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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 TheValueGenius.com 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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Value in an Overheated Bear – Buys and Sells – January 2014

Allegedly we’re still in a Bear market, which is only borne out by the large swath of stocks still crawling out from underneath the pummeling that they took in 2009.  Some companies, many of which we had already held positions in, rebounded handsomely. Some are slower to still make the grade.  Finding new opportunities under our strict value rules of higher capital, lower debt, high cash flow and a sustainable dividend yield at a 17% discount to value is, for the first time in decades, pretty impossible. There are no stocks that fully meet our criterion.

Reserving cash or short-term equivalents, your rain barrels to call upon and BUY when either a sector or the economy overall head south is prudent to a degree, but you have to put enough capital to work that the idle capital waiting for the bigger opportunities isn’t dragging down your growth.

To avoid shrinkage you have to beat the rate of inflation. To materially grow your money you have to beat it significantly.  This is what we in the value world do patiently, not chasing hot stocks or selling in the quarter of a second.

So where do we give in, when this racing, overheated market does not provide us with investments that meet all of our objectives?

You look for the best yield on overall income with the shortest (which may be years) window for sustained growth.  The trade off (a little) is in the price. You may have to go to a 12-15% discount window, which yields just a handful of stocks worthy of your long-term holding. Let’s talk about the first one of this week… EPB.

Pipelines are great. They’re run as master limited partnerships (MLPs) that trade like a stock and, from a tax standpoint act like a limited partnership. They have huge tax breaks and incentives put in by governments, state and federal, to build them. They also have incredibly high barriers to entry for competition as government greatly limits their construction and rights of way are not cheap.  Pipelines are a “grimy business,”  absolutely necessary, good times or bad, because oil and natural gas needed to heat homes and drive cars flow through them.  They are cash cows because they are the only game in town to move a lot of material over long distances at a pretty reasonable cost that trains and trucks can’t duplicate.

These MLPs often have good tax benefits because the K1s which they put out can pass through passive losses from the company back to the limited partners. We’ve made huge returns on Kinder Morgan (KMP) and (KMR), and often times the K1s offer some additional carryover “loss” that can be useful.

Pipelines are high cash flow and Mr. Kinder and his team have proven to be exceptional asset managers with vested stakes in the companies which they own and manage that are in line with those of the limited partner/shareholders.

You can’t touch KMP or KMR for the prices we’ve paid for them in the past. Those investments have doubled or tripled and put out huge returns, but there is a newer opportunity that we feel is a good buy in to the pipeline family.

We’ve always generally liked El Paso Pipeline (EPB) a LNG (Liquified Natural Gas) carrier. You might remember selling when we had a murky view about their forward outlook for the next year or three. We like it more now that Kinder Morgan took over management of the company in 2012.  EPB pays out a 7.33% dividend right now, and while we’d like to get it at $30.00, spending up to $34.10 is still in the comfort range of acceptable, particularly with that solid dividend yield.

The company lost a couple of regulatory fights which cost it some income, but that only slowed it to flat growth over the next 12-18 months. New projects coming on line will grow the bottom line and could increase the dividend in early 2016 and beyond that is already very respectable. Note that if you file a short or EZ tax return, this will increase slightly your accounting costs because the stock puts off a K1 limited partnership form which can only be filed with a full 1040. Your tax professional may charge a bit more to process it, but it’s amply worthwhile.

On the horizon: We look for bad news for large, stable companies. Intel (INTC) has had troubles in the news with its miscalculations of the processor market that have allowed ARM, which builds low-power brains for smartphones and tablets, to eat into their core businesses. Intel will do well in the growing cloud computing market, and is going after ARM. They also have space to do build-outs for other chip makers with equipment that isn’t possible to replace. If the price drifts down to the $17 range, buy it. Right now, sadly it is priced in the mid-twenties, at or above fair market value, which is not a good deal… yet, but we watch and wait to see. (WATCH)

Watch for changes in your stocks by reading the reports for warning signs.  We’re off about 12% in Cherokee (CHKE) and selling it off with that haircut, because we don’t like the company much now.

It was a bending of our rules regarding capitalization to take on such a small company that licenses clothing brands, but with a zero-debt balance sheet of a decade, solid brands being sold by the biggest retailers (Target, Kohls, etc.), great cash flow and very respectable profits, it warranted a small  investment, especially as they sell a lot of well-known value brands in budget-conscious stores that did profit from the down economy.

While profitability has been good, the bottom line has not been:  Cherokee has been buying new brands like Tony Hawk from Quicksilver and leveraging up its balance sheets to do it.  Debt has gone from zero to soar well past the company’s cash flow, reducing returns and indicating a very big change in the way that management is running the company.

Some of these purchases like the Tony Hawk deal are questionable, as it would seem that they might have overpaid for the label. It gets worse when the company starts violating its own operational tenets to chase after possible growth in already mature brands.   Last year seemed like an aberration. This year’s increase in debt seems like a trend which we’re not comfortable with.

The dividend borders around 3%. Growth prospects are not looking strong.  Some stocks we’ll ride with for years if we think that they can work through issues, mostly because we look towards management “walking the walk” of fiscal discipline and not chasing a quick buck. We are concerned that the mangement/debt issue will continue to escalate, which, in a zero-moat company that is very minimally capitalized, can cause the dividend that is marginal to evaporate, and further impact the price of the stock. SELL.

Banks are continuing to make the turn upward away from the disasters of 2009.  Bank of America (BAC) is moving into the land of the healthy and the profitable.  Lloyds (LYG) is further behind but getting much better.  Citigroup (C) is still a work in progress. All of these banks will, barring any other major calamities, be moving into good health. If you bought at the bottom, you are already doing fabulously well. Our bottom feeder buys are up 200-300%. Unfortunately we had some top buys too, so we’re averaging the high and low. BAC will have to hit about 19 before all of the stock hits profit territory, but it’s well on its way. Preferreds did well straight through. Wells Fargo Preferred Series J (WFC.J) has been particularly good.

More as we get through the research.

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Are the Fed and Financial Institutions are Screwing Over Poor Americans’ Savings? Bank on It.

Great article at our sister publication, truth-2-Power.com:

Poor Americans Savings

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Reading the News the Value Vulture Way

To understand how to invest as a value investor, you need to know where the financial carrion is going to be. The best way to do that is to not only read the news, but use it to look for the sharp corrections, either in a sector, or in the economy as a whole. Remember that what we seek are big companies that can outlive their bad news. We’re also looking for tax dodges that far richer people have set up that they have to let the general public into to validate, like the limited partnership oil pipeline or the oil “trust” that pay out high dividends that are even better because they are often almost completely tax free.

Value vultures don’t panic. We watch other people panic and profit from making smart buys when fear or some new investment idea that the Wall Street sharks sell to the suckers drives money out of businesses with real value.

Everything starts with money. Politics is no less a slave to the almighty dollar. Understanding current trends then, in American politics, the largest Gross Domestic Product nation in a financial world where GDP is king, is a good idea.

Our company also publishes truth-2-Power.com which focuses  a lot on the people with the money, and what they are doing to manipulate you, and the systems that manipulate you.

What is a current trend in politics worth watching? The Civil War in the GOP. The Libertarian far Right and the Neoconservative near Far Right are slugging it out. Neocons are defense and world power. Libertarians are 19th century capitalism seeking little or no government and placing people into government who act as monkey wrenches to grind the government into dust.

The net effect of all of this is that compromise, the lubricant that makes politics between progressive and regressive and stay-the-course political postures, has dried up.  Without compromise, coordinated efforts to boost the economy break down.

How does that relate to your money?

The stimulus did indeed work, with apologies to conservative investors who spend too much recreational time watching Fox News. It took a long time because of the safeguards that are put in place to avoid rampant fraud. Good or bad, it takes years to get construction projects for roads, bridges, and schools in motion.

If you look around, there are all kinds of capital improvement projects on roads and airports and what-not that took three years to get the money into the full pipeline, but it’s there now.

That means that if you’re a concrete supplier, or a steel supplier, or you own a construction firm that does large projects, some of this cash is finally coming to fruition.  It means more  money for shipping companies that move all of the materials, from raw to finished goods, too.

It also means that if you’re a new home builder, you might be seeing a few new customers taking advantage of low interest and contracts that will keep people employed through the “downturn.”

You also will note, if you read the news, that everyone is conditioned by the media to talk about how bad the economy over the last few years was, yet the people on Wall Street and those who invested wisely in 2008 and did not panic made hundreds of millions of dollars on purveying that bad news.

Many businesses used the excuse of the Great Recession to fire workers who had been technologically obsolescent for years but who could not be fired unless the business was under imminent financial threat. Companies laid off thousands of workers who computers replaced, and downsized departments. Many CEOs got fat bonuses for pink slipping people as they made their businesses more efficient, and rode through 2008-2011 pocketing the profit.

In the short term, all of these companies took hits.  In the long term, the bigger, healthier ones have come out even more healthy.

If you read the news you might see that construction starts are estimated to be up. Stocks like Cemex (CX), which we follow, easily one of the biggest cement producers in the world, have been getting their debt in line over the last few years after taking a drubbing for being too leveraged (having too much debt) and getting caught in a risky position during the downturn.  They may start to pick up as more people buy cement for bridges, roads, schools and housing. You might make a small investment in CX at the right time if you thought that the countries in which they do business will see some improvement in their overall economies in the next five years.

Also remember, while reading your news, that you have to take the right view of the news that you’re reading.  News is written for the minute, hour, day or week. You are investing in 5-7 year time windows.

How good is the dividend on a stock to buy your patience? How much upside is there to the bad news?  Calamities like a Black Friday or the melt down of 2008 are the real deal. False fiscal cliffs might give something of a bump but less so, because too many of the “smart” guys on Wall Street know that it’s false and won’t tell their clients to head for the exits of their investments.

Likewise, be cautious about giddy news of disaster in places like Greece. The European Union is going through growing pains.  What drove them to union and a single (sort of) currency was not preference but need: The U.S. would always kill them individually for GDP, and a rising China further marginalizes their smaller ability to grow GDP as a bunch of fractious states.  The likelihood that the EU will dissolve completely is zero.  Yet financial folks sell that fear to push people out of European stocks and into whatever they are peddling instead.

Look instead for the EU to have to figure out how to cede more “national” power to the larger EU authority. They are, kicking and screaming, becoming more like the United States because the formula works and, even with their centuries-old traditional power structures and traditions screaming about change, the money dictates the political reality.

So it is wise, when reading the news, to look at companies in Europe with the viewpoint that all of those people to feed, clothe, entertain, etc. all have a value that is not going to be destroyed completely, even by temporarily myopic politicians.  We look then, at long-haul companies in necessary services like French Telecom (FT) that sell communication services to the now-depressed EU and whose stocks pay handsome dividends.  People still need telephones, and crave the Internet, so telephone stocks are becoming like entertainment stocks.. Good places to weather leaner financial years and to profit when people have the money to spend to watch HuluPlus on their iPads.

We look at non-dividend paying bargains like insurer-bank Lloyds of London selling at pennies on the dollar.  European banks will be punished for a long time, perhaps up to a decade, for their sins, but eventually, they will start to get fat and healthy again.  Banks are the lynchpin of the economy. If they remain unprofitable, the rest of the economy suffers because they will extract their pound of flesh directly out of their borrowers.  They also have the political capital in any country to throw their muscle into getting what they want done.   The bigger ones, as we’ve seen, ARE really too big to fail. The government needs them.

So when we look at the news, the normal stink of the rotting corpses of businesses sitting under the bad news of the day that temporarily drive away other investors are really our big meal.

You could get builders like Toll Brothers  (TOL) for $18/share or less in 2009. Today it sells for $33 on a recovering market. At the time you bought it, the news was full of doom and gloom for the builders. Life would be bad for a decade or more. So another facet of reading the news is learning how to shed off some hype.

Go back and look at historic trends for companies in the market sector, like home builders, that you’re looking at buying. There have been corrections and shocks before. Did it really take a decade for them to rebound?  Not really. Usually about 3-5 years, which, as we know, is a perfect value window for making an investment.

Remember too that the key to value investing is in the purchase of stable companies with good cash flow that are suffering from temporary set-backs of their own making or the economy’s.  Read the news with that in mind, and you will start to see your Value Vulture carrion much more clearly.

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July Buys 2012

NOKIA CORP SPON ADR F1 ADR REP 1 NOKIA CORPS (NOK) – We already hold some of this stock.  Nokia continues to be pilloried by the market. The stock dropped to a new 52 week low of 1.92 last week. We like the stink of decaying flesh on corporate bones.  Nokia missed the smartphone wave, and the Tsunami landed on it. They have made deals with Microsoft for the Windows platform and a joint project with Siemens.  Right now, the brain trust of analysts is saying that Nokia will cut its dividend (likely) and that one should sit on the sidelines.  Microsoft infused quite a bit of cash, over $1B into NOKIA to work with a partner to catch up on its Smartphone ambitions, but it did not give an exclusive to the phone manufacturer. They also are being hammered on the low end by Asian competitors who offer viciously low pricing, and their brand name has all but evaporated from the U.S. market. All that said, at $1.92, we think that  NOK isn’t going out of business.  Further, even though the company got burned going its own way with advanced mobile phone devices and got smoked by Apple and Google, it holds substantial patents that Apple and Google need to access, which we believe are worth more than its current very low share price. It holds a BB+ credit rating from Morningstar. Its dividend is at 9.2%. If slashed in half 4.5% is still not that bad to buy a bit of patience.  We are buying cautiously, but see a lot of upside potential at these basement prices. BUY

CEMEX (CX) – The Friday before last the Senate passed a two year, $105B transportation bill that should be good news for Cemex and other building material suppliers. Cemex has been a gradual build of purchases of the world’s largest producer of ready-mix concrete.  Cemex has operations in the US, Mexico, South America, Europe and Asia.  They have been selling off non-core assets to reduce their debt load after acquiring Rinker just before the 2008-2009 correction.  The stock has great recovery potential 2015-2017, which, while a bit slower than our original estimates, is in line with the pace of economic recovery. Look for book value to return to the $15/sh range in 2015-17. At $6.53 you’re getting a great company at a good discount to fair market value.  BUY

 

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Buffett Buyback

What the Fed can’t do, Warren Buffett, whose Berkshire Hathaway is probably more sound than the Fed in many ways, particularly in investor sentiment and trust, is doing. The Omaha Billionaire who may be the last of the great American tycoons signaled that Berkshire would be buying back its stock, which it thinks is cheap, under some strict guidelines.

http://www.ft.com/intl/cms/s/0/f7b22a60-e846-11e0-9fc7-00144feab49a.html#axzz1Z8uZgbq6

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