Telefonica Hits a Busy Signal - A Fallen Purple Chip

1. We bought Telefonica in March 2012 at $17.00. We sold it Friday due to the increasing likelihood that (1) they will be forced to cut their dividend to preserve cash and (2) their debt rating will be downgraded. If these scenarios play out, the shares will likely remain depressed.

2. This is a classic example of a Value Trap; this stock had good metrics, a history of rising earnings, and an attractive dividend, however, since we recommended it the earnings have fallen sharply and consequently the PE ratio has risen to 7.2X from 6X.

3. Ratings agencies still have a neutral or Hold rating with significantly higher price targets. Our core principles teach us to avoid risk and focus on quality, so when a Purple Chip goes bad we follow our disciplined approach and look to redeploy our capital in other low risk opportunities.

4. In addition the Purple Chip rule of limiting the size of core positions to 5% helps us to reduce the impact of unfavorable investments and exit before significant impact.

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6. SELL TELEFONICA $USD 12.25 (TEF-US, $USD 12.25)

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