Follow the Professor

We have been tossing a lot of ideas around Chez Melvin the past few weeks.  Last week we discussed using hedged portfolios of S&P 500 stocks trading at new lows or had fallen to the fallen knife level by dropping 50% in the past year. I am tracking those ideas and have some friends who are more quant oriented than I assembling the models to back test these strategies. Tim Collins, Bob Byrne and I usually have at least three plots to over throw the world and dominate the markets under construction at any given moment in time. Last night I tested using unconventional yield stocks to create a carry trade with interesting initial results.  We throw these ideas around, pick them apart test them and throw the vast majority in the garbage can.

When it comes to markets and finance there are many beautiful ideas and theories that can be dredged from price movements and historical patterns. They are elegant and hold the promise of untold riches right up to the point where you actually test and track them. I have been doing this for a few decades now and I have seen just about every version of every system ever developed. I have dreamed up more than a few of my own. Some worked, most did not. I try to always practice what I learned from Victor Niederhoffer years ago and test everything.  Some added a slight edge to my investing but most were just intellectual exercises that added to my knowledge of what does not work.

One book that never strays far from my desk is Investment Fables by NYU Stern School Professor Aswath Damodaran. The book explores many of the investment theories and approaches that have been developed over the years and exposes the flaws of each. In one chapter he breaks down the concept of buying stocks below book value, my favorite approach to investing. He finds that results are vastly improved by focusing on companies that trade below book value, have manageable debt levels and returns on equity of at least 8%. I have set up a screen using these criteria and it has provided some very successful ideas over the years.

 When I run the screen this morning I see that some old friends are right near the top of the list. Superior Industries (SUP) and Corning (GLW) have both been on this list of stocks in the past. Both are trading right at tangible book and if they fall to the 80% level they will be too cheap not to own stocks. Corning should see an uptick in global LCD demand towards the end of the year and that should boost earnings and get the stock price heading higher. Superior is just an outstanding company that is suffering margin pressures as a result of contracts entered during the height of the recession. As those contracts run off and are replaced margins should recover to historic levels and boost the stock price. Should we get a little more fear in the market and the Volatility index get above 30 both are a good candidate for put selling to back into the stock at a lower price.

Trading at 90% of tangible book value Patterson UTI  Energy (PTEN) is also right on the cusp of being too cheap not to own. The third largest operator of land based rigs is seeing the same pressure from lower oil and gas prices as its competitors. After shuffling its rigs around the company now has 58% of the fleet with liquids rather than natural pressure exposure and that should help them withstand the industry downturn. With firmer energy prices I can see this stock easily doubling to the highs of the past two year.

As with many of my other screens the low price to book, high roe on equity screen shows a lot of stocks that are close to bargains but not quite too cheap not to own. Practice patience. I am pretty sure you will get your chance to buy them at the right price before much longer.

If you do have Professor Damodaran’s web site at http://pages.stern.nyu.edu/~adamodar/ book marked, do it now. It is an invaluable resource.