. The market came around to our view that the cyclical upswing in mining equipment wouldn't last forever, and the stock fell about 85% from the peak to the recent low.
Intuitive Surgical (ISRG)
Current Rating: 5 stars
Robotic-surgery pioneer Intuitive Surgical spent much of the first half of 2008 at 1 star, with a $175 fair value estimate and the stock dancing around $300, reaching a peak of $358. We increased our fair value estimate once during the year, to $223, while the stock collapsed to as low as $110 and fell below $90 in January (our fair value estimate is currently $200). Intuitive has been at 5 stars since November 2008. When Intuitive was in the mid-$300s, we thought the market was being overly optimistic about its growth prospects, extrapolating recent trends in revenue growth and margins far into the future while affording little room for error. Intuitive has since hit a speed bump, as hospitals are becoming increasingly cautious about their capital spending in light of the economic and financial market environment. We think the market has once again become carried away, though this time it is being overly pessimistic.
Current Rating: N/A
We started 2008 with a $60 fair value estimate on property and casualty insurer Safeco. When the company reported poor results for the fourth quarter of 2007 because of weak profitability in the auto insurance segment, the market got spooked, and the stock traded down from around $55 at the beginning of the year to as low as $41. We stuck with our fair value estimate, believing Safeco's new management had restructured the company toward improved profitability. The company carried our 5-star rating for much of March and April, until Liberty Mutual agreed to acquire Safeco for $68. The deal was announced in April and closed in September.
New York Times (NYT)
Current Rating: 2 stars
We made several good 1-star calls on the newspaper industry in 2008. Our thesis has been that newspapers are a declining business with high fixed costs, few remaining cost-cutting opportunities, and heavy debt loads. For example, we put a $15 fair value estimate on the New York Times in early January, and the stock was at 1 star whenever it traded around $20. We didn't think the Times' premium reputation would be enough to shield it from the broader industry trends. We lowered our fair value estimate midyear to $10, and the stock spent several months in Consider Selling territory as it traded as high as $15. We lowered our fair value estimate yet again in November, this time to $3 while the stock was trading as high as $8. At recent prices around $5, we remain unenthusiastic about the Times.
Current Rating: 3 stars
We started 2008 with a $62 fair value estimate on oilseed and fertilizer company Bunge. At the time, the stock was trading above $120, making it a deep 1-star call. Bunge was experiencing spectacular growth on the back of the agriculture boom that resulted from economic growth in emerging markets and the increasing popularity of biofuels. However, we were unenthusiastic about the company because of its exposure to many factors outside of its control--especially commodity prices--and because of its lack of cash flow despite record accounting profits. Bunge fell as low as $28 in 2008 as the commodities bubble deflated, and the firm currently trades in the low $40s.
Current Rating: 4 stars
We entered 2008 with a $66 fair value estimate on biotech Amgen, with the stock trading in the mid-$40s. The market had become scared about possible cardiovascular and cancer risks associated with two of Amgen's best-selling drugs: Epogen and Aranesp. We recognized that these risks only emerged when the drugs were used outside of their approved doses and indications, and we didn't think the sales decline would be as drastic as the market feared. We also saw the potential for cost-cutting and ongoing research and development to boost future results. After bottoming out below $40, Amgen ran up as high as the mid-$60s and is currently trading in the mid-$50s, even as the S&P 500 has shed almost 40% of its value.
MEMC Electronic Materials (WFR)
Current Rating: 2 stars
One of our most dramatic calls of 2008 has to be silicon-wafer manufacturer MEMC Electronic Materials. We started the year with a $20 fair value estimate on the company, with the stock trading in the high $80s. We changed our fair value estimate twice during the year, to lower it to $17 in October and to lower it again to $9.50 in November. Our thesis was that MEMC was in a highly cyclical commodity business with low barriers to entry and that the shortage of silicon wafers prevailing around the beginning of the year would not last forever, leading to rapid price and margin erosion. MEMC's stock collapsed to as low as $10 and currently trades in the low teens.
*Current Ratings as of Feb. 3, 2009
Matthew Coffina does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.