Archive for January, 2016

Is It Henny-Penny Time?

My son sent me an interesting article from Royal Bank of Scotland where their analysts suggested selling off stocks because they expect a 20-21% correction.

As value vultures, we have to love stories like this, because enough of them cause the lemmings to become jittery, and lemmings “flight to quality” usually the “safety” of losing money in Treasury Bonds,  leaves dozens of the world’s best companies at amazing prices.

First, to the facts. There should be a 20-21% correction. The market has been far, far overheated the last few years, and is trading outside of the fundamentals of the world economy.

The last Great Recession was precipitated by not just far too much global greed in the housing market, but by other firms short-selling the market in companies which had stocked the housing system with junk, to blow it up for their own profit-taking.

It left numerous opportunities.  And, while some banks like Citibank never really recovered from their disaster, ladder-buying other “too big to fails” did end up becoming quite profitable.  We became debt holders of General Motors (GM), which made us equity holders of the new company, and saw one of the most profitable bond plays we’ve ever done.  Knowing which end of a distressed company to get into, their equity (shares) or debt (bonds), is really a matter of looking at their balance sheet and their ability to recover and deciding if you want to be there at all, or,  if you do, which end of the investments to participate in.   We bought Starbucks at $6.16 a share, and sold it at $16.85. We bought all kinds of companies whose dividends remained relatively secure, at base rates of 10-16%, and, even some that had their dividend slashed or dropped for a period of time reinstituted them when the storm clouds cleared, and we were rewarded with gains in both the stock and in the returns on the stock again. Meanwhile fully 3/4s of our stocks maintained their dividends, which we took in at double-digit rates and provided more cash flow to buy undervalued stocks.

Then the lemmings moved back into equities, out of treasuries. We made a lot of money selling to them.  The supply of quality value stocks really dried up, which is why you haven’t seen much in the way of articles at because we haven’t had a ton to talk about.

As you know, if you follow my investment strategies over the years, I generally can find great reward in extremely large companies that have great cash flow, generally lower debt, and resources or infrastructures that cannot easily be replicated.  This is the modern equivalent of what Benjamin Graham dubbed “grimy companies.”  All of them hit hard times that are not of their making.  Some companies accumulate value that hasn’t been discovered by the analysts, or is discounted by people who don’t understand the business model, or who don’t have faith in it when the numbers suggest that they should.

So is the sky falling?  Not really.  The softening of China’s ability to produce is significant.  They were the fountainhead of cheap goods for decades, but the signs of the wheels coming off that cart have been happening for at least five years, as we’ve seen even the Chinese farm business into Vietnam and Cambodia in search of cheap labor, and develop connectivity into Africa as a future zone of cheap labor.

We should expect the correction shockwaves to continue, but we in the value world look at it like farmers in California see rain after their long draught.

There is no end of days in this modern economy. The world’s money is too interconnected. There are going to be cliff-worthy drops in some stocks that are overheated “air” that were purchased too high by amateur investors and their even more amateurish “experts” at the full and semi-service brokers schooled in grinding stocks like sausage.

Still, bottom line, you have to ask yourself:  Is McDonalds going out of business in a major correction? Is Starbucks?  Will a company that holds 30% of the world’s resources like aluminum or tin or copper really not have any value for a decade or more?  Oil will ultimately be phased out of the world’s energy supply as will coal, but will it happen overnight or over 10, 20, 30 or more years?

People panic because they make the mistake of thinking that the number on their brokerage statements when it’s up, sometimes way up is real.  Sell when you make a reasonable profit, lock it in, and that  is true. Otherwise, it’s just a notation, just as much as when it’s down 20-30%.

How you make money, as a value investor, is sticking to the fundamentals of the craft.

Find the stocks that are dinged or damaged by circumstances, but have the strength to weather the ups and downs of the market. Buy ones that pay a dividend that rewards your patient holding of them.  Sell when you can’t see any forward growth or them taking another turn downward after a period of great years, and then even buy them again if you find that opportunity to get them at a discount and another run of bright future lies ahead.

Other people’s fear is our fodder.

So what can we expect?

China’s economy will take a substantial hit.  It will not cripple the world economy. Beyond the initial panic of the cheap goods machine not producing at double digit rates, corporates from around the world will find opportunity in exploiting China’s woes because China’s oligarchs, as they always do, will tinker with their currency, economy, and market to get things on track again, which, in effect, will be something like a “sale” on their goods and services.

It’s a correction, and the DOW, which, by real value, really shouldn’t be much more than the mid 16,000s, will correct from the 17Ks where it’s been down to a more realistic level.

Meanwhile, several value stocks will get caught up as the lemmings freak and head for the exits, and those who are heavy into Exchange Traded Funds will see how they underperform in down market conditions enough to possibly think twice about holding them long-term. (We’re not  believers in this newest form of Emperor’s New Clothes market gambling.).

Some stocks to keep your eye on:

Amgen (AMGN), Proctor & Gamble (PG), and Koninklijke Philips NV (ADR) (PHG) – Thanks to Alex Ross for that last find, an excellent choice!  All are companies that are moving out of periods of doldrums into new phases of growth. At the right discount to fair market value, at least 17% under, they are attractive buys in a down market that can be held for years and perform well.  PG was THE flight to corporate safety during the bottom of the Great Recession, as it makes so many products that are a part of daily life that it really isn’t going anywhere, and people have no choice but to buy what they can with what they have, even when bankers are jumping out of windows.



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China’s Tiger Value Window

China’s economy keeps showing its big, ugly cracks. Real growth is nowhere near where it was a decade ago, and even though the Chinese have been keen on initiatives for internal growth, the hyper-infated market rife with government meddling, corruption, and mismanagement are causing the Shanghai and Shenzhen exchanges to melt down, albeit with some government imposed fun-and-games on the way down.

That in turn is causing stock markets around the world, fat with their own hyperinflation, to rattle with some profit-taking on the chance that the Chinese system causes a domino effect.   This, then, brings the prices of several stocks that were hovering outside of value range into line for purchase.

Potash Corp of Saskatchewan Inc (POT) is a $32.00 stock selling in the $16s at the moment. With approx. a 68 year proven reserve of the minerals used in fertilizers, and one of the three legs of the potash oligopoly, this is one of those fundamental “grimy” companies that Benjamin Graham would have loved.  With lower costs of production, it can ride out much of the swings in the commodity. Excellent management, reasonable debt, and a 9.2% dividend that is sustainable all make this a great opportunity of the moment. STRONG BUY.

Other old favorites that we’ve dumped after they’ve had big run-ups are back in play range, with forward news that looks like they’re good for another run upward. Read the reports at Morningstar, which aren’t bought and paid for by the Wall Street firms hustling this and that on the hour or minute. If China continues to rattle markets, all might have some minimal lemming shift out of them, making them attractive.  We’re buying in smaller increments and picking up more at a lower price if we can get them using the laddering techniques we’ve described here at the VG. Here’s our thinking on them:

GAP (GPS) is an older holding that we sold off in one of the clothing retailer’s better headwinds, but since then it has not only solidified its empire, but it has began to scale back its retail operations to the more profitable ones in favor of additional capacity on its web/virtual shopping side. The focus looks to make for greater profitability long-term. (BUY)

CSX Corp (CSX) is one of the nation’s premiere railroad companies, and it’s done something which it wasn’t expected to do when we sold it: Beat the shrinking coal market. Coal has been the backbone of most rail empires, and between the move to solar and warmer weather, both have sent coal sales through the floor.  CSX nimbly has picked up more car and container business, and figured out how to keep its labor costs lower. The stock is at a discount and just around the 3% dividend window that we use along with a 17% discount-to-fair-market. (BUY)

Amgen (AMGN) has been in and out of our portfolios for a while. When it takes one of its legendary runs, we try to be on the ride. When it looks like something may break the run, we depart, and wait for the next trip. Today is the day to get on board. Amgen under $155.00 with a fair market value of $194.00 and a dividend currently around 2.6% is a great slow growth machine which, at the moment, has a pipeline full of opportunities that look like it will prosper for the next few years. This stock will move around with the burps in the market, so don’t buy a full position at once if you can avoid it. (BUY/LADDER).

I’m a bit less enthusiastic about Union Pacific (UNP), but it’s a well run company and it has a massive footprint that is impossible to reproduce. Their exposure to coal, even with their excellent handling of it to date, still remains a question mark.

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