Smith concentrates on stocks in the bottom decile of price to tangible book valuations. He was fortunate enough to have learned personally from Benjamin Graham, when Graham taught at UCLA Business School while Smith was attending UCLA Law School. Smith was inspired to follow a low-P/B strategy when Graham needed help performing calculations to complete a study of the portfolio performance of the lowest P/E stocks of the Dow Jones (i.e., the Dogs of the Dow). During his analysis, Smith found the P/E ratio method flawed and decided a to develop a better strategy based on book value, which he considered more stable.
When asked whether the economy was as bad as people were saying in a August 26 interview, Smith shared an optimistic view: “I don’t think so. At least not in the United States. A lot of this is actually healthy. For the first time we’re actually talking about debt. And we’re talking about doing something. So a lot of this stuff, the fact that we’re just talking about the problem, and maybe we’re going to kick the can down the road a little ways, but Greece was a wake-up call to all of us. And I think politicians know it and I hope something will be done, but even if it’s not done, I’m pretty constructive on some cheap value stocks, because where else are people going to put their money? It’s the best of a lot of alterative, which I consider commodities look like they’re in a topping action, Government bonds looks like they’ve been in a boom and could be topping out, and there’s a lot of money out there."
Right now, Smith likes financial stocks best, followed by consumer services, utilities and industrials. He has 92 stocks in his portfolio and purchased 7 new ones.
The largest low-P/B holdings Smith added to in the third quarter are: Micron Technology Inc. (MU), Southwest Airlines Co. (LUV), Platinum Underwriters Holdings Ltd. (PTP).
Micron Technology Inc. (MU)
Micron Technology Inc. has established itself as one of the worldwide providers of semiconductor memory solutions. Micron Technology Inc. has a market cap of $5.12 billion; its shares were traded at around $5.18 with a P/E ratio of 19.8 and P/S ratio of 0.6.
Micron Technology’s revenue was on an upward trajectory until 2008, when it dropped from $5.8 billion to $4.8 billion in 2009. But it quickly recovered to $8.5 billion in 2010, and increased again to $8.8 billion in 2011. Free cash flow has bounced around. For instance, in 2010, it was $2.6 billion, and the next year a loss of $66 billion.
In 2009, annual semiconductor industry revenues dropped 5.3% in 2008 and 11.6% in 2009. The industry emerged in 2009 from a downturn, achieving profitability for the first time since 2007, reports iSuppli Corp. the DRAM industry in the fourth quarter of 2009 had global revenues of $8.7 billion, a 43% increase from $6.1 billion in the third quarter. The firm had to cut its semiconductor revenue growth forecast for 2011 due to the worsening economy and rising consumer pessimism.
On November 3, Micron Technology announced the debut of the industry’s broadest portfolio for load reduction modules, boosting DRAM performance and memory capacity for enterprise server applications.
Smith has owned shares of Micron for over five years. He made his largest addition, 19,312,341 shares, in the fourth quarter of 2008, when the stock price dropped to an average of $3.11. In the third quarter of 2010 he bought 6,671,567 shares at an average price of $6.69 per share and owns 22,463,503 shares total as of the end of that quarter.
Micron’s P/B ratio of 5.1 has fallen near to where it was when Smith bought so many shares, around 5.8, near the end of 2008.
Southwest Airlines Co. (LUV)
Southwest Airlines is a major domestic airline that provides primarily shorthaul, high-frequency, point-to-point, low-fare service. Southwest Airlines Co. has a market cap of $6.57 billion; its shares were traded at around $8.17 with a P/E ratio of 16.7 and P/S ratio of 0.6. The dividend yield of Southwest Airlines Co. stocks is 0.2%. Southwest Airlines Co. had an annual average earnings growth of 5.4% over the past 10 years.
Southwest Airlines’ highest book value per share of the decade occurred in 2007 at $9.46 per share; the next year it dipped to $6.70 per share. But the company has been climbing up since then – in 2009 book value increased to $7.37, and the next year, $8.35 per share. Meanwhile, the stock price dropped 46% over the last five years.
In its 2010 shareholder report, Southwest called the first decade of the new century the “lost decade” for the airline industry. In spite of the malaise, Southwest marked its 38th year of profitability. Its market share for the domestic market year also increased from 20% to 21% due to its Bags Fly Free and No Change Fees, as customer sought lower-priced airfares. The airline made record revenue of $12.1 billion, increased from $10.4 billion in 2009, and generated $1.1 billion in free cash flows, increased from $400 million in 2009.
On May 2, 2011, Southwest acquired AirTran, which will boost its revenue in future quarters. But gas prices and higher taxes are expected to hurt operating expenses. In the third quarter of 2011, economic fuel costs per gallon for the company increased 34% year over year.
Smith made a profit on Southwest before. From the first through third quarters of 2009, he acquired a total of 5,021,771 shares for an average price from $6.89 to $8.26. He then sold all of his shares at an average price of $12.15 in the first quarter of 2010.
Platinum Underwriters Holdings Ltd. (PTP)
Platinum Underwriters Holdings Ltd. provides property and casualty reinsurance coverage to a diverse clientele on a worldwide basis. Platinum Underwriters Holdings Ltd. has a market cap of $1.24 billion; its shares were traded at around $33.24 with and P/S ratio of 1.2. The dividend yield of Platinum Underwriters Holdings Ltd. stocks is 0.9%.
This insurance company has a history of increasing its book value every year for the last decade. Revenue, however, has been uneven, as well as on a downward slope. It declined each year from $1.8 billion in 2005 to $985 million in 2010. Free cash flow has varied – it decreased from $477 million in 2009 to $24.7 million in 2010. Over the last year, the stock price has drifted down 24.5%.
In the third quarter, Platinum Underwriter reported a net loss of $53.5 million and a loss per common share of $1.43, due largely to international catastrophes such as the earthquakes in Japan and New Zealand. Nevertheless, the company managed to raise its book value per share by 1.8% in the quarter on strong investment results and favorable non-catastrophe reserve development. The company’s stock fell significantly in the first quarter, when the catastrophes occurred and caused a net loss of $157.2 million and loss per common share of $4.20. Book value that quarter decreased 11% from the previous quarter.
Smith bulked up his Platinum Underwriters investment in the third quarter, adding 633,604 shares at an average price of $31.71 to his holding of 753,531 shares, for a total of 1,387,135 shares. Over the last year the stock price has fallen 24.5%, and it is up 11.69% for the last five years.
Platinum’s P/B has been increasing slightly, but at 0.8 is still near its historical low from early 2009.
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