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October 28, 2008 | SIN Picks | | Author Asif

Benjamin Graham, the teacher and mentor of Warren Buffett, wrote two seminal tomes on value investing called Security Analysis in 1934 and The Intelligent Investor in 1949. I was reading The Intelligent Investor at a time when the bear market following the dot com bubble was in full swing and I remember thinking to myself that some of what Mr. Graham mentions in his book may no longer hold true as even at that point  it was almost impossible to find stocks that met his criteria such as a Price/Book ratio of less than 1.5, a P/E < 15, uninterrupted dividends for last 20 years and an adequate margin of safety.

If you like bargain hunting for things, you are probably aware that there is an intrinsic value to things and unless the seller is in distress it is very difficult to get something below this intrinsic value. However the market, which is driven more by psychology than the underlying realities sometimes offers us opportunities at deep discounts to their intrinsic value. This is one of those times and if you have the courage to act, it could represent the opportunity of a lifetime. To quote Mr. Graham,

“Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it- even though others may hesitate or differ. You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right. Similarly, in the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand.”

If you did not see ahead of the curve (very few people do) and rebalanced your portfolio at the start of this year, there isn’t much point in liquidating now as you would be reacting to current events and headlines rather than looking ahead to the next curve in the road.

In the 2008 Outlook section of the January 2008 investment newsletter, I wrote,

“With rising unemployment, declining manufacturing activity, home prices declining 6.7% in the 10 largest metropolitan areas, the inventory of unsold homes representing a 10.3 month supply and record levels of national/personal debt, my enthusiasm for common U.S stocks is the lowest it has been in years and I am even more bearish than I was at the start of 2007. I believe that cash, certain high yielding investments like Canadian energy trusts as mentioned in the blog entry Quest For a 6% yield, generic drug manufacturers like Teva Pharmaceutical (TEVA) and consumer staples companies like Unilever (UL), Church & Dwight (CHD) (the company that makes Arm & Hammer products as well as Trojan condoms) and Procter & Gamble (PG) might be the best places to be in 2008. Unilever and Procter & Gamble have the added advantage of benefiting from middle class expansion in Countries like India and China not to mention a favorable exchange rate.”

After a nearly 40% year to date drop in the major indices, most individual investors are panicking and moving to cash or worse yet are ready to accept negative yields on treasury bonds. The oft repeated mantra is that it is best to wait until things stabilize and a clear uptrend is established. Unfortunately just as it was difficult for most investors to predict this bear market, it is going to be equally difficult to identify signs of stabilization when they occur or identify a “clear” uptrend as any move up could just as easily turn out to be another bear market rally.

Record redemptions from mutual funds and margin calls at hedge funds have created an environment where almost every sector, asset class and country is declining simultaneously. Former hedge fund favorites like commodities and emerging markets are especially hard hit.

My personal favorite indicator of just how scared investors have become is this story about how sales of safes increased 50% towards the end of September and early October. Anecdotal evidence aside, the P/E10 of the S&P 500 is currently about 13.86 based on Yale Economist Robert Shiller’s data (excel), which uses the average of 10 years of trailing inflation adjusted earnings. This is a level not seen since 1987. Please note that since Dr. Shiller last published his P/E10 value in August 2008 and I used a 33% drop in the S&P 500 since then to reach the number 13.86 assuming that average trailing 10 year earnings stayed constant in September and October.

Certain individual stocks are selling at even lower valuations and the key is to focus on companies with strong balance sheets and steady free cash flow. I have started buying aggressively for my personal portfolio in October and have added to my positions in the following stocks: Intel (INTC), Pfizer (PFE), Activision Blizzard (ATVI), Lionsgate Entertainment (LGF), Nokia (NOK), Mattel (MAT), Barclays Plc (BCS), Alvarion (ALVR), Tata Motors (TTM), Powershares Water ETF (PHO) and Jan 2009 calls on ICICI Bank (IBN). As you can see from the archives section of SINLetter, every one of these stocks has been featured in past newsletters and you could consider this list my current high conviction list.

I plan to make one additional round of purchases to buy Sterlite Industries (SLT) and Flextronics (FLEX), which has a forward P/E of 3.05 and P/S of 0.09. I am also considering buying Suburban Propane (SPH) with its 10.2% dividend yield (distributed from operational cash flow). I plan to cover Suburban Propane in more detail in the next investment newsletter and as usual will post my plans about purchasing these stocks on the blog before I buy them for my personal portfolios.

I am also going to try and leave some cash around to buy either S&P 500 or Nasdaq LEAPS if the market drops an additional 15% to 20% from these levels.

Given the uncertainty that many are facing at a time when even disruptive companies like Tesla Motors are laying off employees, it may be a good idea to increase emergency cash from the usual 3 to 6 months of living expenses to a year of living expenses based on job security and other factors. These are trying times and the economic news is likely to get worse for months to come before it gets better. As always do your own research and come to your own conclusions before taking any action.




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