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Gal^Stad
Investments Inc.

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Year in Review

2003 in Perspective,
from the January 2004 issue

"Overall, it is fair to say that we are more confident in stocks now than at any time since the fall of 1999, when we were firing warning flares against the valuations of the day." That was the crux of our Year in Review in this space one year ago. Heck, we were so bold as to set it in boldface!

And what a year 2003 was, sports fans! The Nasdaq set the pace with a gain of 50 percent; not far behind was the Wiltshire 5000, up a stellar 45.4 percent, followed by the S&P 500 at 29.4 and the S&P/TSX Composite at 26.4 percent. Worldwide markets also performed in grand fashion.

Meanwhile, back home at Contra we too could afford to party hearty, even with the American dollar rattling our cage. Our tally rang in at 68.4 percent, our second-best year ever. On the heels of 2002's 47.3 percent, and 2001's 64.8, who can remember the loss of 2000?

Well, perhaps a little of the stench lingers: the five- and ten- year annualized returns went in different directions, as the former vaulted by more than 12 points to 29.8 percent, while the latter -- having lost the oomph supplied by 1993's unmatchable 77.8 percent return -- slipped a bit, to 24.5.

Things were particularly active on the takeover front. Vector Capital won Corel with a stinky-cheese lowball bid; OfficeMax was pinned down by Boise Cascade; Air France looks to be ducking turbulence in its pursuit of KLM; and R.R. Donnelley is dotting the I's and crossing the T's on the Moore Wallace deal.

And we still might yet hear an announcement from the tall heads at Sodisco-Howden who, after making some noise during the summer about their company's being in play, have become inordinately silent.

We began the year 2003 with a portfolio of 23 positions, of which six left the stable -- which is pretty much a normal rate of turnover. On three occasions, we locked in gains of more than 100 percent, although we did have to wait patiently.

Don't be fooled by Network Equipment's score of almost 222 percent in less than nine months; this was an extreme that epitomizes the word "aberration." The greybeard of our roster, High Liner Foods, was purchased in 1993. Who says we don't buy and hold?

After these quantum leaps, what might 2004 hold in store for the portfolio? Hark -- is that us muttering once again about "regression to the mean"? There is absolutely no way that the wondrous returns of the past three years can continue.

In fact, if we take a gander back a decade, we see that 1994 and '95 came hot on the heels of three huge years to deliver returns of 1.5 and 13.2 percent respectively. While our mindset would deem this tolerable, we know others will surely wonder, "Oooh, why did I subscribe?"

Here's a choice morsel from our January 2001 Year in Review: "Our gut instinct suggests that we have our best portfolio in years. Our major winners have all been dispensed with, reducing downside risk.

Many of our remaining positions have been decimated, and various purchases have been made at a fraction of both the companies' past stock valuations and our estimate of their worth." The bottom line was that the vast majority of our stocks were down in value.

Well, cycles being what they are, we have now reached the other end of the spectrum. Of the 23 stocks in the portfolio, every one was up in value as 2004 commenced -- every single one. While that makes for wonderful historical tallies, it does not bode well for the future. The magnitude of the upside is diminished, while the slippery slope toward diminished valuations looms nearer. What to do?

Nothing much, really, except to take profits when the time is ripe and pounce when new opportunities present themselves.

The question of regression to the mean leads to the further inquiry: What mean? Ay, there's the rub. Much as we hope that a 25 percent annualized return can be upheld over time, our standard goal as stated in every renewal letter is 12.5 percent a year -- still a healthy margin above historical stock returns.

A year is a short period of time, though, and in the 14 years between 1990 and 2003 we have only achieved that goal eight times -- one turn better than half. You'd think it would be more, but that just ain't so. Statistics are fascinating, eh? Stuff like this is so entrancing that it makes us feel like dancing. Oh, Mandy, well you came and you gave without taking...

As a final note on this topic, it is worth mentioning that at this time last year we were also expressing concern about a backslide, as 21 of the 23 positions in the portfolio were up in value. We're praying to the gods of regression that the bullet might be dodged again.

Speaking of bullets, this is a U.S. election year, and George Bush will do anything  -- well, just about anything -- for four more years. In this quest, it appears that he's favouring the path of short-term personal gain over the long-term interests of the American citizens.

His monster tax cut has raised spirits after the brutal bear market, but as Warren Buffett adroitly mused, "Give me half a trillion dollars and I'll throw a hell of a party, too." And still, Dubya is anything but a shoo-in for a repeat performance.

But wait, we're getting ahead of ourselves. Irrespective of what happens at the polls, the American economic morass will have to be dealt with. Yep, even in today's high-tech world, the piper must be paid, but presidential resolve and investor psychology will no doubt ensure that the day of reckoning can be put off till next year.

The Fed lately seems fond of saying, "Roll the presses!" and letting the greenbacks flow. This has convinced people that the U.S. dollar is hardly the harbinger of safety many once believed it to be and has helped to make commodities a great story. Their recent price run could easily carry through this year, especially with China stirring the demand cauldron.

However, except for Claude and Corriente, we have taken our leave from this sector. We always find ourselves in a quandary when the gains have been large, yet larger profits might be left on the table. This is a just fact of life when you're searching for beleaguered stocks and sectors that offer potentially greater upsides with reduced risks.

We had barely sent out our releases about the threesome of Cygnal Technologies, Franklin Covey and Penn Treaty American before something happened that was a little shocking: the volumes on all three skyrocketed, while prices shot up by 66, over 100, and 10 percent respectively.

We haven't seen action that intense since our release on Miramar in 1998, when volume increased by more than 21 times on a trade-shortened pre-Christmas day, while the price went up almost 30 percent. Cygnal and Franklin did fall quickly backwards, although they remain well above our purchase prices.

By way of contrast, consider the fates of the stocks we purchased prior to December 2003: seven of the eight buys traded lower, with discounts ranging from 37.8 percent in the case of KLM to 8.8 percent for the Hudson's Bay Company. The only exception was Network Equipment, and even that one was only modestly higher soon afterward.

From a Contra standpoint, the difference can be attributed to a number of factors. Huge profits left folks with plenty of cash to work with. Unlike the previous two years, there were no "midseason" buys to relieve pent-up demand.

Confidence in the market as a whole has revived, but less so where mutual funds are concerned, and demand for less obvious equity bets has thus been fuelled. Finally, the breadth of the rally meant that tax-loss selling was muted.

This environment had a direct effect on our buying plans. Many of our best Stock Watch List prospects squirted away just as we were moving into position. Never in our history have we gone so far into December without buying something, and the delay resulted in our purchases being made during the awkward low-volume pre-Christmas period.

And yeah, that popularity thing made it tough to put out the fire with gasoline. Maybe it is time for us to join that school of mainstream fishies?

One question we are asked is, "How come you only take 1,000 subscribers?" A chief reason is that if we had more, the response would be even greater when a release is sent out. Quite simply, if all the people on the waiting list were made subscribers, our personal financial returns would be higher, but overall, it would diminish the quality of the service that we attempt to provide.

Some readers have asked for a "premium" service, where for an additional fee they will receive information more quickly. A pretty idea, but it ain't gonna happen. Contra is designed to be fair to everyone, and although perfection remains a beacon on the horizon, we do the best we can.

Some of the professional traders who partake of our letter would like to see our releases happen during the day. This is something we avoid precisely because the pros would then have a clear advantage. Our releases virtually always go out the evening that the Buy or Sell is made, with Friday deals dispersed on the weekend, and that practice will continue.

As usual, we would like to thank our subscribers for their support and confidence. We would also like to thank Mark Taylor, who has toiled for us in the background over the last few years, and Lloyd Davis, who edits us to sensibility and keeps our design au courant. Without them, Contra's voice would undoubtedly be a lesser one, perhaps growing hoarse.


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