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Earnings season is the modern day equivalent of Carnivale. The CEO chest thumping, the “beating and raising game” and mindless analysts upgrades have an almost 17th century feel to it. But God-forbid some stock should “miss” the average estimate of these 20 or so mindless chumps. The result is gut-wrenching. Companies miss for a variety of reasons. But the most important reason is that they are run by humans. I get extremely suspicious of companies that always manage to beat by a small amount. Call me a skeptic but I am getting tired of the beat and raise game. It seems too prefabricated in the case of some stocks. Now give me a company that misses by a small amount and I get excited. That is the time to buy. Even in secular growth stories there will be an occasional miss by a good company. It is precisely the carnage that follows that investors should wait for. Transocean (Rig) and Global SantaFe (GSF) were two on the casualty list this week. While Transocean missed by a small amount, Global SantaFe's miss was quite large. Both stocks were hammered down. Let's step back and examine the fundamentals. World oil output is struggling to keep up with demand. No major discoveries have been made in some time. However multiple small discoveries have been made. Each one of these requires a rig. As an oil driller you rather have 10 wells that can produce 50,000 barrels each rather than 1 which can produce 500,000. Reflecting this trend output per rig in recent years has been rapidly falling. Besides the current fleet is over 25 years old and replacing this is going to be a big challenge with shipyards contracted out as far as the eye can see. Most analysts talk about this cycle peaking in 2008. Even if oil output keeps up with demand this cycle will not peak anytime within the next 10 years or so. Rig shortages are real and getting worse. Specially in the deep and ultra-deep water categories. Guess where most of the new discoveries are being made? Both stocks trade at less than 7 times my 2007 estimates for them making them stellar bargains. Both companies are aggressively buying back stock. Ignore wall street upgrades and downgrades. These are guys who thought $35 oil was excessive. Concentrate on the long term These stocks could be up 3-4 times over the next 3 years once the penguins wake up and P/E multiples expand. As always buy in stages. Expect up to 20% downside in the short term and buy a third now, a third at 10% below current prices and on-third 20% below current prices. That way you will not be shaken out. Drillers represent the most undervalued sector of the market based on long term fundamentals. Don't look this gift horse in the mouth. I own shares in both companies. I have not been paid to write this article. Please consult your investment advisor before making any investment decision.
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