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Honing Our Edge In The Market Takes a Plan and Patience

Sticking to the long-term plan is the best investment advice yet


What’s your advantage?  In this era of instant information (and instant market overreactions), you and I as individual investors can enjoy a significant edge over big institutions — but only if we make up our minds to use it!  That’s a vital truth to keep in front of your eyes, especially after the recent stock market leap.

For example, Thursday’s rally was one of the flimsiest in a long line of increasingly dubious one-day bounces we’ve witnessed over the past few months.  The pretext: ECB President Mario Draghi said Europe’s central bank was “ready to do whatever it takes to preserve the euro” (currency).

Duh.  Haven’t we heard that story over and over, in various words and phrases, ever since the Greek crisis erupted two-and-a-half years ago?  Is Europe any closer to a real resolution of its problems?  Investors who swallowed this eyewash (eyewash isn’t meant to be swallowed!) as an excuse to buy stocks are setting themselves up for trouble.

But institutional money managers who see the market starting to move have to chase the truck.  These folks are judged on quarterly, or even monthly, results.  One rough quarter, Tom, Judy—and you may be out of a job.

Fortunately, as individual investors, we aren’t under such constraints.  We can take our time getting invested, and getting out of investments.  Unlike the Raj Rajaratnams of the world, we haven’t got any inside information.  (We aren’t in jail either.)  However, we can more than compensate for that “disadvantage” by outlasting the impatient and even reckless players who trade too soon and too often.

This is the secret of Warren Buffett’s success.  Not so much outsmarting the other guys as outlasting them.

With that principle in mind, we can turn to the latest news affecting the companies we own.  Some of it has been downright wonderful — the eye-popping 34% dividend hike and $2 billion stock buyback announced by Baxter International (NYSE:BAX) on Wednesday, for example.  Ditto for the 12% distribution increase by Magellan Midstream Partners (NYSE:MMP), a huge boost for a master limited partnership.  (MMP is a past selection of the Incredible Dividend Machine.)

We also got strong earnings reports from Covidien (NYSE:COV) and Unilever (NYSE:UL).  All four of the outfits I just mentioned have been rewarded, in the short term, with steep gains in their share price.

But that’s part of my point.  I wouldn’t buy any of these names right now, because all are overextended on the upside.  We can afford to wait for the inevitable pullback.

Meanwhile, our two disappointments this week are teaching us a different lesson about patience.  On Wednesday, Wellpoint (NYSE:WLP) lowered its 2012 earnings guidance by approximately 4%.  Panicky  Wall Street responded by haircutting the stock 13% in two sessions.

Does this reaction make sense?  I don’t think so.  Do the arithmetic.  WLP still expects to generate $2.7 billion of operating cash flow this year.  Subtracting about $450 for capital spending, we get free cash flow of $2.25 billion.  As of tonight’s close, the managed-care provider has a total market value of $17.66 billion.

In other words, your free-cash-flow yield on a Wellpoint share has skyrocketed to almost 13% a year.  In today’s market, 7% is considered very good.  In fact, I don’t know of another investment-grade company with a 13% FCF yield.

I own a lot of WLP, probably more than you, and I’m adding to my stake.  I intend to outlast the folks who are selling.  I can afford to wait, because I know that the odds of making money — big money — over the long run are extremely high if you can compound your wealth at 13% a year.

The story at Barrick Gold (NYSE:ABX) isn’t quite as upbeat.  Pascua-Lama, a high-altitude mine ABX is developing on the Chile-Argentina border, has been plagued (like many such projects) by environmentalist opposition.  Now the company says the mine will cost $3 billion more than expected and won’t go into production until 2014, a year later than expected.

I still think Barrick can recover from this blow.  However, the delay at Pascua-Lama clearly reduces the company’s intrinsic value.  Accordingly, I’m trimming my buy limit.

P.S.  Thursday’s after-hours plunge and Friday’s continued share price losses in Facebook (NASDAQ: FB) probably don’t represent a buying opportunity—yet.  We’ll keep watching, though.  If the tech sector as a whole drops back into oversold territory, FB may be worth a nibble.

It’s about 30% cheaper, on a price/sales basis, than Google (NASDAQ:GOOG) was at a similar stage after GOOG’s 2004 initial public offering.

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