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Nathan, some investors may feel we've
found ourselves in uncharted territory during this market,
but you seem to think value investors should be salivating
right now. Why?
 Nathan
Slaughter: There are always bargains to be had in the
market. Unfortunately, during normal conditions value
hunters looking for deeply underpriced stocks must often
settle for troubled turnaround candidates or sluggish
companies without any real growth drivers. But during last
year's panic, worried investors dumped their holdings
indiscriminately and threw the good out with the bad.
So now, even the most attractive growth stocks have slipped
well into value territory -- the best of both worlds. We're
finding a number of high quality companies with promising
outlooks and unimpaired fundamentals whose share prices have
become completely disconnected from their underlying value.
Thanks to this short-sighted selloff, investors can drive
home these sleek luxury stocks for the price of an old
clunker.
As you might imagine, we rarely get the opportunity to
invest in premium companies at discounted prices. Sooner or
later, the market will realize its mistake and begin
adjusting the price tags. In the meantime, we're cashing in
on the situation by greedily scooping shares of powerful
industry leaders out of the bargain bin.
Given the sheer number of bargains in the market right
now, what strategies are you using to help readers identify
and profit?
Well, as I mentioned in
Tuesday's issue, there are actually three areas where I
see value investors profiting in this market.
In terms of valuation, P/E and PEG ratios can help give us a
ballpark idea of whether a stock is undervalued relative to
its peer group or historical average. But these blunt
instruments don't really quantify just how much a stock is
worth -- so I only use them as a starting off point. From
there, I dig deeper into a company's competitive position,
balance sheet assets, and future cash flow projections to
calculate a more precise fair value.
This discounted cash flow analysis unquestionably shows that
the number of half-priced stocks (those trading at a -50% or
more discount to fair value) has exploded.
For example, Nam Tai Electronics (NYSE: NTE) has no business
trading below $5 per share. The stock is worth at least $10
-- implying triple-digit upside potential. Sure the
electronics manufacturer is facing some challenges this
year, but how often do you find a company with a market cap
of $203 million that has $240 million ($5.40 per share) in
net cash in the bank? Essentially, that means the market is
giving away the firm's equipment and operations for free.
If you're a value investor with a thirst for growth, then
this is your market, too. For example, Fuel Systems
Solutions (Nasdaq: FSYS), which makes components for natural
gas vehicles, has raised its earnings forecast three times
in the past three quarters and delivered an explosive
20-fold surge in profits over that period. However, the
market wasn't paying attention and pushed the shares down to
a P/E of 12.5, against an expected long-term growth rate of
+25%. That means the stock can be had for an unheard-of PEG
ratio of around 0.5.
Finally, I'm using this downturn to lock up extraordinarily
high yields on cash-rich companies in stable industries that
have been unfairly punished -- such as utilities and master
limited partnerships (MLPs). With crystal-clear cash flow
visibility and limited exposure to the problems plaguing the
broader economy, these stocks are throwing off double-digit
payouts and are likely to rebound sooner rather than later.
What are some key factors you look for in an undervalued
stock?
My overriding goal is to seek out wide-moat companies with
sustainable competitive advantages that translate into
superior long-term returns on capital. Without a powerful
brand name, a patented technology, a sticky customer base,
or some other type of defensible competitive advantage,
nothing else matters and profitability will ultimately be
sub-par.
It's possible for a company to grow earnings and still
squander shareholder value, so I pay close attention to
returns on equity and look for savvy, efficient management
teams. I also place a premium on industry leaders who are
aggressively picking up market share, particularly if the
overall industry itself is growing rapidly and has high
barriers to entry. And if the business model allows for some
scalability as the company grows, even better.
In the end, the traits that most investors covet (expanding
margins, healthy earnings growth, etc.) are all driven by
something larger -- a blockbuster drug, a disruptive new
technology, or aggressive store expansion. So I look beneath
the numbers to determine just what's influencing them.
Ideally, all of this points to steady cash flow generation
(the ultimate measure of a company?s worth) for years to
come.
What are some examples of stocks you've found in the past
that rebounded once investors spotted value and what are
some things you're looking at now?
In my November 2008 issue of Half-Priced Stocks, I
flagged heavy truck maker Oshkosh (NYSE: OSK) as an
undervalued company to watch. The shares had slid from $56
to just $7.66 and were being pressured in part by weakness
in the residential housing market.
But I saw a company whose military vehicle division was on
the Department of Defense's speed dial -- it had just
secured a $187 million contract from the U.S. Marine Corps.
I also liked the firm's habit of hiking dividends about +35%
annually, and the fact that it was still upping its earnings
outlook even in this grim environment.
But the market saw the glass as half-empty, and the shares
sunk to just 2 times earnings (down from a historical
average of 18). At that point, the stock was trading well
below half its fair value. I saw a compelling opportunity,
and was happy to see OSK vault +60% over the next couple
months and rally back above the $12 mark.
In December, I called readers' attention to Brunswick (NYSE:
BC), a leading global supplier of boats, billiard tables and
other leisure equipment. Given tighter access to credit and
slack demand for big-ticket goods, the firm is facing some
stiff headwinds. But after an -85% plunge, most of that
weakness had already been priced into the shares.
Furthermore, management had recently unveiled cost-cutting
initiatives that would slash expenses and keep the company
cash flow positive even if sales plunged. In the meantime,
the shares could be had at valuation levels last seen in
1983. With all that in mind, I added BC to my portfolio at a
price of $3.29 per share in early December -- just before it
surged +85% over the next month.
Today, I'm concentrating a good deal of my analysis in the
infrastructure sector -- an area where both the United
States and China will be spending heavily over the next few
years. Elsewhere, demand for oil may be soft at the moment,
but there's little to suggest this downturn is permanent.
Exploration and production companies will still spend
billions each year to find and develop new offshore
discoveries, which means steady business for offshore
drillers like the one you'll find in the "High-Growth Value
Portfolio" of
Half-Priced Stocks.
I'm also bullish on a company that makes pollution
control systems for coal plants. This firm's groundbreaking
technology will help bridge the gap between traditional and
alternative energy. I profiled this company in this month's
issue of
Half-Priced Stocks and added it to my "High-Growth
Value Portfolio." It should do well in the coming year.
In fairness to my paid subscribers, I can't reveal the
names of these firms here... but you'll get all the details
-- as well as instant access to all three of my model
portfolios -- when you join me at
Half-Priced Stocks.
Good Investing!
-- Brad Briggs
Staff Writer
StreetAuthority Investor Update
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