Who would have thought that a Depression-era investing style could be in vogue in 2009? But a growing group of investors are digging out their old textbooks and taking refresher courses in valuing companies based on margin of safety, current asset value and a slew of other concepts perfected 75 years ago. The market’s crash, while devastating to many people’s net worth, has created the types of bargains that drew many pros to investing in the first place – good businesses that can survive the crisis but are trading as if they’re dead. The recent rally hasn’t changed that.
These retro ideas are mostly attributed to legendary investor Benjamin Graham. After taking a beating in the 1929 stock market crash and again in 1932, Graham wanted to tweak his investing style to make money over the long run while taking a lot less risk. Graham, with the help of co-author David Dodd, wrote down their principles in the 1934 book “Security Analysis,” a tome now considered a stock-picking bible by many investors, including Warren Buffett, who studied under Graham. The duo’s theories boil down to a simple goal: An investor should aim to buy $1 worth of company for a lot less than $1.
Some pros say the stock market wipeout indiscriminately crushed companies of all kinds, and they are finding more Graham-esque stocks than at any time since the 1970s. Sure, 21st-century investors have applied some tweaks to the old theories, but high-quality businesses such as Comcast are now trading at below book value, a staple metric of old-fashioned value investing. “That gives you courage when you are looking at some wormy type of situation,” says John Spears, co-manager of the Tweedy, Browne Value fund.
To be sure, many investors, including Buffett, have been tripped up by this perplexing market. Last fall and winter, seemingly underpriced stocks fell even further; since then, the ups and downs of bear-market rallies have made it even harder to judge stocks’ values. But for the first time in decades, Graham-style investing is turning up some great companies that could also be great long-term investments. Below are five back-to-the-future picks.
Judging by the price of shares, the stock market seems to be saying Williams Cos.' exploration and processing operations, two lines of business which brought in more than $2 billion in profits last year, aren’t worth much. That makes the Tulsa, Okla.-based energy firm, in the eyes of some investors, a quintessential Graham stock, one that trades for far less than the sum of its parts. The disconnect leaves some investors flabbergasted. “I’ve never really seen these types of opportunities before,” says David Giroux, manager of the T. Rowe Price Capital Appreciation fund, which owns Williams shares.
Williams is primarily a pipeline business, but it also sits on 4.5 trillion cubic feet of natural gas. It has a so-called midstream business as well, which processes the gas and sells byproducts such as propane. Clearly, those parts of Williams aren’t as valuable when natural gas is priced at around $4 per million cubic feet, like it is now, versus almost $14, where it was last summer. Still, several analysts believe that the market is not valuing the operations high enough. After all, the businesses combined still are expected to make at least $725 million in 2009.
The only business the market seems to be giving Williams credit for is its 15,000 miles of pipeline, which carries natural gas up the East Coast and through the Pacific Northwest. But even that, some investors contend, is undervalued, because the pipeline makes money regardless of energy prices. “It’s a cash machine,” says Don Wordell, manager of the RidgeWorth Mid-Cap Value Equity fund, which owns the stock.
Security Analysis was written back when television was a novelty and cable was nonexistent. But many modern-day investors feel that if Graham were around now, he might be attracted to America’s largest cable company, Comcast.
Cable is not recessionproof. In the final three months of 2008, Comcast disappointed some analysts when it added only 290,000 new subscribers, down from the 732,000 it added in the same period in 2007. But the company’s 45.6 million customers are on average paying 9 percent more per month now than they were a year ago. For all of 2008, Comcast had $2.5 billion in earnings, a 23 percent increase from 2007, on $34 billion in revenue. The profit number was impressive, but its free cash flow, or the money left after paying the bills and reinvesting in the business, was even better, rising 56 percent, to $3.7 billion. Comcast expects to grow again in 2009, Chief Financial Officer Michael Angelakis told investors in February.
The valuation itself is compelling to many fund managers. Comcast’s free-cash-flow yield, the amount of free cash it generates divided by the company’s market value, is 9 percent. That’s high on its own, but when compared with the 10-Year Treasury bond, which yields less than 3 percent, it demonstrates what Maloney calls “a heck of a margin of safety,” another Graham favorite.
Dell has been trying to right itself after falling from its perch as the world’s largest computer maker in 2007. But just when Dell was laying the foundation for a turnaround, personal-computer sales slowed as the recession took hold. The result: Dell’s stock recently traded at its lowest level since 1997. While a low price alone doesn’t make Dell or any other stock a good deal, the Round Rock, Texas, company has $9.5 billion in cash and investments. That’s equal to $4.77 a share, or almost half its market value. “It has become so cheap, you can almost say the operations can go to zero and you could still come out ahead,” says Charlie Bobrinskoy, director of research at Ariel Investments, an asset-management firm that specializes in value investing.
That kind of math is drawing investors like Causeway Capital Management’s Sarah Ketterer. While she admits Dell’s turnaround isn’t a sure thing, she says the cash and a low debt load “gives them the financial wherewithal to take a lot of blows.” The company still holds the No. 2 spot (after Hewlett-Packard) in PCs and boasts a strong presence in data storage. Then there’s all that cash. Dell has started making small acquisitions, and some think it eventually might pick up a computer-services business. However, Dell Chief Financial Officer Brian Gladden told investors in February its plans would be “pretty conservative” in the short term, with an eye toward “liquidity and survivability.”
NV Energy supplies the power to Las Vegas, but investors looking at its recent stock price might wonder if all the neon in Sin City has gone dark. The company’s shares have fallen by a third in a year, as the casino and construction booms in Vegas have turned to busts. But the market value of the firm is far less than what its power plants and other assets are worth. In Graham’s lexicon, that means NV is trading at “less than tangible book value,” one of the factors he and Dodd looked for to find undervalued companies. “It’s trading like it’s going out of business, and that’s not the case,” says Robert Becker, manager of Cohen & Steers Global Infrastructure fund, which owns the stock.
Analysts estimate the company could generate a 10 percent annual profit increase over the next several years, thanks to investments in wind turbines and other renewable energy sources. Plus, regulators are weighing in on NV’s rate hike request. While raising rates is hard during a recession, NV may have a better shot than most because of its relatively amicable relationship with Nevada and California utility regulators, says T. Rowe Price utilities analyst Steven Krichbaum. Meanwhile, NV reinstated a dividend in 2007 and, unlike many high-profile companies of late, has been raising that quarterly payout. It now has a 4 percent dividend yield.
In “Security Analysis,” Graham and Dodd wrote about Patican Co., a conglomerate that held stakes in many miners. The stock of Patican traded at a big discount to the value of the smaller miners it owned. This was an example, the authors declared, of an undervalued stock.
That resembles the current situation of Japanese trading conglomerate Mitsubishi. The giant firm has 590 affiliates, from copper mines in Chile to a solar-power producer in Portugal (not cars, however; that’s another Mitsubishi). According to some analysts, the parent company trades well below its book price, or the value of all the smaller firms it has stakes in.
Investors have begun to notice – the stock is up more than 30 percent in the past month. But more good news could be on the way. The company has built up its cash reserves to about $14 billion to shore up its already strong balance sheet. Mitsubishi Chief Financial Officer Ichiro Mizuno told analysts in February that the company would try to sell assets to fund new investments. But despite a cautious approach, a spokesperson said Mitsubishi would not miss out on good medium- and long-term growth opportunities.
T. Rowe’s Giroux says Mitsubishi is not in as bad a shape as some other investors believe. Many of its metals and energy stakes were bought between 1998 and 2002, well before the recent commodities boom. The company is still generating cash, proving it is not wasting away. “If we sold (Mitsubishi) off in pieces, we would get substantially more than what it trades for,” Giroux says.
Copyright The New York Times Syndicate