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61

Which brings us to , a large and well-managed regional banlc holding company. Keys stoclc plummeted from $20 in mid-1989 to $12 in the fourth quarter of 1990. The bank announced large real estate write-offs, but even so eamings in 1990 did not fall from the $2.32 a share eamed in 1989. Keys capital was still 6.7% of assets, well above the minimum required. So strong was its financial position that Key did not cut, but instead increased its dividend in 1990 by 10%. This provided a high 7% yield, with the stock near its lowest price in years. It also traded at only 80% of book value.

Needless to say, it recovered rapidly, more than doubling in price in 12 months and reaching $70 by late 1997. It was also a high dividend fans dream. Yield increased almost 73% in the next six years.

This was not an isolated instance; literally dozens of large- and medium-sized banks could be picked off by the shrewd buyer in the same manner, which Ill more fully detail in chapter 12.

Figure 8-10

KeyCorp

,,n,<

12/89 12/90 12/91 12/92 12/93 12/94 12/95 12/96

1990

1991

1992

1993

1994

1995

1996

Price

16.13

24.75

32.13

29.75

25.00

36.25

50.50

Dividend Yield (%)

11.5

11.0

15.0

37.3

12.5

11.5

Source: Prepared from FactSet data.



An Overview ofthe Eclectic Approach

The eclectic contrarian approaches I present have worked well both for my chents and myself. While I would be the last to argue that the record is definitive, the strategy has succeeded through both bull and bear quarters." Although the degree of success will certainly vary among individuals-and for the same individual-over differing time periods, the eclectic approach seems to be an extremely workable investment strategy, ehminating most complex judgments.

Indicators 1, 2, 4, and 5 are reasonably straightforward calculations, avoiding the major portion of the configural and information-processing problems previously discussed. Indicator 3, which projects only the general direction of eamings, is much simpler and safer to use and consequently should have a better chance of success, than the precise estimates ordinarily made by security analysts.

Obviously, this is the method I favor.

As an investor, however, you may choose to follow this strategy as I have laid it down, or look at the other variations in the next chapter that should also allow you to outperform the market. But before doing this, lets revisit our casino of chapter 1.

Owning the Casino

At this point I think I hear a few murmurs out there-and rightly so. There are zillions of "how to" investment books, touting this method or

A Beneficial Side Effect

All five of the successful examples-Galen, Eli Lilly, Ford, Fleet Financial, and KeyCorp-demonstrate a beneficial side effect of these strategies. Often contrarian stocks can move substantially higher in price and still be good holdings. The reason: Eamings are moving up rapidly enough so that the P/E, price-to-book value, or price-to-cashflow ratios remain low. This produces a substantially lower tumover rate than most investment strategies. A lower tumover rate means that, if you are in a taxable account, you will have lower capital gains taxes. This is particularly important for capital gains under 18 months that are taxed as ordinary income. You will also have lower commission and transaction costs, as was noted earlier.



that. Are there any real odds that contrarian strategies will beat the maricet over time? Indeed there are.

Calculating the retums of our 27-year study of the 1,500 largest stoclcs on the Compustat database, we find the odds of contrarian strategies outperforming the market are about 60-40 in any single quarter The casinos in Las Vegas and Atlantic City make a bundle with odds 5-10% in their favor. The probabihties of beating the averages using contrarian strategies, then, are even higher. In chapter I, these probabilities were described in general terms; now well look at them in detail. The results, I think, will su rise you.

First, unlike Vegas, if you only do as well as the market, you walk away with your pockets bulging. You dont just get your cash back, you get it compounded. Ten thousand dollars invested in the market, as Figure 1- showed, became $289,000 twenty-seven years later before dividends and capital gain taxes. In the market casino, just breaking even would give you over 28 times your money in 27 years.

However, Figure 1-A also demonstrated how well we would have done in contrarian strategies over time. Using low price-to-cash flow, you would have doubled the performance of the market, increasing your $10,000 of initial capital 57-foId. With price-to-book value, you would have outperformed price-to-cash flow some, increasing capital a modest 68 times. Investing in stocks produces enormous retums, even if you do only as well as the market. If you adopt a contrarian strategy, the results are spectacular.

You may have some questions at this point. First, is 25 years a realistic time frame? How many people invest for anything near this time? If you are in your twenties or thirties, 25 years is not unreasonable, particularly if you are building your nest egg in an IRA or other retirement plan.

But as Table 8-2 demonstrates, you get some mouth-watering gains for shorter periods. The table indicates the amount that $10,000 would become in periods of 5 to 25 years relative to the market using the four contrarian strategies we have examined." As you can see, all four contrarian strategies whip the market in every period. And the percentage they do it by goes up dramatically with time. Low P/E had the best retums. In five years using the price-to-eamings strategy you outdistance the market by 19%. This rises to 67% in 15 years and 101 % in 20. Look at the difference compounding makes. At the end of five years, for example, again using the price-to-eamings measure, the retum is $3,727 over the markets, by ten years its increased to $15,241, and by the end of 25 to $340,437. Remember this is an initial one-time investment of only $10,000.



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