Kool & The Gang is Hard CORE!!

In today’s overleveraged economy, with equity markets best characterized as overvalued and overbought, measures of investor sentiment have quickly rebounded to overbullish extremes.  This is not a market environment that has historically been kind to equity investors.

Whereas metrics such as mean reversion, beta and price momentum rewarded speculative investors during last year’s low quality rally, we believe a peak in leading indicators early will soon be accompanied by an important inflection point in the markets: “The Rebirth of Quality.” We expect a handsome level of outperformance from Price (valuation) and Quality (fundamentals) as policy makers debate their “exit strategy” from the greatest monetary experiment in financial history. Considering the likelihood of policy mistakes along the way and the severe consequences of any missteps, investors would be well served to mind their Ps and Qs.

In the presentation below, we review our thesis in one of our CORE equity holdings, which coincidentally, fits quite nicely into today’s macroeconomic landscape:

  • High quality, defensive business . . . check
  • Substantial discount to intrinsic value . . . check
  • Fragmented industry ripe for consolidation . . . check
  • Strong operating culture and health balance sheet . . . check
  • Underappreciated catalyst likely to drive substantial profit growth . . . FRESH!!

Seth Klarman, respected founder and president of The Baupost Group, reminds us, “The best investors do not target return; they focus first on risk, and only then decide whether the projected return justifies taking each particular risk.” We like the idea of owning quality in the “new normal” given the risks associated with extended periods of deleveraging. In the long run, high quality stocks have proven to be the one “free lunch” offered by Mr. Market.

Hard Core (Jan-10)

Disclosure: At the time of publication, the author was long Core-Mark Holding Company, although positions may change at any time.