(XLF) How You Can Profit From Maximum Pessimism

January 22nd, 2009

Stock Profits from Today’s “Maximum Pessimism”

by Louis Basenese, Advisory Panelist

Senior Analyst, The Oxford Club

Wednesday, January 21, 2009: Issue #919

Yesterday was a train wreck for State Street Corp. (NYSE: STT). The stock cratered 59%. But don’t read too much into it…

Sure, the company’s quarterly results sent most investors into shock. A 71% drop in earnings? Another $1 billion in new credit exposures? If no one’s lending, how in the world are they just now discovering this liability?

I’ll be the first to confess, I flubbed the extent of the downturn in the financial space. Last April, I recommended “backing up the truck” and playing the rebound via the Financial Select Sector SPDR ETF (AMEX: XLF). Instead of a short-term opportunity, it’s turned into a really long-term rebound play.

But as I told members at our Central American meeting in Nicaragua last week, I’m human. I make mistakes. Both in life and investing. Thankfully, I’m not as bad as Wall Street analysts…

Forget Your Broker, Wall Street Analysts are a Bigger Threat

Most people will tell you a bad broker, motivated to increase his net worth by leeching fees off your net worth, is your biggest enemy. Not so. A blind faith in Wall Street analysts poses a bigger threat.

Forget being wrong some of the time. They’re wrong most of the time. Or as a recent MarketWatch article tells it, “If there’s one group of Wall Street denizens that have performed as poorly as bankers in the credit crisis, it’s the equity analysts who cover Corporate America.”

For instance, well into the credit crunch, they predicted earnings growth of 11.5% for the fourth quarter of 2007. Low and behold, earnings actually plunged 25%, based on Thomson Reuters data. They were off a whopping 36.5%! No rational explanation could explain, let alone justify, such a big miss.

Here’s the most compelling observation, though. According to Ashwani Kaul, the numbers cruncher at Thomson Reuters, the “figures show that analysts tend[ed] to err on the side of the positive when predicting earnings growth.”

But that was then. After being so wrong, for so long, I’m convinced most analysts fear for their jobs… and the pendulum’s swung back the other way. They’re being way too pessimistic now.

Case in point. Analysts’ estimates for the S&P 1500 companies rest at their lowest levels for the last four years. In the last month alone, they’ve piled drive expectations into the ground, lowering EPS forecasts for 982 companies.

Companies themselves have even jumped on the pessimism bandwagon. In the third quarter, only 3% raised guidance. While the majority – you guessed it – lowered expectations.

Bottom line, the negative side of the market is getting overcrowded. And for once, I think analysts actually got ahead of the downward spiral.

That’s not so say we won’t have any more repeat performances, ala State Street. But we will certainly get pockets of outperformance. Companies beating expectations, with share prices eventually rebounding to reflect the good news.

Here’s how to play it…

Stock Profits From the Point of Maximum Pessimism

The late Sir John Templeton believed, “The time of maximum pessimism is the best time to buy.” (I agree.) And he did just that.

But he didn’t load up on the market indiscriminately. Instead, he cherry-picked companies trading at cheap valuations, with solid businesses and above average growth prospects.

He was talking about companies like Minnesota-based Fastenal (Nasdaq: FAST). It’s a supplier of nuts, bolts, parts and tools to manufacturers and commercial contractors.

I’ll concede that such a business is unglamorous and mind-numbingly boring. But the fact is, the company’s nearly 700,000 products are vital. They are used to operate and keep up large buildings, campuses and industrial plants, as well as bolt together furniture, appliances and trucks.

Recession or not, demand remains stable for Fastenal’s products. Otherwise, simply put, stuff stops working.

I originally alerted Oxford Club members to this stock in November. It reported earnings yesterday. And guess what? It beat expectations. The company posted a 10% increase in profits and enviable same-store sales growth of 8%.

Moving forward it will continue to grow thanks to four key competitive advantages – unparalleled convenience, market penetration, cost leadership and customization.

Strong insider ownership, double-digit growth opportunities and the most attractive valuation in over a decade (approximately 40% below its historic price-to-earnings ratio) only make the stock more compelling. I still rate it a “Buy.”

Whether you trust my analysis on Fastenal or not, just remember this: Analysts’ earnings estimates resemble a waterfall, cascading lower and lower with each passing week. They’re bound to overshoot the mark.

In many cases, like Fastenal’s, they already did. And that means plenty of bargain stocks exist to profit from the imminent pivot from pessimism to optimism.

Good investing,

Lou Basenese

Editor’s Note: Lou recently recommended another “maximum pessimism” play to Oxford Club members. It, too, just toasted expectations and surged 20% above his recommended price. Not a bad profit considering it’s only been 46 days since his original recommendation… and the S&P 500 slumped 8% over the same period. To find out all the details, sign up for The Oxford Club. Then check out the December mid-month issue.

Today’s Investment U Crib Sheet

Yesterday, the nation celebrated our new president and the hope for his administration. Today however, we get back to work. Obama’s invocation that we need to be responsible for ourselves may have been a revelation to some but not all. As many have argued that the Statue of Liberty is meaningless without a Statue of Responsibility – more importantly, fiscal responsibility.

Here at Investment U, we’re focused on giving you actionable advice you can use – right now. It’s not enough to hope for the future, you must put ideas into action. Here are a few ways you can do this today:

Convertible bonds represent an excellent way for investors who are worried about the markets movement, but who want to start “putting a toe in the water” so-to-speak. Alex Green showed us why we need to consider these “Income Securities with Positive Income Exposure.”

Lou Basenese looked at why China isn’t exactly the most popular choice for foreign investments last week. Here are the 11 reasons why you shouldn’t listen to the analysts’ “noise.” Even better, Lou gives us five ways we can “Invest In China.”

Gas prices have been on a roller coaster lately. It’s no wonder. Oil prices have been all over the place. But here are other opportunities in powering our transportation network. And our energy and infrastructure expert, David Fessler, has been keeping us tuned in to the recent developments… Here are six more ways he you can ready you portfolio for the Obama administration with “Energy and Infrastructure.”

View original at: Investment Advice and Investment Research with a Contrarian Point of View