Agora Financial’s Rude Awakening

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Laguna Beach, California

·      Six dirt cheap companies for your consideration,
·      Some words of wisdom from the “Father of Value Investing,”
·      Bargain hunting like it’s 1929 and plenty more…

Eric Fry, reporting from Laguna Beach, California…

Epic stock market panics don’t happen every day, which is why no one knows quite what to do when they strike. No one knows whether to buy or sell. But everyone knows that they must do one of the two…and that their choices could dictate their financial destinies.

Now that a relentless barrage of stock market selloffs is raining down upon us day after day, most of us investors are just trying to avoid the shrapnel of lifestyle-altering capital losses.

We are scared…and we are afraid to raise our heads above ground level. But as we wile away the hours in our financial foxholes, we wonder what the heroic investors of legend are doing. Are they ducking also? Or are they loading up their high-caliber brokerage accounts and charging into a hail of “Sell” orders, hoping to capture as many wounded stocks as possible?

Of course, even if we knew exactly what these heroic investors were doing, we aren’t certain we’d be doing the same thing. Cowardice is not always a vice. It’s true that cowardly soldiers never win any medals, and never advance up the ranks…but it’s also true that cowardly soldiers tend to live longer than courageous ones.

So we think it’s fair - and prudent - to wonder what sort of war we are fighting. Is the stock market of 2008 like 1974 - a market that dropped 45% from its high and then advanced, more or less, for the next 30 years? Or is 2008 like 1929, a market that fell 40% from its peak, bounced a little, then erased another 50% of its peak value before hitting its ultimate low?

Raise your hand if you know the answer?

We should also mention that today’s stock market valuations remain well above those of previous panic lows. Today, the S&P 500 sells for about 13 times earnings and yields 2.3%. But at the bottom of the 1974 bear market, stocks sold for only seven times earnings and yielded three times more than they do today.

So you see, all panics are not created equal.

We realize that many of today’s heroic investors are the guys who won all the Medals of Honor during previous bear market campaigns. But we also realize that old soldiers sometimes use old tactics to fight new wars. And the Bear Market of 2008 looks to us like a brand, new sort of war. It is so new, in fact, that we haven’t seen anything like it since the 1930s.

Therefore, we have no confidence that today’s “smart money” will also be tomorrow’s. Maybe the guys like Buffett - who are buying up stocks at current prices - are fighting the last war, and not the current one. But Warren Buffett’s investment record is indisputably brilliant. So if this old warhorse is charging into the battlefield, we should probably consider trailing behind him…at least from a distance.

And Buffett isn’t the only soldier of fortune that’s joining the fray. So is James Paulsen, founder of Wells Capital Management. Paulsen is the guy who booked more than $1 billion betting against the very same mortgage-backed securities that crippled the American financial system. In other words, he anticipated the disaster and made a fortune from it.

Last April, while Treasury Secretary, Hank Paulson, was foolishly declaring, “The worst of the credit crisis has passed,” James Paulsen was warning, “Jumping in too early in the credit cycle can be a disastrous investment situation…

“I think the credit crisis is not over; it’s likely to get worse,” the hedge fund manager cautioned during the Grant’s Investment Conference last April. “My outlook for the economy is that house prices will continue to fall and consumer spending will continue to decline. Credit costs will rise, the recession will be worse than anticipated, and fiscal and monetary stimulus will not be able to stem the decline.”

Unfortunately, these dire predictions came to pass.

Paulsen, the billionaire hedge fund manager maintained his bearish tactics, even while Paulson, the mega-millionaire Goldman Sachs Alumni, was conjuring up ever-more-creative ways to funnel government money to Wall Street firms. But Secretary Paulson’s ruse failed. The stock market tanked. Hedge fund manager Paulsen’s bets paid off…and then he began adjusting his outlook. The bearish Paulsen started tiptoeing toward the bull’s camp.

“Assets are being given away,” he said recently. “They may not do well in the next several months, but looking ahead two or three years, investors may see some of the best opportunities of their lives.”

Declarations like these, especially from the lips of those who have been betting successfully against the market, pique our interest. And so, over the last few days, we’ve consulted with several successful investors whose insights we value. The gist of these conversations revolved around one simple, two-part question: If we should be buying, what should we buy? The column below contains highlights from these conversations.

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Soldiers of Fortune
by Eric J. Fry 

Should we be buying stocks? History says, “Yes.”…Well, history doesn’t actually say, “Yes,” it says, “Maybe…I guess…if you think that’s a good idea. Buy you should probably buy slowly and cautiously…Did I answer your question?”

History tells us that epic panics create epic buying opportunities. Inconveniently, history does not tell us in advance how long the panics will last or how low stock prices will ultimately fall. Great buying opportunities always present themselves in hindsight. In other words, to quote Henry Ford, “History is bunk.” Financial history, in particular, is bunk.

Therefore, knowing only that we do not know how low prices will fall, we must exercise a measure of caution and prudence. That said, a cheap stock is a cheap stock, even if it is destined to become cheaper. So let’s get a little crazy. Let’s imagine that we are prepared to risk some of our precious capital. Let’s imagine that we are prepared to stare financial peril straight in the face until it buckles under the strain and runs away whimpering. Let’s imagine that we are courageous enough to buy a stock…What stock would we buy?

In the midst of one of the many recent multi-hundred-point selloffs, your editor dialed up an expert on Canadian investment trusts.  “Hey Danny, how’re you holding up?” Your editor started off.

“I’m still answering my phone,” came the reply. “But I can’t say that I’m enjoying myself.”

“Well, you’ve got plenty of company,” your editor empathized. “This is brutal. So what’s the smart money doing?”

“No idea,” Danny joked. “I haven’t seen any smart money around here for several weeks.”

“Okay, so what are YOU doing?” your editor persisted.

“Well, all of my clients are selling, so I’m thinking that I should probably be buying.”

“Are you?”

“A little,” Danny said, “but the problem is that the stocks I follow looked dirt cheap two weeks ago. And now they’re down another 30% or so. It’s unbelievable.”

“What’s causing this carnage?”

“Panic…Pure panic.”

“Understood,” your editor empathized, “but if you were making your first buys today, what would you buy? In other words, if an alien, loaded down with cash, stepped out of his spacecraft and strolled into your office, what would you tell him to buy?”

“Almost anything,” came the reply. “I’d start with Penn West (NYSE: PWE). That’s a blue chip investment trust that’s down 50% from its mid-summer high. And now it’s yielding more than 20%.” [Editor's Note: Your editor does not own Canadian investment trusts, but at least one member of his extended family owns PWE and ERF.]

“Amazing!” your editor replied. “Is this company susceptible to any credit problems?”

“Not that I know of,” Danny said. “It carries very little leverage. But look, with the benefit of hindsight, you can see how we got here. Oil is collapsing, the Canadian dollar is collapsing and to top it all off, investors are freaking out. You add it all up and you get Canadian investment trusts that yield 25%!…I mean this Canadian dollar is just hard to believe. It is down 4% just TODAY! So that brings its loss against the US dollar to more than 15% since mid-Summer. I think you could easily argue that Canada’s finances are in MUCH better shape than the U.S.’s. But the markets see it differently.”

“Yeah, these are incredible times. What else do you like?”

“I’ll give you a short list,” said Danny. “I like Baytex Energy Trust (NYSE: BTE), Provident Energy Trust (NYSE: PVX) and Enerplus Resources Fund (NYSE: ERF). All three stocks yield about 20%, which seems totally crazy. Even if you believe energy prices are going to remain depressed, these stocks are too cheap.”

“Thanks Danny. Hang in there!”

To be clear, dear investor, Danny’s “short list” of distressed investment trusts are not automatically a buy because they yield more than 20%. But as we never tire of observing here at the Rude Awakening, they are probably less of a sell. (Please remember, that oil and gas investment trusts like Penn West derive their incomes from oil and gas production. So when energy prices are tumbling, as they are currently, these trusts earn less income, which means that their dividend payouts could fall sharply).

A few days after speaking with Danny, your editor checked in with Chris Mayer, editor of Capital & Crisis. [By the way, if you missed the October 14 edition of the Rude Awakening, you almost missed Chris' examination of Atlas Pipeline Partners (NYSE: APL), a deeply depressed stock that pays a very high dividend. Click here to read the story].

Chris is nervous, but excited. “I never expected to see stocks as cheap as they are today,” he said. “I had always assumed that deep value stocks became extinct sometime in the 1940s and that I would never see them during my career. But I was wrong. Deep value stocks are reappearing in parts of the stock market. The ENTIRE stock market is not cheap, of course. But many individual stocks are.”

Chris expanded upon this observation in a recent email alert to his subscribers:

“Recently, The Wall Street Journal reported a fact that shows just how extreme some valuations have become out there. According to the WSJ, nearly one out of every 10 stocks trades below the value of its per share cash holdings, “an even greater proportion than [Benjamin] Graham found in 1932.” [Graham, author of "The Intelligent Investor," is legendary among us value investors as the "Father of Value Investing."]

The year 1932 was horrific for stocks. By July 9 of that year the Dow Jones Industrial Average had collapsed 91% from its 1929 peak. So it’s hard to believe that there are more stocks trading below their cash balances now than in 1932. Amazing!

Or to put it more specifically, of the 9,194 stocks Standard & Poor’s tracks, about 876 trade below their per share cash holdings. In theory, you could drain the cash in these companies’ treasuries to buy the whole company and get everything else for free. 

Loews Corp. (NYSE: L) isn’t quite that cheap, but it is VERY cheap. For starters, the stock is 40% cheaper than when I first recommended it to my subscribers. But that’s not all. At the current quote of $26 per share, Loews trades for just under 6 times earnings and has $3.5 billion of net cash — or about 30% of its market cap. If you net out that cash, Loews’ price-to-earnings ratio slips to well under 5. That’s incredibly cheap for such a well-financed company. 

Even better, the company’s net asset value comes in around $40 per share. Much of that NAV is in publicly traded companies. So it’s easy to figure the values. And they are good investments on a stand-alone basis. Loews owns stakes in Boardwalk Pipelines and Diamond Offshore, both of which look like bargains. If these shares rise in value, as I expect they will, Loews’ NAV will also rise. In other words, Loews is cheap on its own merits as is, and you get its cheap portfolio, too. Loews is also a buy. 

There are a lot of these kinds of opportunities out there now. At least in pockets, we have the kind of true Depression-era valuations that Ben Graham would have recognized. Old Ben Graham is more relevant now than ever because the market we are in increasingly resembles the ugliness of 1930s, when Graham plied his trade. Graham wrote in 1932, and I think it will prove true today: “In all probability, [the stock market] is wrong, as it always has been wrong in its major judgments of the future.”

[Joel's Note: Legendary investors like Graham did not amass their fortunes by following the crowd. They did not buy when everyone was optimistic or sell when everyone else was jumping out the window. Instead, they carefully passed a fine-toothed comb of due diligence through the carnage of post-apocalyptic markets and loaded up on bargain companies.

Now, as stocks become cheaper and cheaper (by the day, in many cases) Chris Mayer recommends for pennies on the dollar the best ones he finds. Take a look at his Mayer’s Special Situations portfolio for a selection of the best bargains out there.

Also, one final reminder before we leave you for the day: At 11am today, all Rude Awakening and Executive Series readers have available to them – free of charge – an emergency financial crisis presentation. The webinar will feature our resident short seller, Dan Amoss. In it, Dan will detail:

• How we got in this mess in the first place
• Where we will go in the near-term future
• Specific ways you can protect yourself — and profit — from this dismal situation right now

This is a complimentary resource designed to help protect our reader’s wealth, i.e. your retirement savings and investment nest egg. Simply drop your email address into this box to let us know you wish to view the presentation and be on the lookout around 10:30 for the instructions on how to view the program.

We’ll be back tomorrow to discuss some of the ideas in the presentation.

Until then…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com