Courtesy of John Nyaradi
How to find a fallen angel, part science, part art, part science, explained by master value investor Gabriel Wisdom, author of Wisdom on Value Investing: How to Profit on Fallen Angels.
John Nyaradi: Hi, I’m John Nyaradi, publisher of Wall Street Sector Selector
and today I would like to welcome our special guest, Gabriel Wisdom. Gabe is
the author of Wisdom on Value Investing: How to Profit on Fallen Angels.
He’s co-founder of American Money Management and host of The Gabe Wisdom
Show on National Business Talk Radio. Gabe, welcome to Wall Street
Sector Selector.
Gabriel Wisdom: Thanks, John. It’s great to be here.
John Nyaradi: What I’d like today is to talk about your view of the economy
overall and about your book and how to become a great value investor. So let’s
start with your take on the economy.
Gabriel Wisdom: Well, that is the most important decision that any investor
can make is what’s the big picture. Where are we now in the business and
economic cycle? And the average economic recovery, by the way, lasts about 5
years. So we’re really early into this one. And there’s a lot of skepticism
around. But our central bank and the others like the Federal Reserve are
reflating their economic systems, printing money. Now it appears that Japan will have
to do the same thing. They’ll create more Yen to pay for, you know, the tragedy
there. You can’t buy back the cost of human lives. You know, that’s far, far
too great for anybody to make up for, but they will rebuild. Their energy came
from those 54 nuclear plants. Eleven of them have been offline, so from a big
picture perspective, they’re going to be doing a lot of infrastructure
building. In the meanwhile, to make up for the shortage of energy, they’ll be
buying coal and natural gas and oil from mostly their Asian trading partners,
and that’s one reason why, I think, oil prices will go up.
John Nyaradi: Sure.
GabrielWisdom: Another big view is the agriculture situation. We have about
200,000 new citizens on planet Earth every single day. In much of the world
where the median age is around 35 years old, they’re experiencing an enormous
population boom. People are living longer. That’s the good news. Bad news is
that it’s putting a strain on natural resources, and in much of the world, they
can’t keep up with the demand for food.
John Nyaradi: Yes.
Gabriel Wisdom: Much of the conflict along the Nile – That revolution along
the Nile that began in Egypt has everything to do with the cost of food in Egypt. It requires about 40% of the
average Egyptian citizen’s budget just to put food on the table. So we’re
seeing rice riots elsewhere in the world, and now, corn prices seem to be
sustainably high. It’s a real problem. So big view, we want to have exposure to
agricultural commodities. We want to own energy. We want to be on trend with
what’s really working while we’re early in this economic recovery.
John Nyaradi: Now let’s take a look at the US market. What’s going on in our
own domestic markets and economy?
Gabriel Wisdom: Well, the Federal Reserve has no choice but to stimulate. We
heard Bernanke say just recently that he’s going to do whatever it takes, and
that if you read between the lines, there will be a QE3…..at the same time that
the world’s largest bond fund run by Pimco and Bill Gross out in Newport Beach,
California, sold 100% of its treasuries and government bonds…he realized that
he’d have to sell early because eventually, interest rates will be going
higher. It’s almost a certainty that rates will be higher 2 or 3 years from
now.
John Nyaradi: Do you see the United States ever getting out of debt?
Gabriel Wisdom: No, I don’t think so. I don’t think we’re ever going to get
out of debt. Debt is a very valuable tool for financing economic growth in a
modern society like we live in. First of all, the government has a trillion
dollars in untapped piggybank right now. And Congress seldom uses these
un-obligated funds for deficit reduction. Instead, they prefer to spend the
money because politically speaking…
John Nyaradi: That’s what they’re best at, right?
Gabriel Wisdom: That’s what they do. Now the Office of Management and Budget
is estimating that over $700 billion in un-obligated funds are going to remain
when fiscal 2011 ends. That’s on September 30.
John Nyaradi: Right.
Gabriel Wisdom: You can be sure that every politician on both sides of the
aisle is looking for ways to spend that $700 billion… it gets spent and it will
find its way into the system, and with interest rates this low for so long, I
think that the government can very, very easily carry this debt load.
John Nyaradi: What do you see as the
biggest dangers and the biggest opportunities for investors this year?
Gabriel Wisdom: The biggest danger I think is that we would have a war.
There are war cycles that date back, you know, 2000 years. One thing we know
for sure, there’s been more saber rattling in the last 10 years that we’ve seen
in some time. There’s a good deal of evidence to show that when commodity
prices like food and energy are declining, people around the world are less
likely to have conflict. By comparison, when commodity prices are rising and
basic materials, food becomes scarcer, that’s when war breaks out. And we’re
seeing it…..On the plus side, you’ve got the Federal Reserve and other Central
Banks around the world increasing their money supplies. Money has to go
somewhere and so that creates a rising tide, and companies are recovering, and
earnings are going up. So I think markets will go quite a bit higher before
this is over.
John Nyaradi: You’re the author of Wisdom on Value Investing: How to
Profit on Fallen Angels, which was published by John Wiley and Sons.
So let’s start at the beginning with what’s fallen angel and what do you look
for to find a fallen angel?
Gabriel Wisdom: Well, a fallen angel is-that’s an old Wall Street term to
describe a security that’s fallen. We’ve redefined the definition just a little
bit, and it describes, in our view, a security that’s fallen but should be
rising. It’s fallen, but it’s an angel…just that market doesn’t recognize it
yet. So the two critical elements of a fallen angel are: one, the price has
declined to a level below the securities underlying intrinsic value, and number
two, close scrutiny reveals the entity’s fundamentals are likely to propel it
to future revenue in earnings growth. That’s the most important component. Now
when both of these criteria exist, we have a fallen angel.
John Nyaradi: In your book in Chapter 10, you talk about how to pick stocks,
about the fallen angels formula. How does one get started at this?
Gabriel Wisdom: Well, I think the first place to start honestly is to have
that big picture that we talked about.
John Nyaradi: Okay.
Gabriel Wisdom: You know, everyone looks back a few years and says, “You
know, I knew that real estate was in a bubble. I knew real estate was
unsustainably high,” you know, and we all did it just before the tech wreck in
2000. Everybody knew those Dot.com and technology companies were, you know,
inflated.
John Nyaradi: Sure.
Gabriel Wsdom: And there’re a lot of other things that we know now too that
we can see from a big picture perspective. I mentioned the population boom and
agricultural commodity prices…
John Nyaradi: Right.
Gabriel Wisdom: And once you figure out what your big picture is then you
buy super sectors. You figure out where the super sectors are. And then you
drill down to find the stocks that are the fallen angels and rising stars in
those super sectors. If you want to make a lot of money, I can’t think of a
better way.
John Nyaradi: In Chapter 15, you mentioned 10 fallen angels for the next 5
years, and of course, I recognized General Dynamics and Google, Johnson and
Johnson. Are they still on your list and what fallen angels are you taking a
look at today?
Gabriel Wisdom: Yeah, those 10 are up well over 50% cumulatively since the
book was published. Do we still like these 10? Well, there’re a few that are
still very, very cheap. There are others that have become certainly fairly
valued like Google. General Dynamics, fairly valued, but not cheap. World Fuel
Services. I mean you’re paying for quality there. Sketchers, probably
overpriced here now.
John Nyaradi: Yeah.
Gabriel Wisdom: But there’s a little company called Move, M-O-V-E. Most of
us know it as RealEstate.com or Realtor.com. If you ever go to list your home
or look for houses that are for sale… you’re probably going to wind up at
Realtor.com. They have nice revenue. They’re trying to grow again and that
stock was down some 90% from its old highs. It’s moved up since we’ve listed it
in the 10 fallen angels for the next 5 years. It’s up about 50% but it still looks very cheap.
John Nyaradi: You have a couple of catchy slogans, one being buy cats and
avoid dogs. That’s not something that I’ve heard of before.
Gabriel Wisdom: Yeah, that’s an original. Cats, that’s a simple way to say
cheap and timely securities.
John Nyaradi: Yes.
Gabriel Wisdom: We’ve all heard about the dogs of the Dow. You know, buy the
worst-performing stock in the Dow at the end of each year, and then the next
year, it would be the best performer. Sometimes, that works really well.
John Nyaradi: Yes.
Gabriel Wisdom: I know the boards of big companies, especially members of
the Dow Jones average, when they’re in the last place, the worst performing of
the 30, they were under terrific pressure to get out of the basement just like
any professional baseball team would be. You know, if the managers want to stay
on, they’ve got to get out of the last place. So they do everything they can to
raise, to enhance shareholder value in this case. Some of the dogs can work, but cats are even better and safer.
John Nyaradi: Yeah.
Gabriel Wisdom: I used a quote at the beginning of that chapter, and I can’t
find anyone to attribute it to, but I love it. Thousands of years ago, cats
were worshipped as Gods. Cats have never forgotten this. Anybody who’s ever had
a cat knows that cats consider themselves, you know, fairly independent.
John Nyaradi: That’s right.
Gabriel Wisdom: And cats are cheap, but they’re timely. They’re under
accumulation. They’re going up. Everything’s working. Everything is right. And
they’re becoming more and more popular. So buy the cats, avoid the dogs. I
think that’s the safest way to go.
John Nyaradi: I always like to end these by asking an open ended question,
and that is, “What’s on your mind right now? What’s the big issue you’re
thinking about and that people need to know about?
Gabriel Wisdom: I would say that the number one thing that’s on my mind is
fighting the last war. Don’t fight the last war. It happens all the time. We
just went through this very severe bear market and recession. It was almost a
depression.
John Nyaradi: Yes.
Gabriel Wisdom: And in some parts of the world, in the country, it was. So
memories are still very, very fresh. And we know for a fact that pension plans
that were normally 65% invested in stocks or equities are now down to 50%
because of, you know, the retirees that they invest for don’t want to be in
stocks. We know that individual households, which used to be 25% to 30% in
equities, are down to 20% or less.
John Nyaradi: Right.
Gabriel Wisdom: One valuable lesson is not remaining on the sidelines too
long and fighting the last war. There is a great old story about a frog that
was made famous by Mark Twain. Mark Twain’s frog, who would never sit on a
stove again after being burned on his behind, and as a result, the poor frog
froze to death when Mark Twain didn’t turn the heat on in the house.
John Nyaradi: Yes.
Gabriel Wisdom: See? If you just keep thinking about what happened in the
past and not focusing on the opportunities just ahead of you, I think you can
be just as hurt, maybe even more so than you would be by, you know, by being
too bold.
John Nyaradi: Well everyone, we’re talking with Gabriel Wisdom, author of Wisdom
on Value Investing: How to Profit on Fallen Angels. As
I mentioned, Gabe is also chairman of American Money Management, a registered
investment adviser, and manager of two mutual funds, and he definitely has a
great deal to offer investors like you and me.
To learn more about Gabe’s book, just click on the link at the end of this
interview and that will take you straight to Gabe’s page at Amazon.com. Gabe,
it’s been great chatting with you today. Thanks for joining us, and I know
we’re all really looking forward to talking with you again.
Gabriel Wisdom: Same here, John. Thank you. It’s an honor.
Learn more about Wisdom on Value Investing: How to Profit on Fallen Angels
(recorded interview, edited for length and clarity)
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