Darwin's ideas work in stocks, too
“If I’d known I was going to live this long, I would have taken better care of myself.” – Eubie Blake, American composer (1887–1983)
You cannot underestimate the power of cycles.? They reoccur in nature, business, and financial markets with great regularity.? When we ignore them, cycles seem obvious in hindsight.? Foresight is where you’ll make your money.
Time frames may be different based on secular trends, weather phenomenon, innovations in health care, and government intervention, but generally, what goes around, comes around.? For example, economic booms and busts occurred, on average, every 14 years for 2,000 years.?Beginning in the late 20th?century, they began cycling every seven years as a direct result of government efforts to stimulate economic activity during recessionary downturns.? While they occur more frequently, they’re cycles nonetheless.
Tall Parents Have Shorter Children, On Average
Charles Darwin and his cousin, Francis Galton, were the first to note that tall parents have shorter children, on average, and vice versa.? With Karl Pearson, they studied over one thousand father and son pairs.? Galton termed this phenomenon in nature “regression to mediocrity.”? Since then, the method of studying how one variable leads to another variable has been called “regression analysis.”
Financial market observers see it all the time.? Excessively high prices eventually lead to excessively low prices.? The key to succeeding as an investor is knowing where the excesses are when they’re happening and exploiting them.
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“Joining The Dow Can Be The Kiss Of Death”
In September, Jeff Reeves of InvestorPlace.com conducted research showing that by the time companies have grown to become the recognized leaders in their industries, share prices are inflated.? For example, turning the clock back to March 1999 when the Dow Jones Averages closed above 10,000 for the first time, then crested to 11,000 a few months later, four of the biggest names of the day joined the Dow 30. Here’s how they fared: AT&T (then SBC Communications), down 38%; Intel, down 50%;?Microsoft, down 47%;?Home Depot, ?down 38%.
During subsequent reformulations of the Dow Jones Industrial Average, laggards were replaced with other leaders of the time.? They included Pfizer, Verizon, Bank of America, Cisco, and AIG.? As a group, these stocks have been shellacked since they joined the Dow 30, but along the way they have continued to make a lot of money for anyone who purchased shares when stock prices were excessively low.? Many have tripled off of lows in 2003 and 2009.
The point is this: You cannot fight the power and magnitude of cycles.? They can make or break an investor.? Here’s one stock that appears far too low right now:
Fallen Angels Focus Stock: Cisco Systems? (CSCO, 20.15)
Cisco is the dominant player in the global networking industry.? Shares plummeted more than 16% on ?Thursday following a less than stellar outlook presented by company management.? While management cited near term challenges, we believe the selling has provided an attractive entry point for longer-term investors.
The company has a solid balance sheet, operating profit margins of more than 20% and net margins in the high teens.? Our fair value estimate (based on discounted cash flow analysis) is $30 per share; providing investors with 50% potential upside from current levels.
Gabriel Wisdom and clients of American Money Management LLC, including mutual funds managed by AMM may buy or sell securities mentioned without prior notice.
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