Whitney Tilson: Selected Published Columns

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Valuation STILL Matters

Are companies such as Siebel Systems the best bet for the Rule Maker Portfolio? Whitney Tilson is wary of tech stocks that are priced to perfection, and fears that focusing on everyone’s favorite stocks — at the expense of valuation — is a sure path to underperformance. He likes the idea of identifying dominant businesses with strong franchises, but prefers to wait until the price is just right.

By Whitney Tilson
Published on the Motley Fool web site, 2/20/01


Almost exactly a year ago, I wrote a column called Valuation Matters. In it, I said:

“I believe in The Motley Fool’s core investment philosophy of buying the stocks of quality companies (or index funds), holding for the long run, and ignoring the hype of Wall Street and the media. But if I were to level one general critique of the Fool, it would be that there is not enough emphasis on valuation… The experience of the past few years notwithstanding, [the] ‘pay any price for a great business’ attitude is a sure route to underperformance.”

Since I wrote those words on February 7, 2000, here’s what has happened:

Portfolio/Index     % change

S&P 500                 -9%

Nasdaq                 -44%

Rule Maker             -48%

Rule Breaker           -45%

Berkshire Hathaway     +36%

My goal in showing these figures is not to gloat, but to make a point that I’ve made over and over again: valuation really does matter.

Regular readers might think, “You’re beating a dead horse, Whitney. After the events of the past year, everyone already understands and agrees with you.” I’m not so sure.

As evidence, consider that in a survey TheStreet.com conducted recently to determine which stocks its readers wanted more articles about, 47 of the top 50 were tech stocks. The Fool’s own Rule Maker portfolio has dedicated three recent columns to a potential purchase of Siebel Systems (Nasdaq: SEBL) — an exceptional company, but also one whose stock is trading at either 126 or 264 times trailing earnings per share (depending on whether you use the company’s adjusted figures or actual GAAP numbers) and 85x analysts’ (very optimistic, in my opinion) estimates for 2001.

Siebel is almost certainly overvalued

My answer to the question posed by the title of the Rule Maker’s most recent column on Siebel, “Is Siebel Overvalued?,” is “Almost certainly, yes.” In my mind, Siebel falls into the same category of stocks I raised questions about in a column last October. That column named some of the most poplar tech stocks at that time — Cisco (Nasdaq: CSCO), Oracle (Nasdaq: ORCL), EMC (NYSE: EMC), Sun Microsystems (Nasdaq: SUNW), Nortel Networks (NYSE: NT), and Corning (NYSE: GLW) — and claimed:

“It is a virtual mathematical certainty that these six companies, as a group, cannot possibly grow into the enormous expectations built into their combined $1.2 trillion dollar valuation… Even if the companies perform exceptionally well, their stocks — in my humble opinion — are likely at best to compound at a low rate of return, and there’s a very real possibility of significant, permanent loss of capital. Investing is at its core a probabilistic exercise, and the probabilities here are very poor.”

I received more hate emails from that column than any other — which should have been a clue that I was on to something. Less than five months later, here’s how these stocks have performed:

Stock     % change

Cisco         -50%

Oracle       -29%

EMC           -39%

Sun           -57%

Nortel       -68%

Corning       -64%

Average       -51%

Nasdaq      -28%


These numbers certainly highlight the dangers of investing in the most popular stocks that are priced for perfection — like Siebel.

Does valuation still matter?

One might argue that with so many stocks so far off their highs, perhaps one needn’t focus as much on valuation today. I think the opposite is true. A year ago, you could argue that even if you bought an overvalued stock, it didn’t matter since someone would come along and buy it from you at a higher price. As silly as that argument might sound, a rapidly rising stock market over the previous few years had lulled many into believing it. But today, with the market psychology broken, I don’t think a reasonable argument can be made that the “greater fool theory” of investing is likely to be very rewarding going forward.

My kind of Rule Maker: IMS Health

So am I rejecting Rule Maker investing? Not at all. I wholeheartedly agree with the strategy of buying and holding for many years the stocks of exceptionally high-quality companies. But I won’t pay any price. In fact, I will only buy a stock when I think it is so undervalued that I’m trembling with greed. Let me give you an example: a stock I bought last summer and still own, IMS Health (NYSE: RX).

IMS Health is the world’s leading provider of information solutions to the pharmaceutical and healthcare industries. Its core business — in which it has built approximately 90% market share over the past half-century — is providing prescription data to pharmaceutical companies, which use the data to compensate salespeople, develop and track marketing programs, and more. More than 165 billion records per month flow into IMS databases worldwide.

The company has offices in 74 countries, tracks data in 101 countries, and generates 58% of sales overseas. IMS Health has a near-monopoly and there are very high barriers to entry. As a person I interviewed at one of the largest pharmaceutical companies (who is in charge of its relationship with IMS) said, “There will be no more entrants into this market.”

Due to its powerful competitive position, IMS mints money: It has a healthy balance sheet, very high returns on capital, huge 19% net margins, and solid growth. Revenues in the first three quarters of 2000 (IMS reports Q4 00 earnings after the close today) increased 14%, or 16% in constant currency, and net income rose 16%. With large share buybacks — in the latest quarter, shares outstanding fell 7% year-over-year — EPS grew 25% in the first three quarters of 2000 and is projected to grow 19% in 2001. (All figures are pro forma, as IMS has spun off a number of entities.)

At Friday’s close of $25.45, I don’t think the stock of IMS Health is cheap enough to buy at this time, but it sure was last July when I bought it for $16, equal to approximately 16x estimated 2001 EPS. It was cheap because management was widely disliked by Wall Street, due in large part to an ill-conceived merger that was subsequently called off.

While I wasn’t thrilled with the management team either, I figured this was already reflected in the stock price, and I could not find a single element of weakness in IMS’ financials. I couldn’t see much downside to owning the stock and, over time, if the business continued to grow strongly, I suspected that management and Wall Street would smooth out their differences. This is exactly what happened. Even better, new management is now in place.

This was my kind of Rule Maker: a company with a bulletproof franchise that meets most of the key Rule Maker criteria, but which is priced very attractively due to the market overreacting to a short-term issue.

— Whitney Tilson

Guest columnist Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. He owned shares of IMS Health at the time of publication. Whitney appreciates your feedback at [email protected]. To read his previous columns for The Motley Fool and other writings, visit www.tilsonfunds.com.

Bargain Shopping in Uncertain Times

We are currently faced with more economic uncertainty than we have seen for some time, and it’s being reflected in the stock market. But now is not the time to sell stocks and hoard cash, says Whitney Tilson. Investors would do better to look for good companies trading at attractive valuations. In this column, Tilson shares some of the stocks he is looking at, and the rationale behind his investigations.

By Whitney Tilson
Published on the Motley Fool web site, 10/2/01


Terrorists have attacked our country, killing thousands. We are preparing for war with an amorphous enemy. The economy is slowing, more than 100,000 people have suddenly been laid off, and we may already be in a recession. Stocks are tumbling: The Standard & Poor’s 500 Index has declined in five of the past six quarters, the Dow Jones Industrial Average recently had its worst week since 1933 and just concluded its worst quarter in 14 years, and the Nasdaq Composite Index had its second-worst quarter ever.

Time to sell stocks and sit on cash until the situation stabilizes, right? WRONG! The best time to buy stocks is when uncertainty is at its greatest, because that is when prices are often at their lowest. As Warren Buffett wrote in his 1986 annual letter to Berkshire Hathaway (NYSE: BRK.A) shareholders:

“We have no idea — and never have had — whether the market is going to go up, down, or sideways in the near- or intermediate term future. What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable. And the market aberrations produced by them will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

So is it time to wade into the market, buying stocks left and right? Absolutely not! Many stocks are still richly valued: The S&P 500 is trading at 28x earnings and the Dow at 23x, both nearly double their historical averages. But with so many stocks down significantly in the past year, some bargains may be beginning to appear. It’s about time! For quite a while, excessive valuations across the board have forced me to invest primarily in special situations and in the stocks of very small companies. I much prefer to invest in good businesses at good or great prices, and then hold for a long time.

Without further ado, here’s a quick overview of some companies I am now investigating seriously:

Berkshire Hathaway

Berkshire is already my largest position, which is why I didn’t buy more when it dipped under $60,000 less than two weeks ago. (Berkshire’s “B” shares, which have the ticker “BRK.B”, trade for approximately 1/30 the value of the “A” shares.) It’s a decision I’m already regretting. The stock has gone straight up since then, with more and more investors apparently agreeing with my assessment that the events of Sept. 11 were a net positive for the company.

Though it may sound awful to say that, Berkshire — primarily an insurance conglomerate — can easily afford the estimated $2.2 billion cost of claims, and will benefit hugely from the following factors:

  • More companies will be buying more insurance and will pay a lot more for it.
  • Not only will the size of the market increase substantially, but Berkshire Hathaway’s share of it will undoubtedly rise as well due to a flight to quality in the reinsurance business. No one has a stronger balance sheet than Berkshire.
  • Insurance companies make money in two ways: underwriting profitably and/or earning investment returns on the float they generate. (Float is money collected in premiums but not yet paid out in claims.) Booming equity markets over the past decade or more yielded healthy investment gains, which led many insurers to sacrifice underwriting profits. This led to inadequate pricing, which hurt Berkshire’s business, but the decline in worldwide equity values over the past year has renewed the insurance industry’s focus on underwriting results.
  • The decline in equity prices should, over time, help alleviate Berkshire’s single biggest problem: how to invest the company’s immense cash hoard at attractive rates of return.
  • Meanwhile, I expect Berkshire’s Executive Jet subsidiary — the leader in the fractional aircraft ownership industry — to benefit tremendously from the turmoil in the airline industry.

Airline, aircraft, and travel companies

Most stocks in the airline/aircraft/travel industry have been crushed since Sept. 11, but I believe the industry will rebound as it always has — maybe not 100%, but close to it. If you share this belief, I suggest looking at high-quality, market-leading companies with strong balance sheets that can withstand a severe, prolonged downturn. (A rebound won’t help companies that have gone out of business.) Here are four ideas:

In the aftermath of the Sept. 11 tragedy, airlines have pushed back delivery of new aircraft, which will likely hurt Boeing’s (NYSE:BA) earnings. (The company has not yet conceded this.) But Boeing’s military aircraft and missile business, which accounted for 20% of revenues and 25% of operating earnings in the first half of this year, should rise substantially.

Over the past two-and-one-half years, the company generated huge free cash flows — far exceeding net income — and bought back $6.8 billion of stock, reducing shares outstanding by 13.5%. The stock appears quite cheap today: it’s trading at nine times trailing earnings and 13 times estimates for next year’s (presumably depressed) earnings. (For more on Boeing, see Paul Larson’s column from last week.)

Rockwell Collins

Rockwell Collins (NYSE: COL), a recent spin-off from Rockwell International (NYSE: ROK), describes itself as “a world leader in providing aviation electronics and airborne and mobile communications products and systems for commercial and military applications.” The company has a strong competitive position, high margins and returns on capital, and now trades for less than 11 times trailing earnings. Like Boeing, its commercial aircraft business will be hurt in the short term, but 38% of sales are to the military, which should offset the decline to some extent.


Sabre Holdings (NYSE: TSG) has a proprietary computer network used by thousands of travel agents and others in the travel industry. It’s the market leader, has high margins and returns on capital, and generates abundant free cash flow. If you think earnings will eventually rebound to anything close to pre-attack levels, the stock is very cheap — especially considering that Sabre’s 70% ownership of Travelocity (Nasdaq: TVLY) is currently worth about $3.50 per Sabre share.


Headquartered in Brazil, Embraer (NYSE: ERJ) is one of two major manufacturers worldwide of regional jets. (The other is Bombardier, a Canadian company that trades over-the-counter.) The company has been growing like gangbusters and — where have you heard this before? — has high margins and returns on capital. The stock is now selling at about six times reduced earnings expectations for 2002. Investing in international companies, it should be noted, can add substantial additional risk to the equation, and may not be for everyone.


Miscellaneous other ideas
The entire retail sector has gotten whacked on fears of damaged consumer confidence, presenting many interesting opportunities. At the top of my list are Intimate Brands (NYSE: IBI), which is mainly Victoria’s Secret and Bath & Body Works, and Limited (NYSE: LTD), which owns 84% of Intimate Brands. At present valuations, you can buy the latter for its stake in the former and just about get the rest of Limited’s businesses free — though it’s unclear whether this represents a bargain.


Aetna (NYSE: AET) infuriated doctors and, after enduring a 70% decline in the stock over the past two years, investors hate the company too. The stock therefore looks very cheap, and with health insurance premiums due to rise more than 20% next year, earnings could pop, rewarding investors who are willing to hold their noses.

Arbitron (NYSE: ARB), which has a virtual monopoly on measuring radio audiences, has some of the most mouth-watering economic characteristics of any company I’ve ever encountered. The company reached agreement on a multi-year contract with its largest customer, Clear Channel Communications (NYSE: CCU), in August. This removed the biggest risk factor surrounding the stock, yet it is down slightly since then. I’m intrigued by the real option value (.pdf file) embedded in a new device Arbitron is testing, the Personal People Meter. While the shares are intriguing at current prices, I won’t be trembling with greed until they fall perhaps another 20%.


As always, do your own homework and don’t hesitate to email me with any insights you might have about any of these companies.

— Whitney Tilson

Guest columnist Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. He owned shares of Berkshire Hathaway at press time. Mr. Tilson appreciates your feedback at [email protected]. To read his previous columns for The Motley Fool and other writings, visit

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