The 'Cocktail-Party Indicator' Can Save (or Make) You a Fortune
Editor's note: It's one of the most reliable investing tools out there...
When everyone at the cocktail party is raving about an investment idea, run – don't walk – in the other direction. The opposite is true, too... Some of the best opportunities come from things you'd be embarrassed to tell people about.
In today's Masters Series – adapted from a pair of essays that appeared in our free DailyWealth e-letter earlier this month – our friend and Empire Financial Research founder Whitney Tilson details two examples from his Wall Street career when he just did that...
The 'Cocktail-Party Indicator' Can Save (or Make) You a Fortune
I've learned a lot of things throughout my 20-year career on Wall Street.
But perhaps nothing is as valuable as talking about investing with average folks.
I call it the "cocktail-party indicator."
It doesn't matter if it's your trainer at the gym, a neighbor who has never shown any interest in the markets, or the proverbial shoeshine guy. When you hear these folks talking about how much money they've made in bitcoin, 3D printing companies, or the latest hot IPO... run, don't walk, the other way.
I've found, again and again, that when the least knowledgeable investors among all of the people I know are piling into whatever is hot, it's usually very near the top of a bubble.
Today, I'll explain how you can use the sentiment of average investors to your benefit – instead of riding the bandwagon to disaster. While the rest of the crowd is busy looking for the next way to get rich quick, I strongly suggest taking a different route...
Look for investments that are so hated, you would be embarrassed to say you own them at a cocktail party.
The best example that comes to mind is the only time in my life I bought an oil stock...
You guessed it – BP (BP) in 2010, just after the Deepwater Horizon oil spill. Shares had gotten absolutely clobbered, falling from around $60 in April to a low of $27 in June.
Indeed, it was an environmental calamity, and a number of people lost their lives in the tragedy. CNBC's Jim Cramer went so far as to call the stock "unownable." That week, the New York Times wrote...
It seems unthinkable, even now, that the disastrous oil spill in the Gulf of Mexico could bring down the mighty BP. But investment bankers get paid to think the unthinkable – and that is just what they are doing.
The idea that BP might one day file for bankruptcy, particularly as part of a merger that would enable it to cordon off its liabilities from the spill, is starting to percolate on Wall Street.
The fear in the market – bordering on hysteria – was music to my ears. I'd analyzed the fundamentals and was convinced that BP wouldn't have to file for bankruptcy... and that the stock was an incredible opportunity. So on June 9, 2010, I appeared on CNBC's Fast Money.
Whitney Tilson on CNBC's Fast Money
BP deserved the anger and blame. But when it came to the company's future, the crowd was just flat-out wrong. Here's what I told viewers that day...
What everybody's missing here is this is truly one of the most profitable businesses on the planet. They have managed to screw everything up. There's really no excuse as best I can tell in terms of allowing this disaster to happen. The PR has been horrific ever since. And BP is going to pay billions and billions, maybe even tens of billions, of dollars for this debacle.
But what everybody is missing is this company consistently earns well north of $20 billion a year in profits, and keep in mind all the damages are paid for with pre-tax money, so now we're talking close to $30 billion a year. And it's trading at five and a half times earnings, paying a 9% dividend yield...
We fully expect the headlines to be horrible for a good, long time. But the stock is just too cheap.
That day, BP shares closed around $29. By early August, the stock was trading around $41 per share. Folks who took my advice were up 40% in just two months.
When I looked at BP, I saw a company anyone would be embarrassed to own... And yet, it was a huge, profitable business – the kind that can weather a storm. Not only that, but it was trading at a dirt-cheap price compared to what it was worth.
Those are odds I like in an investment. As my years on Wall Street have taught me, it's a setup you should always be searching for in the markets. And it wasn't the only one...
Years ago, I became bullish on another idea that the rest of the market had left for dead. The companies in this sector weren't the kind you'd bring up at a cocktail party, either. They weren't the market darlings you hear about every day on CNBC or read about on the cover of Fortune.
But you can make a lot of money if a stock or industry goes from being terrible to mediocre... mediocre to OK... OK to good... or good to great. (As longtime readers know, my friend Steve Sjuggerud calls this concept "bad-to-less-bad trading.")
You may have to look closely for these opportunities, but the effort is well worth your time. Once the market realizes its mistake, the gains can pile up fast.
In this instance, my potential bad-to-less-bad candidates were airline stocks – which legendary investor Warren Buffett had criticized for decades. As he noted in his annual Berkshire Hathaway (BRK) letter to shareholders back in 2007...
The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.
Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers.
Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.
But then, the industry slowly got better...
What changed? Simple: The industry consolidated.
Over the past decade alone, we've seen mergers between Northwest and Delta, Continental and United, Air Tran and Southwest, and U.S. Airways and American Airlines. These four companies collectively control about 80% of the U.S. airline market, making it an oligopoly.
And they're behaving like an oligopoly, minimizing the incessant price wars that once plagued the industry. Plus, the airlines crammed more seats on their planes and started charging to check bags. The combination of higher prices and lots of ancillary fees generated billions in new profits.
This allowed the airlines – which historically had terrible, debt-laden balance sheets – to slowly pay down their debts and improve their financial footing. The fundamentals got a big boost while nobody was paying attention.
My first opportunity to profit from this was JetBlue Airways (JBLU). I had gotten to know the company when I wrote a series of five articles about it starting in June 2003. I hadn't bought the stock, but I followed it closely over the next decade.
I finally got my chance and bought shares in 2014, when the company made big improvements. JetBlue followed its peers by charging bag fees, squeezing more seats on the planes, and launching a first-class cabin on transcontinental flights. Not only that, but a new CEO was taking over, and my contact at JetBlue told me he was the real deal.
I could see that profits were set to soar – and they did. The company's operating profits tripled in 18 months – and so did its stock...
Then, in November 2015, I told Bloomberg TV's Stephanie Ruhle that discount airline Spirit Airlines (SAVE) was my favorite long idea. The stock nearly doubled over the next year.
Buffett himself eventually came around to the idea of going long airlines. In 2016, he scooped up shares of American Airlines (AAL), United Continental (UAL), and Delta Air Lines (DAL). In early 2017, he appeared on CNBC and joked...
The airlines had a bad 20th century. They're like the Chicago Cubs. And they got that bad century out of the way, I hope.
Things didn't go from good to great with airlines. They didn't have to. They merely went from terrible to mediocre. And folks who took my advice made a lot of money because of it – and fast.
The next time a hated stock or industry catches your eye, tune out all the negative headlines and analyst "sell" recommendations, keep an open mind, and take a fresh look. Maybe the fundamentals are quietly getting stronger, or sector-wide pressures are letting up.
All it takes is a little improvement... Chances are, you'll walk away with big, quick gains.
Remember, when you find an investment so hated that you'd be embarrassed to talk about it at a cocktail party, you might just be on to something good.
Regards,
Whitney Tilson
Editor's note: Whitney has nailed so many accurate market calls that CNBC once called him "The Prophet." He predicted the dot-com crash... the housing crisis... the bottom of the market in December 2008... and many others. But during the Empire Investment Summit on Wednesday night, he shared what could be his biggest one yet. If you missed it, that's OK... For a limited time, you can watch a full replay of the free event right here.