Market prices are always fluctuating around true fundamental value. Sometimes, investors become overly optimistic about a particular company or the market as a whole. When this happens, prices often increase beyond what long-term fundamental growth can justify.
Other times, an overly pessimistic outlook drives the price of a stock too far down. At Donaldson Capital Management, we call these kinds of companies “vexed”. In other words, the market is discounting a stock based upon a current or upcoming headwind. These headwinds can come in many forms including concerns about future company growth (IBM), legal problems (JPM), or concerns about a particular economic region (AFL).
The market often overreacts to these headwinds, causing these “vexed” companies to be driven below their true fundamental value. Investors who can see through the short-term doom-and-gloom have an opportunity to purchase high-quality companies at a temporary discount.
One particular company we believe is “vexed” right now is a real estate investment trust (REIT) Health Care REIT, Inc. (HCN). HCN owns a diverse portfolio of healthcare real estate that includes senior housing communities, skilled nursing facilities, and inpatient/outpatient medical centers. The price of HCN has dropped by over 29% from highs near $80 in mid-May 2013.
The most obvious reason for HCN’s decline has been the upward hike in interest rates. An increase in interest rates is negative for REITs such as HCN for two main reasons: