Deep Value Letter - Banner Ad / Email Capture

Tuesday, August 13, 2013

Scary Markets, Solid Stocks


Okay kids. It is time to have the talk. Last night during a discussion of markets I gave my usual I am more of a bottom up guy and try not to pay too much attention to the stock market quote. That is how I run my day to day activities for the most part but my friends were a little pushier than usual and got me to talk about the current state of the stock market. I have hinted at this before with talks of portfolio pruning and caution but in reality this is the scariest stock market I have seen in my career. I worry more about the market now that I did in the late 1990s. At least that market had a story and life changing technology to fuel the excess. This one has nothing but a blind faith in the Fed.

One of the biggest lessons I have learned in the past three decades is that fortunes are made in the stock market buying into a collapse. If you look at some of the most successful investors of all time, that’s how they made their money. John Templeton talked about buying at the point of maximum pessimism. Walter Schloss liked to buy stocks trading at 4 or 5 year lows. Warren Buffet has a knack for getting into companies like Goldman Sachs (GS) when things go bad. Sam Zell has made a fortune buying real estate when no one else was interested and prices had collapsed. Wilbur Ross buys stuff that would freeze the innards of a less disciplined patient investor.

US stocks are nowhere near a point of maximum pessimism and are at 4 to five year highs not lows for the most part. We have gone straight up since the lows of 2009 and are more than 2.5 times the low. The only driver of the gains has been zero interest rates. Earnings have not been fantastic. Revenues of late have been flat. Much of the earnings gains are driven by cost cutting and financial engineering such as buybacks. The economy is just drifting along in a better but no good mode. It has been a great run and I have benefitted enormously but the overriding question has to be how long can money printing and financial shenanigans support stock prices?

Some of the smarter guys in the investment world are getting as nervous as I am. Sam Zell flatly said that stocks remind him of 2007 real estate markets and its time to sell. In April Leon Black of Apollo management said they were selling everything that wasn’t nailed down after the markets rise. At the same Milken Conference as Mr. Black Wilbur Ross warned of a bubble in junk bonds and said sometimes it is just better to hide. Seth Klarman’s recent comments to a private business group have been widely quoted and are the stuff of sleepless nights. He calls the current economy is a house of cards that will eventually implode.

One thing all of these men have in common is that they agree with my basic premise that things are dangerously over inflated and the markets and the economy are running on an addiction to cheap money and quantitative easing. I have no idea when this silliness will end of what may happen between now and then but I do know that when it does I do want to be caught massively long a bunch of overpriced stocks or 5% junk bonds. This is a time for extreme caution in my opinion.

I put together two new money portfolios the a few weeks, one concentrating on just plain of ordinary cheap stocks. I ended up finding enough opportunities to become about 35% invested buying names like MultiFine Electronics (MFLX). Arcelor Mittal (MT), Pericom Semiconductor (PSEM) and Volt Scientific (VISI).  The rest is in cash and staying there for now. The same held true of small banks where we are able to find enough stocks to get close to 50% invested based on my strict criteria. Most were well below %50 million in market cap. I have no idea what will happen in the market and the economy but I do know that the red flags are flying if you take your eyes off the screen long enough to look at the window.

What if I am wrong? What if all this financial chicanery and money pumping actually works and reignites the economy? Here the beauty of the deep value investing approach.  If you look back at the archives we own things like steel companies, iron ore producers, coal companies, silver miners and banks bought at fractions of book value. We have been buyers of energy companies at a fraction of their net worth. Even with new portfolios at less than 50% invested and older ones at something around 70% we are going to have a monster return from those stocks. I want making a macro call but just buying what is too cheap not to own but the process has left me well positioned even if I am dead wrong with my cautious approach. If things do blow up in the next few years existing positions will feel some pain but I will have a lot of cash to take advantage of the point of maximum pessimism.


If you are concerned about the markets and the economy right now I suspect you just aren’t paying attention. Rely on caution and value to protect yourself no matter what happens out there.

I will get a lot of questions once this is published. Many will want to know if I am really that concerned about the market. Of course I am. If you are not you are not looking deep enough. There are some structural problems with the market and the economy and it could be a disastrous. I hope it never happens but I intend to be prepared if the cracks expand. The next question of course is exactly which stocks I was buying to get 35% invested in this market. I would be less than fair if I didn’t answer that question so I will devote some time to highlighting the stocks I would buy today with new money.

First lets understand that this is a new money portfolio. The fact that I stock I bought last year is not in it does not mean you should sell it. It just means its moved up enough that I am not putting any new money in the stock. Feel free to email me with questions on a particular stock I suggested that is not listed here. Second this is a domestic non-bank portfolio invested on strict asset based criteria. There are no longshots, foreign maximum pessimism stocks or small banks in this portfolio nor are there any of the Graham growth type stocks I occasionally suggested for younger investors like my kids. This is a classic Tim Portfolio. Also be aware most of them are tiny so I am only going to be able to cover those large and liquid enough to discuss here.

I have talked a lot about Richardson Electronics (RELL) and it definitely goes into a new portfolio. The stock trades right around the value of its net current assets. They are not setting the world on fire by any stretch of the imagination but the company is profitable and pays a 2% dividend. Business is just going to slog along until we see a stronger global economy. The stock is trading at 90% of tangible book value and they have more than 80% of the share price in cash.

Alpha and Omega Semiconductor (AOSL) is struggling along with the economy as well. The company makes chips used in batteries, smart phones, computers and gaming systems. The shares fetch just 70% of tangible book value and also have more than half the share price in cash.  The company has done a solid job of increasing shareholder equity over the past few years and should see strong results in a better economic backdrop.

I included all the resource and mining stocks we have talked about in the past few months. If we ever do have an economic recovery, and I am confident that at some point in the next few years that will happen, then companies that dig stuff out of the ground and provide the basic materials. I included shares of Resolute Forest Products (RFP), Pan American Silver (PAAS), Cliffs Natural Resources (CLF) and Arcelor Mittal (MT) in the group. While some of those are foreign they are not part of a maximum pessimism trade such as I have suggested in Brazil and European banks. All of them are very cheap on a price to tangible book value basis. I am aware that if the economy does collapse so will these stocks but I am more than willing to buy more at a deeper discount.

I still like Brookfield Properties (BPO) as well. It is rare to be able to pay a portfolio of global world class real estate at this type of valuation and I feel like this could be a huge winner for over time. The market is too focused on the space they have to lease in lower Manhattan and not looking at the quality of the portfolio of premier office space around the worlds. In spite of the space available in New York the overall portfolio is 91% leased and they are renewing many of their leases at higher rates. Trading at 70% of tangible book value this REIT is too cheap not to own in my opinion. They should close on their acquisition of MPG Office trust in this quarter giving them a nice chunk of the LA skyline at a very good price.

I will conclude this portfolio wrap up tomorrow. Even in a market that has serious long term concerns that are stocks that are just too cheap not to own. The key to making this all work is that I have a very long time frame and have no problem buying any of these stocks down 50% from the current price in a market pullback, decline or crash.

Today I want to finish up my review of stocks I consider cheap enough to own regardless of your view of market conditions. As I said earlier this week I find the current market and economic conditions more than a little scary and am as cautious as I have ever been, however I follow a discipline of buying stocks at the too cheap not to own level regardless of market conditions and opinions. Given the run in the market the last few years there are not a lot of them and I am keeping positions sizes fairly small so there is plenty of room to buy on a scale if needed. Again these are stocks that I would be buying right now and not those that may have been purchased over the past few years and still hold.

Pericom Semiconductor (PSEM) make integrated circuits and frequency control products used to transfer route and time signals between computers, networks and telecom systems. Their products are used in laptops, notebook, smart phones and a wide range of other electronics devices.  Revenues and earnings were basically flat in the second quarter and I expect they will be pretty much the same when the company reports second quarter results. Computer sales are still weak and Pericom is in the early stages of expanding into higher growth markets such as networking and crowd computing. The stock is cheap at a little under 90% of tangible book value and more than 70% of the stock price in cash and securities at the end of the first quarter.

Cowen Groups (COWN) stock price has moved up a bit but the stock is still cheap enough to buy at just 80% of tangible book value. The brokerage and asset management firm has a strong asset management and alternative investment arm and the investment bank is well represented in key industries. Cowen has invested its capital well and since 1999 has earned over 16% annually on their proprietary investment accounts. If the markets did collapse I would be a big buyer of this stock as they would likely make a fortune in the aftermath form activist investment strategies and merger activity.

 I also like Calamos (CLMS) in the asset management space selling just over book value and at less than 3 times free cash flow. The have a strong presence in their markets and are a leader in convertible bond funds. The stock pays a decent yield of more than 4% so you get paid pretty well while you own the stock.

There are still some energy names that I think investors can buy at current levels. WPX Energy (WPX) is off slightly this morning after missing the always highly accurate analyst estimates. The stock trades at just 70% of tangible book value and even after adjusting for the loss of value in their Argentinian holders the actual asset value of the company is probably higher than book at this point. Swift Energy (SFY) is still transitioning from conventional shallow water oil and gas company to an unconventional production company. The product mix has not shifter away from gas to oil and liquids as fast as Wall street would like to see but they are making progress. In the meantime you can buy the stock at just 50% of tangible book value.

Tellab (TLAB) is still seeing weakness in its business lines as telecom spending remains very weak right now. The company is taking steps to refocus their business and I like the fact that Third Avenue was able to put a representative in the board last year.  The stock trades at $2.28 and they have $2.18 a share in cash as of the end of the first quarter. They report earnings later today so it will be interesting to see how the cash balances held up in the quarter. In the meantime the stock is just too cheap not to own.

These are the stocks that have enough liquidity to mention here on Real Money. About a dozen other non-bank stocks qualify but they are tiny with market caps between $25 and $50 million and trade pretty much by appointment. Given my concerns about the world and the markets I am focusing only on those names that I consider safe and cheap enough to own through a period of high volatility. I am willing ot add to all of them at lower prices if necessary. Should the economy surprise me and catch fire I think they would explode higher and more than offset my cautious positioning.

Be Sure to check out my newsletters here:






No comments: