Uncommon Common Sense

If you are like me your email inbox gets a lot of those oh so enticing offers promising instant stock trading profits in just 15 minutes a day and endless stock promotions. I spend a lot of time visiting financial sits on the web kicking over rocks in search of ides so it is no surprise that I end up on many of these mailing lists. What is surprising to me is that many of these firms have been in business for some time so apparently people are spending money to become the next Stevie Cohen or George Soros between dinner and dessert.  Folks must be buying those stocks that will benefit from the looming crisis or loading up on those $.10 stocks with breakthrough technology that will change the world.

It must seem silly for me to say this since write for a subscription service but there is a huge difference between advice and hucksterism. The guys and gals on Real Money share their thoughts, ideas and the trades they make with their own money which is light years away from Five Stocks to Buy if the Government Shuts Down , or Six Stocks to Sell If The President Trips On The Way to the Podium.

We need to see a healthy dose of common sense applied when it comes to trading and investing our money. There is no magical system that will make you risk free millions in just minutes a day. When you open the account and decide you will make your living trading stocks or forex in your spare time you are stepping into someone else’s arena and odds are you are mere lunch money. I have done a lot of work on trader survival rates and returns of late and you have a better chance of beating Lebron James in a one on one basketball game than you do of being a consistently profitable trader in your spare time. When I talk to successful traders like Tim Collins, Bob Lang or Bob Bryne they are always working to define and refine their edge. You are up against the best minds armed with the best technology and you have a better chance of earning outsized profits betting a hard 8 every roll at the craps table.

The other area where I see any illusion of common sense thrown out the window is this idea that we can somehow predict where the market is going and book huge profits in the process. Predicting the market sis an absolute waste of time and the lucky ones who get a call right are then usually wrong for the next several dozen predictions. We make stars out of folks like Elaine Garzarelli and the Joe Granville for a lucky coin flip and spent a long time paying for that mistake. The economic, financial and psychological stews that are the financial markets are impossible for anyone to predict with any sustained accuracy.

Big money is made in the stock market by reacting to what the markets do, not in predicting their future movements. If you look at the most successful investors they made their biggest returns by buying when markets were ridiculously undervalued or hopele4ssly overpriced. Investors like Jon Paulson and Michael Burry didn’t sell subprime mortgages because of a chart pattern or trading system. They made billions because they correctly recognized that the securities traded at price will beyond their true value. The markets went against them for a while but they held on until the process inevitably corrected themselves.

Investors like Wilber Ross, Warren Buffett and Howard marks did not get rich by predicting the direction of the stock market. They did it by buying assets they were egregiously undervalued and held them until the market entered another euphoric stage and selling them to over excited traders and investors. They are far more active when the markets are crashing down around our ears and everyone else was panicking. They bought assets and earnings cheaply by acting as the buyer of last resort for scared sellers. They got rich by applying common sense to the markets and waiting for a chance to react rather than predict.

I have no idea what the market will do in a reaction to a government shutdown. I do know that the best way to lose some serious coin here is to try and predict the outcome and the market’s reaction. Common sense tells me that if the markets react negatively we could sell some bargains created. In the long term the shutdown has no real impact on the future of my small bank and cheap stock so I would be foolish to rush to sell.

As investors we need to apply common sense to the markets and quit chasing impossible pipe dreams. Charlie Munger once attributed his success to the fact that he acted rationally when other did not. We need to do the same.

http://www.marketfy.com/store/item/the-tim-melvin-deep-value-letter/preview/

Investing Michigan Style

As I have mentioned in the past I am something of a geek. Once I finished running stock screens and checking the stocks in my portfolio for any important fundamental changes I turned to serving business school websites for interesting new papers or research article that might contain significant information that would help us as investors. I found a few on interest and will report back on them after I have digested them but at the University Of Michigan Webster School Of Business I found something that interested me greatly and should you as well. They are running two portfolios that are posted on the website identifying stocks that are undervalued and another one that lists what they call earnings torpedoes.

Earnings torpedoes are stocks that the students have identified as having the potential to blow up as a result of poor earnings. They use academic theories such as earnings quality, cash flows, momentum and valuation to identify stocks that could be set to sink your portfolio.  I checked through the historical lists they keep on the site and the theory actually worked very well at finding potential disasters and torpedoes underperform the market much of the time. I have mentioned more than few times I am cautious about the markets and sometimes the best way to make money is to lose it so the list is worth a review to see where danger may lurk.

The list is littered with energy related Mater Limited Partnerships (MLPs). Many of these oil and gas collection, transmission and storage partnerships have been bid up to very high levels as a result of strong oil prices and indiscriminate yield seeking by investors. Billions of dollars have flooded into the sector as ETFs and funds were formed to take advantage of the higher yields offered by these vehicles. Some of the better known MLPs that are potential torpedo stocks include Atlas Resource Partners (ARP),Atlas Energy (ATLS),  Cheniere Energy Partners (CQP) and Eagle Rock Energy Partner (EROC). Investors who own these names may want to review their holdings and consider lightening up on the shares.

The list is absolutely dominated by small cap biotech stocks.  50% of the list is biotech’s like ARIAD(ARIA), VIVVUS (VVUS) and  Idenix Pharmaceuticals (IDIX). Biotech has been red hot this year with the industry indexes and ETFs up more than 30% but investors might want to get some money off the table. I have ling maintained that this is an incredibly specialized filed and if you don’t possess, or have an advisor who possesses, a medical degree with a biotech concentration, small biotech’s are a danger zone for individual investors. Using traditional fundamental or technical analysis techniques on these stocks is a game of financial Russian Roulette in my opinion. If you own individual small biotech’s it is worth your time to go the schools website and see if you are hanging on to a potential torpedo stocks.

There are some big market darlings on the list that momentum investors need to be aware of before you take a torpedo amidships to your net worth. Salesforce.com has shown up on several of my red flag lists in recent weeks even as the stock has run higher in recent weeks. With a forward earnings estimate multiple of 100 times the slightest disappointment form this company is going to cause an implosion in the share price and all but the most nimble of traders should probably avoid the stock at this level. Zillow (Z) is another trader favorite that has had a nice run as housing markets have recovered somewhat but it is now on the danger list. At more than 150 times estimated profits it would not take much bad news to explode the stock and your portfolio along with it.

It is worth your time to check out the torpedo list on the Webster Business school site. Even if you decide you do not agree with them on certain stocks or sectors it is thought provoking and educational. Next I will take a look at the stocks the students have identified as undervalued and see if we can find any potential gems to buy.

. The folks at University of Michigan Webster School of Business not only has a list of stocks you should avoid they have one that gives you 40 stocks they think are undervalued. They do not reveal exactly which metrics they use but the website says they use Value, Momentum, Quality and Predictability. It is a combination of several of the more successful academic theories and it producers a really interesting list of stocks that might appeal to ling term investors. According to the site the screen has beaten the market handily in 8 of the last 10 years.

It is easy to see that momentum and value are heavily weighted in the 40 stock list as many of them are former deep value stocks where the price has begun to improve. It was no that long ago that basset Furniture traded at a fraction of book value and was wildly out of favor on Wall Street. The company is firing on all cylinders now with three quarters in a row of strong sales growth and the stock is now at a small premium to book value. Insiders have been buying stock outright and exercising options and keeping the stock so that’s another academic theory at work in this stock. The company has plenty of cash and little debt and seems to have put the recession in the rear view window. Basset is doing much better than many other consumer related companies right now.

They have a few little banks as well which comes as no surprise to me at all. I will highlight two from opposite ends of the bank spectrum. Monarch  Financial Holdings (MNRK) is a little bank  with 11 banking offices, 15 residential mortgage offices, and 1 investment services office in the Norfolk /Virginia Beach area. It also operates 2 full-service banking offices and 2 residential mortgage offices in the Outer Banks of North Carolina, as well as 28 additional residential mortgage offices outside of its primary banking market area, The bank is in great shape with  nonperforming assets of .29% of all assets and an equity to assets ratio of more than 10. The stock trades at 1.2 times book value and has momentum on its side with the share up almost 40% this year.

Parke Bancorp (PKBK) is on the other end of the spectrum. The New Jersey bank has 6 offices in in its home state and one if the greater Philadelphia area and about $740 million of assets. The stock is much cheaper than Monarch at 75% of book value and there is a good reason. The loan portfolio is a mess with non-performing loans at more than 7% of total loans and nonperforming assets at a staggering 9% of total assets. They do have excess capital with equity to assets ratio of a little over 13 but asset quality has been slow to improve. This one has more a long shot feel to it but if they do succeed in getting their house in order the upside could be huge.

There are also lots of small insurance stocks on the list including one, Eastern Insurance Holdings (EIHI) that announced a takeover bid yesterday at a pretty big premium. This stock was one of my top picks for 2011 and has more than doubled thanks to the acquisition offer. This is going to be repeated throughout the industry over the next few years as smaller life and property and casualty insurance companies are very cheap compared to historical valuation level. It is worth your time to go to the schools site and run through the insurance picks stock by stock.

For fans of sin stocks Ricks Cabaret (RICK) makes the grade as a University of Michigan cheap stock. The only publicly traded operator of Gentleman’s Clubs. The stock trades at 12 times earnings and 1.27 times book value and business is apparently pretty good. The CEO and CFO like what they see as much as the customers as they have been buyers of the stock over the past few months.

Star Gas (SGU) makes the grade as well as this remains one of my favorite little long term income stocks. The propane company is not going to set anyone’s portfolio on fire but it will continue to roll up Mom and Pop propane dealers and pay a strong dividend. The stock yields 6.75% and is a good fit for most income investors in addition to the schools value stock list.

Tracking the academics makes a lot of sense to me. When they have proven they can outperform and are willing to publish their stock lists as Michigan has it makes even more sense to check the page regularly.

http://www.marketfy.com/store/item/the-tim-melvin-deep-value-letter/preview/

http://www.marketfy.com/store/item/banking-on-profit/preview/

Proven Performance and an Offer

I was going through my desk this morning looking for some research material I was using to set up my new International Deep Value Letter when I came across some print outs of articles I wrote in July 2012. I had used them as handouts at a business networking event and then just stuck them in desk drawer.

One was on the power of asset based investing and why it worked. I suggested buying 4 deeply undervalued stocks in an article called simply Asset Based Investing Works published on July 17, 2012. I suggested four stocks, an oil and gas driller, two banks and a staffing company. Had you purchased an equal dollar amount of all 4 your return through today's close would be 82% in a little over a year.

The second article was called Real Estate is the New Plastics published on July 31 of the same year. I suggested that 7 REITs were deeply undervalued based on the concepts used in deep value investing. If you put an equal dollar amount through today would be 41%. Not as good as the first article but not too shabby either.

Deep value investing works. It works very well and it works consistently though all sorts of different market conditions. I want to help use it to make you money over time.

In order to encourage you take the leap and put deep value to work making you outsized profits here is what I am going to do. If you sign up for my Deep Value letter this weekend I will give you $100 off . Instead of $499 I will let you have it for just $399 for the year. To add a little extra incentive if you join me today at the deep Value letter I will GIVE you a free year of the brand new International Deep Value letter just launched today. 

That’s what I call a deep value. Use this link to sign up.

https://marketfy.com/secure/checkout/the-tim-melvin-deep-value-letter/201/?coupon=valuevalue

Thanks .

Tim Melvin

Gross Profit, Great Gains

I have long held the opinion that for most investors the money is made on the edges. The two top performing strategies I have uncovered over the years are deep value and what I call real growth. Real growth companies are those that are growing revenues, earnings and the net value of the firm higher consistently over the years. It is basically an earnings momentum and growth strategy based on high profitability and management execution. As long time readers are aware I am a bit of a geek and spend a good amount of time reading academic research and I recently forum a paper that basically confirms my thoughts on this subject and brings some interesting new data and possibilities for individual investor.

Robert Novy-Marx is a professor at the University of Rochester and a fellow at the National Bureau of Economic Research. His research efforts are spent studying asset pricing, real estate and finance, He recently produced two studies that are of interest to me as a value investor. The first paper has the provocative name of The Other Side of Value: Good Growth and the Gross Profitability Premium that was originally published in Journal of Financial Economics. The other is a working paper titled the Quality  Dimension of Value Investing. The papers make two discoveries that are extremely useful to us as long term value investors.

The first is that companies with a high level of profitability are as useful as price to book value when it comes to predicting future performance of their shares. However he eschewed the usual standards of profitability such as earnings per share and return on equity. He remarked in one paper that “gross profitability performs better predicting future stock returns than ROE, the profitability variable most frequently employed in earlier academic studies, because it is a better proxy for true economic profitability. In particular, the study points to the fact that accountants treat many forms of economic investment (e.g., R&D, advertisement, sales commissions, and human capital development) as expenses, so these activities lower net income but increase future expected profitability. This makes earnings a poor proxy for true expected economic profitability.” He compares group profitability to total assets an finds that those stocks with high gross profits as a percentage of assets used to produce the profits as the best way to measure profitability.

His study cover a period from July 1963 to December 2012 and finds that stock with high profitability using his measures outperform the market at a rate comparable to those that fit in to the classic deep value approach. The conclusion supports my conclusion that investors would do better focusing on the what I call true growth firms and what he calls profitable firms and classically cheap stocks based on book value. While I prefer picking one for or the other there is a suggestion n the data that investors might be best served by focusing on both strategies.

While that seems like an interesting concept and would probably work very well over the long term the two studies give us another useful idea to apply it the investing process. What would happen if you combined the profitability factor with traditional value approaches? You end up outperforming the market, straight value approaches, and true growth strategies by a pretty significant margin with lower drawdowns and fewer years of underperformance according to the study. It works on both large and small cap stocks over a long period of time. He concludes the study by saying “The basic message is that investors, in general but especially traditional value investors, leave money on the table when they ignore the quality dimension of value.

I am a geek but I am also a cynical optimist. I had to go back and look at some results for myself and how it has worked recently. I looked back one year and selected stocks that had high profitability using Mr. Novy -Marx’s profitability calculation and also traded below tangible book value. The results are incredible. The list of stocks over $100 million in market cap returned on average 45% over the past year. 79% of the profitable value stocks are higher a year later. For the microcap stocks under $100 million the average return was 54.8% and 70% of the small profitable value stocks went higher.

Naturally I then sat down and ran the screen on the current universe of stocks. I found two things to be of great interest. The first is that there are a lot fewer cheap profitable companies right now than there were this time a year ago. The second is that there are some pretty interesting names of the list worthy of further exploration by long term value investors.

That is impressive performance to say the least so I quickly built a screen that looked for cheap stock that have very high gross profits when compared to their asset base.I found some surprises when I ran the screen. Some companies you might not think of as wildly profitable actually are when you measure it by gross profitability. Keep in mind that gross profitability is simply total sales minus cost of goods sold and leaves out all the overhead and other expenses. Mr. Novy- Marx found that this was the best measure of profitability and that it has strong predicative value so that is the one we will use.

Arcelor Mittal  (MT) is  a large integrated steel company and one would not necessarily think of it as wildly profitable as they have struggled in recent years. They took a bottom line loss in 2012 but had managed to paint the bottom line black in the preceding decade. The CEO of the company recently told investors he believed the company had turned the corner and should see conditions in the steel market in 2014. When we measure it in terms of gross profitability compared to assets we find that the company has assets of $112 billion and gross profits over the last four quarters have been a little over $74 billion. That is one of the cheapest ratios in the deep value high profits screen. The stock is certainly cheap trading at less than 60% of tangible book value.

I almost feel out of my chair I when saw Radio Shack (RSH) on the list of high profitability cheap stocks. This has been one of dogs the past few years as I was way to early buying the stock in anticipation of a turnaround or takeover. The company has its issues but it also has a very high level of gross profitability with $1.4 billion of gross profits in the past year on an asset base of $1.9 billion. The stock is still cheap at 78% of book value so if they can find a way to improve the items between gross profits and the bottom line my patience may yet be rewarded.

I was further happily surprised that although my credit and fundamental models use a lot more than 1 factor the gross profitability and book value combination picked  out a lot  of the companies I have mentioned here on Real Money and own for myself as well as family and friends. Stocks like Kimball International (KBALB), Xyratex (XRTX), Real Networks (RNWK) and Sky West (SKYW) have very high gross profits as a percentage of assets.  Transworld  Entertainment  (TWMC)is one of the stocks I hate to love as I think the brick and mortar music and video stores is an industry in the way out but those stock has high gross profits as a percentage of asset and trades at just 85% of book value.

 So do a couple of companies I have had my eye on but haven’t pulled the trigger and purchased yet. Tropicana Entertainment is Carl Icahn’s casino empire based purchased out of bankruptcy a few years back. They now own casinos in Nevada, Indiana, Louisiana, Mississippi, and New Jersey as well as one in Aruba. The stock may not do much until Carl decides to sell or otherwise transform the company but it trades at just 3 times gross profits and 80% of tangible book value.

I have also been negative on for profit education stocks for several years now and Apollo Group (APOL) is one of the best shorts I have ever put on in my life. However many of the stocks in the group such as Corinthian Colleges (COCO) and Career Education (CECO) are now trading below book value and have high gross profits when compared to assets. I haven’t bought in yet as I am still a fan of the business model but the valuation is getting quite compelling.

The idea of using gross profits as a measure of profitability when selecting stock is clearly effective and should be an arrow in every investors analytical quiver. When used with value stocks it appears to work extremely well at locating stocks that can survive to thrive.

Value at Work: The Credit Crisis and Beyond

Now that we have launched the Tim Melvin Deep Value Newsletter and Banking on Profits we have seen a steady flow of subscribers and I think over time we will grow this service. I have been told that if I would be more self-promotional and dramatic about my offerings we could probably accelerate the sales process. I am just not that guy. Even if I wanted to pose in front of fancy cars with half naked women all gained as a result of my terrific trading advice I am pretty sure my wife would kill me for even suggesting it. The fact that I drive an old Jaguar that fits me like a glove and I refuse to part with might also hamper my efforts in that type of marketing.

I am not going to make shrill dramatic pronouncements about my ability to make you millions of dollars in minutes a day. Value investing does not work that way. This is a long term approach to the markets that puts margin of safety first and lets the upside take care of itself. It works but it won’t make you rich overnight either. It is a service for investors who are tired of the hype and the promises and want a way to earn solid returns over time and build their net worth the way private equity and other long term investors do it by buying cheap assets and selling them when they are fully valued.

Rather than try to convince you to subscribe to my newsletters with hype and promises I am just going to run on my track record. Listed below are comments dating back to 2006 that were recorded in my personal blog or published on Real Money, Daily Speculations or one of the other sites where my work has appeared over the years. This is value investing at work over the long run. It runs through the credit crisis when investors were losing a fortune ,the late 2008-2009 period when everyone was terrified to buy and up to 2011 when we started to feel like the worst was behind us. Judge for yourself if my approach to investing makes sense for you and is worth the small cost of an annual subscription. I think it is and hope you will join me by subscribing to the newsletters and putting deep value investing to work for you.

Good luck to us all,

Tim

12/05/2006

You might be able to sell me the fact that this market is fairly priced, providing I’ve been drinking heavily, but undervalued, I can’t see it. The bond market and the dollar are telling you it’s just not that good out there right now. We have rallied almost 12% since August without a real pause of any length and anybody who is not cautious now pretty much deserves what they get.

April 1, 2008

Even if I am dead wrong here I think the risk of being fully committed to stocks carries too many risks for the idea of a margin of safety to exist. I am willing to miss this run up to protect capital. There appears to be very little common sense being used on Wall Street these days when it comes to the overall economic and financial matters, as well as a total lack of fear. Bottoms are accompanied by fear and loathing not cheerleading and bottom predictions. The bullish arguments are laughable. Anyone who does not clearly see that the recent pullback in gold and other commodities is deleveraging by hedge funds in light of recent volatility is not looking close enough. Anyone who thinks that the bank write offs are at an end has just simply lost their mind. Yes, eventually they will write all this crap down too far and it will create an opportunity. I particularly look forward to moves like that of UBS to separate the bad assets into separate vehicles as this will create huge pools of underpriced and unloved mortgage assets that no one wants to own, reminiscent of the Texas bad Banks of the late 80s and early 90s. But that time is not now. Small community banks will thrive and benefit from the tighter credit conditions and steeper yield curve. But not yet. Patient investors will see one of the best buying opportunities of their lifetimes. But it is too soon. 

June 20,2008

Interest rates are starting to rise. I continue to think that only an illiterate deaf mute kamikaze could be aggressively long the US stock market. Of course there are lots of those around. We call them mutual fund managers.

11-20-2008

As for the market itself there is a fortune to be made over the next several years. I see companies that are profitable trading for less than 3 times E/EBITDA. I see an ever growing list of companies that sell for less than cash in the bank. We are fast approaching the depths of an ugly bear market and there is money to be made. I am buying DAR, HDNG, DOW,ASH and other like a crack addict at a rock convention.

3-14-2009

You can buy stocks like ADPT, TECD, and ESIO for less than the value of the company’s liquid assets. You can literally build a portfolio of 40-50 of these that have a good credit scores, viable businesses and excellent recovery prospects. That’s enough to make me salivate at the possibilities for gains over the next several years.

DIS trade for about two thirds of my appraisal value. That is provided we give no value at all to the film library or character rights and price the parks as raw land and put a 5 multiple on after tax earnings .DELL trade for less than two cash. HTH is a pile of cash in the hands of a proven investor in distressed banks and other financials. As a bonus the company landed a back door bank charter and will be able to bid on distressed assets and institutions. Southwest Airlines is stupid cheap, trading below tangible book value. Oil service companies like RDC and PTEN trade below net asset value at these levels. I like the idea of buying the Forest City senior debentures at a 30% YTM and what looks to be more than adequate asset coverage. Whitman has been a buyer and although struggled with everyone else last year, he is one of the best credit analysts and distressed guys around.  

1-16-2010

This is the type of trade I am hoping begins to develop in earnest in the first half of 2010. As commercial and real estate woes continue to fall I am looking for the market to wake up to the problems facing the small banks. When it starts the stock market, being the bastion of irrational insanity that it is ,the baby will go out with the bathwater. This type of activity created a situation back in the early 1990s that allowed many people to literally get rich over the next decade. When the good get sold with the bad I am looking to buy up a portfolio of small banks below tangible book value that have low loan losses and adequate reserves. As real estate improves-and it will someday- we will start to see a wave of mergers and acquisitions in the banking community. These transactions will occur at multiples of book, not at a discount. Those solid bank stock bought in this next sell off will show tremendous gains for those bold enough to step up.

  August 8,2011

The current turmoil in the markets is creating some opportunities. Any type of corporate disappointments is leading to a steep and drastic sell off. Right now foreign banks are god-awful, point of maximum pessimism cheap. I like two of the larger Japanese banks, Mitsubishi UFJ (MTU) and Mizhou (MFG). Both sell at a fraction of tangible book value and for an investor with a time horizon of five years or more should be very profitable. The same is true for Royal Bank Of Scotland (RBS). The stock is at 40% of tangible book and management has a solid plan to de-risk the balance sheet and return to profitability. As a final foreign excursion the shares of Dutch insurer Aegon (AEG) are also very, very cheap. They have repaid the Dutch government for the emergency funding and should pay a dividend again starting next year.

Here at Home Hudson City Bancshares (HCBK) have sold off sharply. After the reorganization of the balance sheet the bank should do very well going forward and at a discount from tangible book and yield of 4.40% it’s an attractive long term investment. First Bancorp (FBNC) is also cheap and replacing the TARP funding with Treasury Small Business program funding will be an enormous boost to the bottom line. Locally Shore Bancshares(SHBI) has been a severe disappointment as loan losses have continued to mount. I am going to hold that name and add Severn Savings (SVBI) at this price. I have a lot of faith in the Hyatt families’ strong desire not to lose the millions they have invested in the bank. Insiders have been buying so it’s worth a shot at one third of book value.

Force Protection (FRPT) missed earnings and is now trading at very cheap prices. This company should have sold out last year and now I think it is just a matter of time. They have a decent business but will function better as a division of a larger defense contractor. LB Foster has decent earnings but there is a product liability claim with Union Pacific involving 1.6 million rail road ties. The question becomes is that worth the 50% of market cap the stock shed? They will be a huge winner when we finally get all this crap behind us and our economy is once again growing to the point that infrastructure spending resumes. Demand for computers and other tech products may be slow but it will come back when the economy does. That makes Micron Technology (MU) a screaming long term buy at 75% of book value in my opinion.

I like the idea of buying a small package of mortgage REITS here. I would buy a little Annaly (NLY) and a little Invesco Mortgage (IVR) here with the idea of building the position over an extended period of time. You are likely to get a chance to buy lower based on conditions and volatility in the bond markets going forward. However they are cheap and the yields of 15 and 20% respectively make them worth a shot here.

http://www.marketfy.com/store/item/the-tim-melvin-deep-value-letter/preview/

https://marketfy.com/store/item/banking-on-profit/preview/

Stealing Ideas

Originally published as a series on RealMoney.com

Special offer for my Deep Value Letter at bottom

As the 13f filings piled in  like everyone else I reviewed some of the bigger ones just to see how was doing what. The Whole street was reading them at pretty much the same time so there was no information advantage to be gained but the information on the buying and selling of David Einhorn, Daniel Loeb and other heavyweights is useful background information. However the fact that Einhorn sold Microsoft (MSFT), Loeb bought Disney (DIS) and John Paulson still likes Gold is not really actionable research worthy information for me.

That’s not the case with Paul Isaac of Arbiter Partners. I find some useful investable information in his portfolio every quarter. I enjoy reading his portfolio filings and to be honest its really good for my ego. Mr. Isaac is one of the most successful hedge fund managers of the last decade and learned the craft from his father and legendary Uncle Walter Schloss. He owns and has been buying many of the same stocks that I have in the past year and that really increases my comfort level with stocks s like Calamos Asset Management (CLMS), Cowen Group (COWN), National Western Life Insurance (NWLI) and a host of small cap banks that we both own right now.

The fund opened some interesting new positions in the second quarter. Arbiter bought shares of oil and gas company Apache (APA) in the quarter. The stock has traded right around book value in recent months. The company is selling its Gulf of Mexico assets to focus on onshore operations in the  Permian/Anadarko basins. They also have operations in Egypt which is a concern for many investors right now. The large cap company is on my buy in a big decline list of stocks as the stock could easily move back over the $100 a share mark in the next couple of years.

The fund was also a buyer of the recent spin off from Brookfield Asset management (BAM). Brookfield Property Partners (BPY) was formed to hold the commercial real estate operations of Brookfield and owns shopping malls, multi-family housing, office properties and have been buying industrial properties of late. The shares trade at about 80% of the equity value as reported at the end of the second quarter and yields a little over 4%. I am a huge fan of Brookfield deals and will be reading further on this one over the weekend.

The filing also shows a large new holding in AMBAC  Financial Group (AMBC) that I suspect was gained through participation in the bankruptcy process. The bond insurance company emerged from bankruptcy back in May of this year. There is a lot of stock in the hands of distressed funds who will be looking to sell strength so I am not really interested in this one right now. The recent developments in the municipal market may make the stock more interesting should vulture fund selling push the stock back below the $20 area later this year.

The fund was also buying some of the battered technology stocks that have underperformed the market in the past few years. The fund added to its stake in Amkor Technologies (AMKR) the semiconductor equipment company in the quarter. The stock is pretty cheap trading at just around tangible book value and earnings should gain some momentum in the future driven by increasing demand form the smart phone and table computing markets. The company is working to restructure its debt load and success in this endeavor could help unlock the value of the stock in the next year.

Mr. Isaacs fund also opened a new position in shares of Emulex (ELX) the network solutions company. As the economy eventually improves and corporations and governments begin to spend on IT infrastructure again the company should see revenues and earnings begin to grow at a decent pace. The company has made acquisitions that broaden its product line and should also help drive future growth. This one is not really my cup of tea as it trades well above tangible book value but investors should note that Mr. Isaac is a lot smarter than I am.

The fund held firm on most of its small bank positions in the quarter but they did add to two banks that had outstanding earnings reports this month and showed strong improvements. Both Intervest Bancshares (IBCA) and Eastern Virginia Bancshares (EVBS) are in my trade of the decade portfolio and I am happy to see that a smart and successful fund manager is in agreement.

The reports from the larger fund managers have turned into just more market noise the past few years. However the smaller higher returning mangers like Arbiter are still a source of great ideas worthy of further investigation and investment.

 Last month as 13F filings were coming fast and furious I sat a couple aside with the intention of reviewing and reporting the information to viewers. They are two managers I respect enormously and as proof their all-around intelligence and stock picking prowess we often own many of the same stocks. As with everything else that gets set aside for later here at Chez Melvin the reports fell into the black hole of Tim’s desk and went unreported. Today I will begin to fix that.

EJF Capital was started back in 2005 by Emmanuel Friedman one of the co-founders of Freidman Billings the broker dealer and asset manager. The firm made a name of itself with its research and investment banking success in the finance and real estate fields. Mr Friedman partnered with the former head of FBR’s Alternative Investment and Wealth Management divisions Neal Wilson to start EJF and they have more than $4 billion under management.

The firm is doing some interesting stuff in both the banking and real estate fields. That of course is right in wheel house as I am a huge fan if both sectors when you can buy the securities cheap. EJF has been finding some opportunities in both that are cheap and appear to have significant long term potential.

They have been big buyers of little banks and the second quarter of the year saw the buying streak continue. EJF opened new positions in shares of Fidelity Southern (LION), Charter Financial (CHFN), VantageSouth Bancshares (VSB), Newbridge Bancorp (NBBC),Heritage Financial (HBOS), and ConnectOne Bancsshares (CNOB) as well as a few much smaller banks. Of these listed here, only Charters Tim cheap trading below book value as the rest have moved up in recent months. I continue to be big believer in the small bank trade of the decade and it appears Mr. Friedman also likes the sector.

The firm is also a big believer in the mortgage servicing story as they have large positions in leading servicers and added to several of them in the quarter. To my discredit I totally missed this story and left a lot of money on the table the past few years. They hold shares of Nationstar Mortgage Holdings, PHH Corp (PHH) and Ocwen Financial (OCN). They added to Nationstar and PHH Corporation in the quarter and they are now the largest positions at EJF Capital. At this year’s Ira Sohn Conference Steve Eisman gave a very bullish presentation of mortgage servicing companies and EJF appears to share his enthusiasm.

They bought a lot more of Colony Financial   (CLNY)in the quarter as well. The hybrid REIT is involved in several segments of the real estate market place as they have been buying troubled real estate related loans with an eye towards working them out at a profit. They have originated higher yielding loans on properties such as hotels and offices. They also invested heavily in a related company, Colony American Homes, that was created to invest in single family homes and rent them. There are a lot of moving parts to this company and I am going to have to spend a little time on it but it is cheap at 90% of tangible book value right now.

They were also big buyers of Silver Bay Real Estate (SBY) in the quarter. Silver Bay also owns and rents single family homes. Silver Bay Silver Bay currently owns single-family properties in Arizona, California, Florida, Georgia, Nevada, North Carolina, Ohio and Texas. They currently have more than 3400 homes for rent. Investors have not received the company well since its IPO as it has taken some time to get the homes rehabbed and rented but now the company is starting to see progress. The stock trades at 90% of tangible book and about 80% of managements estimate of current net asset value.  I have been watching this one closely since the IPO and am going to pull the trigger on the stock very shortly.

Small banks, real estate financing and single family homes all offer significant upside over the next decade. Tacking the holdings of investors like EJF Capital that have been earnings outstanding results in the sectors for decades is a solid way to uncover ideas. These guys are now on my must read list and if you are a long term investor they should be on yours as well.

I have one other 13F mea culpa file to share with you. This one also made its way to the bottom of the stack after being reviewed and marked up. It is also one of the probably the top 5 filings I follow every quarter simply because following this manger has made me quite a bit of money over the years. Joseph Stilwell is a value and activist investor who has been active in community bank stocks. He usually keeps a pretty low media profile but I have run across him in so many bank stocks that I have learned to pay attention to his buying and selling activity.

He is not afraid to take an activist stake, engage in proxy fights or do whatever else it takes to unlock the value of one his holdings. Since that process is going to make money for investors who get in early it makes sense to pay attention to his 13D and 13F filings. He also writes one of better letters to management when he takes an activist stake with a very blunt fix it, sell it or go home.

Looking at his latest filings Mr. Stilwell was fairly quiet during the second quarter. Smaller bank stocks were stronger in the quarter and there were not a lot of new opportunities to buy stocks at cheaper levels. The story thought out the sector continues to be improved credit conditions, weak loan demand and lower net interest margins. Most of us who invest in the space have our positions and saw little opportunity to add new names or buy more of existing stocks.

The fund did take a position in shares of Charter Financial (CHFN), joining  EJF Capital in owing shares of the recently converted thrift.  The bank has been around since 1954 and has 16 branches in Georgia, Alabama and the Florida Panhandle. Total assets are $1.1 billion. At first glance it looks like the bank has an asset quality program as nonperforming assets stand at more than 4%. A little deeper digging shows that most of those loans are covered by loss sharing agreements and assets not covered by such an arrangement are just 1.08% of total assets.

Like all recently converted thrifts the company has a lot of excess capital after completion of the stock offering and the equity to capital ratio right now is a little over 24. Eventually we hope to see that capital used to pay dividends and buy back shares when permitted. The stock trades at 85% of tangible book value and yields a little under 2%. As the Southeast region of the US continues to slowly recover this bank should see its stock price do very well over time.

Westbury Bancorp (WBB) is a Wisconsin based bank that also completed a thrift conversion offering earlier this year and Mr. Stilwell purchased shares in the bank. Westbury is a 12 branches bank with a little over $500 million in assets and serves the area just north of Milwaukee and is the largest bank in their service area. Post offering the bank has excess capital with equity to assets ratio of more than 15. Nonperforming assets have been steadily improving and are now just 1.72% of total assets. At the current price the stock is trading at less than 75% of book value.

Mr. Stilwell invests in these little bank stocks in much the same manner I do. The filing reports a total of 75 stocks owned and all of home are little banks. We have common ownership in about 10 tiny little banks that cannot be written about here for liquidity reason. Most of them trade at significant discounts to tangible book value and should provide enormous returns as conditions continue to improve. The difference between us is that he is willing to take an activist stake and push management o get the stock price higher, fix operating difficulties or simply sell the bank.  As passive investors we can sit back and benefit from his more aggressive approach. I probably owe him lunch after seeing several holdings improve substantially as a result of his efforts over the years.

Investors with an interest in the Trade of the Decade in small bank stocks would be well served to download and read his filings very carefully.

Special offer for Tim Melvin Deep Value Report

https://marketfy.com/secure/checkout/the-tim-melvin-deep-value-letter/201/?coupon=DEEP20

Invest Like a Pelican

 My daughter was in town this past weekend for a semiannual visit so we schlepped her down to Islamorada in the northern Florida Keys. Given my aversion to frolicking I spent a lot of time on the shore just watching the collection of birds and other wildlife that are so prolific in that part of the world. I confess to a particular admiration for the noble pelican. This bird spends a great deal of its time just hanging around relaxing and observing the world. When it is hungry it flies out to where it knows there are fish, picks off the easy ones and heads back to a nice piling or tree to renewing the observation process. If a fat tasty fish should swim by his perch he will react but he is content to sit and watch the world go by for long periods of time.

Now consider the seagull. This bird seems to spend its entire life flitting form potential foods source to food source. It circles in a mad screaming frenzy looking for an opportunity to eat. It will leave one food source if it thinks the flock has found a better one. One kid on the beach with a hot dog can attract 100 birds  fighting over scraps. Once one seagull finds a potential easy source of scraps the entire flock and every flock within screeching distance heads to it with a great deal of enthusiasm. The late arrivals expend a lot of energy for very little food. It does not strike me a very productive approach to finding food.

There is a great metaphor here for the investing process. Most investors are seagulls. They flock from stock to stock, sector to sector in search of the hottest and brightest ideas. There have been numerous studies showing that individual investors do not earn as much as they statistically should because of this heart seeking behavior. They trade too much and hold for way too short a time to make a decent return on their investing dollars. All too often they follow the squawking flock into areas that are picked over and ready to fall.

We can improve our results by taking more of a bird’s eye view of the market. If you look at stock right now the flock is swarming around stocks like Tesla (TSLA) and Netflix (NFLX) that are popular and priced like lottery tickets instead of corporations. Big dividend paying blue chips have bid up to the point where it looks to me like they are trading for about twice what the business is worth in a slow growth global economy. Large REITs are priced like 2008 never happened and REITs are lining up to come public or do secondary offerings.  Restaurant stocks have shrunk portion sizes and laid off employees so successfully that investors are beating down the doors to buy the shares. When you step back and take a bird’s eye view of the markets it is easy to see the pockets of excess where the flock is fighting over scraps.

It is also easy to see where the easy pickings for long term investors are in the current market. Every stocks are priced fossil fuels will never be used again and we have found some magic solution tour energy problems. Many of them are priced at discounts to net asset. All these companies have to do is survive and their tocks price should rise sharply over the next few years. Energy demand may be relatively sluggish right now but it will pick up in the future. Like it or not natural gas and domestic oil is the path to energy independence for the United Sates and will be for several decades.

Materials and resource stocks are priced like the world is going to end. I do think it may take a while for the natural human desire to improve their lives overwhelms the incompetence of our politicians but it will eventually and there will be strong demand for things like iron Ore, pulp, paper and steel. . Again these companies just need to survive until demand pick sup to pay off handsomely for patient investors.

Net net and near net stocks are the fat fish of the stock market. When stocks trade at levels close to or less that what the entire company could be liquidated for its makes sense to pick up a few shares. They are simply too cheap not to own and history shows us that buying these stocks is usually a profitable endeavor.

Investors would do well to emulate the pelican and avoid the squawking flock of gulls fighting over scraps in their approach to investing.

Check  out the Tim Melvin Deep Value Stock Letter and put deep value investing to work for you

http://www.marketfy.com/store/item/the-tim-melvin-deep-value-letter/preview/

The Right Minded Investor

With all the traveling and distraction this week I didn’t get around to reading Barron’s all the way through until last night. The highlight was the interview with David Rubenstein the co-CEO of Carlysle Group (CG) the giant private equity firm. He made several interesting points in the article including the fact that one of the best opportunities is in the energy space. He told the magazine that carbon based fuels are the most efficient and inexpensive energy source we have and as long as that’s true we will burn the stuff. He doesn’t expect renewables to be a viable source in his lifetime and neither do I. Companies that explore for, produce, transport and store oil and natural gas have not really participated in the market rally of the past few years and are very cheap. Long term investors should be focusing on the group.

He also talked about opening private equity up to the general public by creating vehicles for investors along the lines of limited liquidity closed end funds with monthly or quarterly redemptions. He correctly points out that private equity usually has higher returns than public markets over time for a variety of reason. I have to say I think this is a horrid idea. Investors have proven that they will earn less than they should because they trade too much and are too vulnerable to news, emotion and price action. Private equity vehicle may return more than equity mutual funds but investors will probably enter at the wrong time and exit at an even worse time as they have done with other investments and strategies.

Investor’s do not need a private equity investment vehicle as much as they do a private equity mindset. Private equity earns higher returns because they investor for an average 6 year holding period. They buy companies no one else wants and focus on industries that are out of favor. They buy companies rather than trading electronic betting slips day in and day out. They also sell when the markets are moving up and investors are looking for merchandise to buy. The private equity mind knows that they get more than the company is worth by selling into a happy stock market.

I pay a lot of attention to what’s going on in the private equity world because we tend to be looking at the same types of stocks most of the time. Their activities also usually set a benchmark for buyout prices and that is part of our intrinsic value calculation. If you have a private equity mindset and are paying attention right no you will see that most private equity firms are selling with both hands. In fact Leon Black of industry leader Apollo (APO) recently said that his funds were “selling everything that is not nailed down.” Mr. Rubenstein’s co-CEO at Carlisle recently told the Wall Street Journal “With the world awash in liquidity, interest rates at rock bottom levels and asset prices being bid up, it has become increasingly difficult for us to compete when underwriting our investments, particularly in the U.S., to a 20% to 25% internal rate of return."

A look at recent and pending IPO activity shows that a lot of the deals are private equity cash outs. We have Hilton Hotels coming public soon as Blackstone sells back part of one of the 10 largest PE buyout deals in history. TPG and Warburg Pincus are preparing to unload some of their stake in Neiman Marcus in an initial offering. Blackstone has already unloaded part of Sea World (SEAS) and Pinnacle Foods (PF) in earlier offerings. So far this year there have been 18 private equity backed deals and the IPO calendar is crowded with PE exit offerings. The ZIRP fueled market wants to buy and the PE mindset is happy to oblige.

Individual investors should consider adopting a private equity mindset. Take a look at the market objectively and sell the stocks and sectors that have been strong the past several years and now carry premium valuations. Dividend paying blue chip stocks have been pushed beyond the boundaries of reasonable valuations and are not worth chasing here. Homebuilders have rebounded nicely and now trade above any reasonable calculation of corporate worth. Barring an economic miracle in the next six months many retailers are selling premium valuation in spite of non-premium prospects. High multiple hot story stocks have a had a good run but the time to take the money and run is before momentum shifts not after large selling wipes out your gains in a short period of time.

A private equity mindset is looking where no one else wants to go right now and considering the 5 to 7 return potential for industries like oil and gas, coal, mining and small banks. They are not chasing hot deals or market indexes and are doing far more selling than buying. There are reasons PE returns more than public equity and patience and discipline are a big part of that equation.

Bank Stocks and Alligators

This weekend my daughter was in town and we took a trip down to the Keys though the Everglades. I have never driven the entire length of Highway 41, the Tamiami Trail, and was fascinated by the idea. Along the way we took the mandatory airboat ride back up into the glades and it was quite an experience. I confess to an admiration and fascination of alligators and although I see them all the time walking the dog here in Windermere, this was alligator heaven. They were everywhere and they were enormous. I do not know if you have spent any time watching gators but they are pretty opportunistic creatures. They do not hunt as much as wait for something to be foolish enough to get closer and then they pounce. They tend to eat a lot of smaller animals that wander by but will occasionally take down bigger prey like a deer that makes a crucial mistake. If nothing comes close they are content to float around the lake or take a nice nap in the sun.

Being small bank stock investor is a lot like being an alligator. It is an opportunistic approach as we tend to wait for banks to come to us in price and value and not force the issues. We are looking for the smaller banks most of the time but in environments like 2009 and 2010 larger regionals will also get cheap enough to buy. We wait for perfect little banks with strong loan portfolios and balance sheets to be cheap enough to buy at a large discount to book value or for an activist on other influential investor to take a stake in a special situation bank that has less than perfect loan portfolios or needs capital. If nothing comes by today that is cheap enough we are quite content to just hold what we have and wait. Days and even weeks can go by without a trade. I have owned banks for years that steadily appreciated but at a slower pace than the book value grew so they never became overpriced. I have gone months without adding a new name to the portfolio.  When prey is rich on the ground in periods like 2003 to 2005 and 2008 to 2010 I can become fully invested in an instant. It is a very opportunistic and patient approach to the markets. A good friend once described small regional and community investing on a value basis as the most productive and boring way he ever found to make money in the stock market.

Perusing the bank call reports for the second quarter shows a drop in total banking assets for the second quarter in a row. The biggest drops are in trading assets and real estate owned as banks continue to dispose of troubled assets and cut back on riskier activities. Net loans and leases increased slightly in the quarter with farm loans and car loans leading the way. 1-4 family mortgage and junior lien lending continues to decline as does home equity loans. Commercial and industrial loans as a percentage of total loans are at a very high level of 20.1%. Big banks are rushing to make these loans while ignoring mortgage loans to the greatest degree possible. This bears watching. So does smaller banks exposure to muni bonds in the aftermath of the Detroit bankruptcy as they have long been a safe haven for smaller banks looking for safer investment securities.

Small banks really are the trade of the decade. These quiet little almost boring  stocks can make you a fortune. In the aftermath of the S&L crisis the bank stock indexes rose roughly 10 fold over the next decade and I see no reason the same won't happen this time as banks are ripe for consolidation at current levels.

Check out my new bank stock newsletter for bank stocks poised to outperform :

http://www.marketfy.com/store/item/banking-on-profit/preview/

Tropical Islands and Value Investing

My daughter was in in town last week for the first time since Christmas so we took a little jaunt around Florida. We ended up down in Islamorada in the Upper End of the Keys and spent a fantastic weekend taking in sun and seafood. As the weekend wound down we found ourselves discussing the age old question of why more people do not just chuck it all in and live the island life in the Keys or somewhere similar. After all there are tropical breezes, fresh seafood, sunsets, frozen cocktails and other symptoms of paradise galore and it strikes me a pleasant unrushed place and way to live.

Lots of people talk about doing it. Some even visit for a while and day dream of living there. The truth is that very, very few people ever give it all up and move to a tropical paradise or mountain hideaway town. There are jobs and schools to think about after all. You have to be prepared to basically thumb your nose at conventional thinking, separate yourself from the herd, trade in your dress shoes for flip flops and turn your back on the community at large. You have to be ready to give up the bright lights and big city life, or the comforts of suburbia, to become an island dweller and the simple truth is most people cannot do it. This makes life a little less crowded for those that do make the trade from ties to  tiki  and live a life of which most people can only daydream. The idea either makes complete and total actionable sense to you or it is just a pipe dream.

Deep value investing is a lot like that. Lots of people talk about and only a very small handful ever actually engage in the practice. Everyone can quote Ben Graham but very few people invest like him. Lip service is paid in the form of relative value and other such schemes but there are not too many investors who ignore the income account almost in its entirety to focus on the balance sheet. It flies in the face of conventional wisdom about EPS growth and hot stocks and is in defiance of almost every academic theory about markets ever taught in our colleges and universities. You have to be willing to separate from the herd and buy stocks no one else wants.  Deep value investing makes for bad television and poor tweeting most of the time. You have to practice patience beyond 4:00, and even beyond the next quarterly earnings report. You are buying companies, not tradable electronic blips in the night. It either makes absolute actionable sense to you from the very start or it does not. I see more deep value investors on the list of those with long lasting success and profits, but most cannot resist the psychological pull of the open casino of Wall Street and hot stocks.

Deep value is not for everyone. Not everybody has the discipline and patience to earn the outsize profits history shows us can be earned through business like investing practices such as buying assets for less than their full value. For those that can there is a lot of money to be made. 

Chekc out my Deep Value newsletter here - http://www.marketfy.com/store/item/the-tim-melvin-deep-value-letter/preview/- and put this approach to work for you

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:

http://www.marketfy.com/store/item/the-tim-melvin-deep-value-letter/preview/

http://www.marketfy.com/store/item/banking-on-profit/preview/

Cheapest Banks

It was bought to my attention that in last week’s articles on the cheapest stocks no banks were mentioned. I assure you this was intentional on my part. As part of my ongoing efforts to avoid anything remotely resembling frolicking here at the beach I have spent my time calling everyone I ever met to discuss weighty and lengthy business matters. I also set aside several matters that would require in-depth arduous research and consume as much of the daylight hours as possible. While the others are engaging in traditional beach activities I am on the deck considering bank stocks over a cup of coffee.

While the larger regional banks caught fire last week as investors realized that higher interest rates could actually be good for them this really did not trickle down to the smaller community banks. These stocks are not attracting much investor interest. They are too small for most institutional investors and individual investors. The have moved up off the lows but their valuations do not reflect the vast improvement in their balance sheet and financial condition. The returns from these stocks over the next five to 10 years will be breathtaking in my opinion

The bank stocks that rank among the very cheapest on a price to book value basis have some ongoing problems that have caused the very low valuations. Some are still dealing with credit and loan loss issues while others will need to raise capital. Others are simply struggling to remain profitable due to low net interest margins and higher regulatory and compliance costs.  As a result these banks have a few proverbial fleas on them. If they are able to dust off the fleas and clean up their act the stock prices should rise by several multiples of the current price.

I am a little constrained by market cap and liquidity issues as the very cheapest bank stocks are too small and illiquid to write about. However the cheapest of those large enough to mention is actually the largest bank on the list. I have discussed Synovous Financial (SNV) and will not reinvent the wheel here. Suffice it to say the bank is rapidly cleaning up its act and the stock is very cheap at just 60% of tangible book value. They sold off some distressed assets and but the bullet and charged off others to clean up the balance sheet. The stock may not get back to its pre-crisis highs in above $30 a share but even halfway back would be a 6 bagger.

Intervest Bancshares (IBCA) is hitting new highs but the stock still trades for less than 70% of tangible book value. I confess to missing the boat on this one as the stock did not fit my strictest guidelines and I missed the 13d filings by several sharp bank activists. The bank has cleaned up its act and is no longer operating under restrictions from the Office of the Comptroller of the Currency, although the holding company is still bound by an agreement with the Federal Reserve that restricts some activities. They were recently successful in buying back some TARP securities from the Fed. It may take some time for nonperforming assets to get back to the level of their peers but the upside is tremendous if they continue to have success.

Mutual First Financial (MFSF) is also on the list of cheapest bank stocks. This stock first came to my attention when the guys at PL Capital filed a 13d on the stock earlier this year. The activist firm owns 8% of the bank but has not put forth any activist proposals so far. The bank is not setting the world on fire but conditions are improving steadily. Nonperforming loans are 2.52% of all loans, roughly in line with its peer group. The equity to asset ratio is 10 so they have adequate capital right now. The ROE and ROA are well below their peer group right now but that should improve with time. If it doesn’t look for increased pressure to sell the bank.  A sale would be well above the current 70% of tangible book value.

Several of our old favorites are still on the list as well. Berkshire Bancorp (BERK) has not done much in the last year but it is still cheap at 80% of tangible book value. Pacific Mercantile  (PMBC) is still at less than 80% of tangible book value as well. The super cheap banks may take some time to see their price improve but for long term investors the greater risk is in not owning these trade of the decade stocks.