Pennsylvania Investment Observer

The Promise of Problems

by Daniel J. Nestlerode

The world can be divided into two general sets: problems and conditions. Conditions are circumstances to which we must adjust. Death, taxes, rainy days and flat tires are conditions. Sooner or later we will all have one or more of these experiences and we have to learn to accept these circumstances. Problems are of a different set and presume a solution. People who find solutions to problems are generally paid a great deal of money and often make a contribution to society at large. Furthermore, accurately distinguishing between problems and conditions allows for insights that can lead to impressive returns.

Problems can be categorized into simple, complex, vexing and opaque. The simple problem is one you can generally solve or fix by yourself. Complex problems often require the assistance of another or the coordination of action with other people in order to arrive at a resolution. Vexing problems are those that recur, especially after you believed you had them solved. Finally, opaque problems are those that you do not recognize as a problem and therefore you either accept it as a condition or you just ignore it regardless of the circumstances. This is not a complete taxonomy of problems, but it is helpful in looking for exception investment opportunities.

One place to look for exceptional investment opportunities in the stock market is to examine those companies that have fallen from grace in the markets.

For whatever reason, a number of companies fall on hard times every year. Within this group are a few gems that are misunderstood by the investment markets. The crux of a great investment opportunity is the general misunderstanding by the market of the problems and conditions with which a company is dealing. Furthermore, a large part of the investment community never attempts to deal with these investment opportunities, as they don’t want to be bothered with idiosyncratic investment research. In the past few years, a few stunning examples come to mind. Qualcomm designed and developed a software technology called CDMA or code division multiplexing for wireless telephone systems. For a number of years the established telephone companies and wireless cellular phone providers believed that CDMA was an interesting technology, but was essentially not workable in the real work. Qualcomm had only computer simulations to prove that their system worked. Qualcomm was trading around $50 in 1998, with most of the market believing that CDMA was not workable. Eighteen months later, the system was proven in the field and Qualcomm was trading at $200 a share, after a four for one stock split. Investors who challenged the standard beliefs of wireless industry were rewarded with a return of 16 times their original investment. Even after the fall of the tech stocks, these investors are holding at ten times their original investment made just six years ago.

The recent fall of the stock market has created a passel of companies that are priced into bankruptcy. In other words, the market is saying that these companies will not survive the current economy. Some of these opportunities have already moved up in price while others are still trading at bargain basement prices. Two of the central Pennsylvania winners are Corning Glass and C-Cor.net. Both companies traded down in the two to three dollar ranges and now trade over ten dollars per share. Note that not every stock that trades under five dollars is a great opportunity. Some companies really do go bankrupt. Furthermore, careful company analysis and research sometimes misses important issues and turns out to be less than profitable. Yet, for all the possibilities of an adverse outcome, the profit potential for misunderstood and miss-priced securities is enormous. We are currently taking positions in two companies that are trading around two dollars per share. I will let you know in future articles how these ventures turn out.

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