The Old Lady And the Salami Slicer

"I'd like to buy stock in Hebrew National Electronics," said the old lady to her broker... thinking she'd discovered a hot technology issue that no one else had noticed.

"But Hebrew National Electronics is a kosher meat packer, ma'am. They have nothing to do with electronics," explained her broker.

The news disappointed the old lady. You see, in the 1950s, a handful of small technology companies had clocked up massive gains. Control Data, the supercomputer firm, for example, was up 12,100% between 1958 and 1961, while Litton Industries, the radio wave and vacuum tube firm, was up 5,000%.

By early 1962, electronics and computer stocks had captured the public's desire... You could overhear people discussing the latest hot IPO on commuter trains. Taxi drivers turned into tech-stock pickers. One book – written by a gypsy dancer – hit the bestseller list with the title: How I Made Two Million Dollars in the Stock Market.

Basically, if the stock had "tron" or "ics" in its name, investors wanted it. Nytronics, Bristol Dynamics, and Suprasonics all scored large gains at IPO. Dynatronics was issued at $7 and jumped to $25 in its first few minutes on the market. Risitron Laboratories went from $1 to $4. Simulmatics had a negative net worth. It jumped 450% in the first hour following its IPO. 

Even the stock of Hebrew National Electronics started rising. When the old lady noticed a couple of months later, she called up her broker:

"They are too in the electronics business!" she yelled. "They sell salami slicers."

The panic that came in April and May 1962 washed this foolishness away. An SEC study conducted in the years following the bubble found 12% of these new issues had vanished, 43% had gone bankrupt, 25% were losing money, and only 20% had ever turned a profit.

Here's the thing:

I'm seeing the same thing in the mortgage market today. Any stock with the word "mortgage" in its name has gotten punished by investors... even if it has nothing to do with risky lending.

Take Annaly Capital Management, for example. Annaly is a mortgage REIT that has nothing to do with the subprime-mortgage business. It invests in loans issued by Freddie Mac and Fannie Mae. These loans are almost risk-free. The irony is, the subprime crisis may actually help Annaly's stock as the Fed cuts interest rates.

Anyway, last year, Annaly decided to change its name from "Annaly Mortgage" to "Annaly Capital Management."

Why did Annaly change its name? On the website, it says, "management renamed the company Annaly Capital Management to better reflect the business objective."  

Translation: the mortgage market is going to blow up, and we don't want our name connected to it.

Take a look at the Yahoo! homepage. Everyday you'll find headlines about subprime lending and foreclosure. I found these two next to each other yesterday: "Six Steps to Avoiding Foreclosure" and "Protecting Yourself from the Wrong Mortgage."

Investors are charging around like a herd of spooked wildebeest. They're not using their heads. They're not looking at fundamentals. They're making decisions based on trivial details like a company's name.

In short, the behavior of these investors reminds me of the old lady and the salami slicer.

From the 'tronics boom back then to mortgages today, "the Wall Street name game" can easily grab investors... and the stocks with the right (or wrong) names can get bid up to (or punished down to) ridiculous levels.

We're always looking for these situations, as sometimes you can come upon a great opportunity. The one in the upcoming issue of The 12% Letter is just such an opportunity. It yields 10.5%. It's time to load up.

Good investing

Tom