Half-Priced Stocks Snookered by Hellman & Friedman?

By Travis Johnson, Stock Gumshoe, February 27, 2008

Just a quick note for those who didn’t notice: Two-time Gumshoe coveree Getty Images agreed to get bought out today. Yippee for the smart newsletter advisers who recommended this one, eh?

Not so fast — this is the new era of private equity, apparently, when even a 30% premium doesn’t necessarily mean they’re overpaying … or that the investors who’ve patiently stuck by a stock will be rewarded.

I don’t have a personal opinion about Getty Images, other than the fact that it was generally a bad newsletter recommendation (in hindsight, of course, which is my favorite kind of sight … I can even take off my giant coke-bottle glasses for this one).

Getty Images was recommended by Half-Priced Stocks and featured as the “Undervalued Stock of the Month” in both April and October of last year (and maybe again, I didn’t keep checking back). Great news now that they’re getting a buyout offer, right? The stock was really undervalued?

Well, the first recommendation was when the shares were trading at about $50 back in April. The second was when it was trading dramatically lower at about $27 in October.

So today’s buyout at $34 a share is certainly nice for current Getty shareholders who bought recently — especially since, with dropping margins and investor pessimism, it had eventually fallen to the low-$20s.

But it also serves as a reminder, buying undervalued companies because you are convinced that their value will eventually get recognized can be a trap. Sometimes they can certainly fall much farther, and if the private equity vultures, or cash-rich competitors, snap it up at a bargain, as they appear to have done here, you’re out of luck — you can’t just hold and wait for the turnaround anymore, you’ve got to sell at $34 even if you paid $50 a year ago and were willing to wait a couple years.

And actually, this relatively inexpensive newsletter has had a few stinkers in this “undervalued stock of the month” series (as have we all this past year, I imagine) — the four I’ve looked at, including Getty twice, Broadcom, and Time Warner, clock in with an average loss of about 24% so far.

You all know this market verbiage about “value traps” already, of course, and you’ve heard the adage about the falling knife. Buying companies on sale is extraordinarily tempting, but sometimes the sale gets better … much better. Buying Getty at $50 when half-priced stocks sent out that ad last April might have seemed like an enormous bargain and a great temptation — after all, the stock was down from $95 not that long before. Similarly, buying at $27 in October would have been a “bargain” because the stock was down from that recent $50.

Eventually in this case, even the big pockets decided the bargain was good enough and, thanks to the private equity “rescue,” buying at that $27 would have paid off, though many would probably have been stopped out of that position by the time it hit $22.

But in my opinion that’s one of the hardest judgements we can make in valuing a company, and it’s one we’ll all be asked to make probably hundreds of times in the coming year if the markets are going to continue presenting stocks that look like incredible bargains. Who on earth would have predicted Citigroup at $24 after it peaked near $60 just a year ago? And if $24 is shocking, might not we have been at least a little bit tempted by the bargain at $35 last fall just because it had fallen so far? (assuming, of course, that the Gumshoe chose an example other than the most loudly trumpeted business failure story of the year)?

The newsletter guys will undoubtedly take advantage of this, too, bringing up household names that you will be shocked to see trading at such a “discount” to their previous value, and trumpeting “half price” sales, so I’m sure the deep value newsletters will be advertising heavily in the months ahead.

Woohoo! More fuel for the Gumshoe! Hey, you never know, this next one might just be the fire sale that makes you a gajillionaire. I’ll keep my eyes open, and my glasses on.

So how do you decide when to buy? When is it cheap enough?

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2 Comments on "Half-Priced Stocks Snookered by Hellman & Friedman?"

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Jerry Kindall
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February 28, 2008 11:55 am

I bought GYI at $24.65 when it showed up on the Magic Formula screener less than a month ago, so I’m pretty happy! Actually, I almost passed it by because with the price of stock photos being pushed lower and lower by sites like Flickr, it didn’t seem to me like a good business to be in long-term. But I guess short-term, hoo-boy!

tonyw
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tonyw
February 28, 2008 12:54 pm

An article in today’s Financial Times shows how going with the momentum makes more money. so just follow the herd:-)

http://search.ft.com/ftArticle?queryText=momentum&y=5&aje=true&x=14&id=080218000064&ct=0

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