When Justice first asked me to fill in as a guest editor this week, I thought, “Those are some tough shoes to fill.” But I realized that if I wrote about what I’m passionate about and what I’ve spent my entire career focusing on – investing, stock picking and wealth creation – then I would be okay.
First, let me quickly share with you some of my background. I am currently editor of Taipan’s Safe Haven Investor, in which I write about the markets, long-term investing and, of course, stock recommendations for the Safe Haven portfolio.
My goal is to outperform the S&P with a more conservative, safer approach to long-term wealth creation and capital preservation. I try to use my 20-plus years of Wall Street experience to bring safe, strong and profitable investment ideas to Safe Haven Investor readers.
I actually took over Safe Haven duties from Justice this past spring, and he left me with a portfolio that is doing extremely well. The latter has fortunately continued its success from that date. Our picks are handily outperforming the S&P 500, with all of them up from their recommended date and over half up more than 40%!
Looking for Value
I consider myself a contrarian value investor – someone who uses fundamental analysis and deep research of industries and companies to make money. (Think Ben Graham, Warren Buffet, John Templeton and Seth Klarman of The Baupost Group – to name some of the investors I admire.)
Justice has written a lot about different investing styles and value investing specifically, so I won’t go into deep detail. But let’s just say I generally like to buy cheap stocks, with strong fundamentals and limited downside risk, that are generally out of favor. And as you’ll see, my core focus is on long-term wealth creation... but my closet trading side still comes out every so often.
So What’s My Take?
Here are the facts as I see them. The equity markets have done well this year – exceedingly well. I believe that the market is fully valued to overvalued at this point, so further upside through 2010 is maybe 10%-15% higher from here, with a high risk of setback or correction.
I believe the economy, both in terms of the United States and globally, has its worst days behind it. I more or less expect a slow and steady recovery, with some minor bumps along the way.
The market is up 21% year to date (YTD) as of this writing and 60% off its March 9 lows. Remember, long term the equity market has returned around 10% annually. So, despite the major losses of last year, this year the S&P 500 has bounced back very strongly. Exuberance, combined with some confusion, is a prevalent tone we hear.
But wait. While it’s tough to notice, what with all the exuberance and positive sentiment in the mainstream media, not all sectors have performed equally. With some good old-fashioned research and hard work, I am still finding ideas to share with you.
In spite of the big run-up, I think there are a few sectors and stocks that still look attractive from a long-term investment perspective. Let’s look at a few examples to show some areas I’m still excited about.
Opportunity #1: Healthcare Is Cheap for a Reason... but the Outlook Is Strong
“Opportunity is missed by most people because it is dressed in overalls and looks like work.”
– Thomas Edison
We all have heard about healthcare reform ad nauseam. And many of you may have noticed that healthcare stocks are under immense pressure. In fact, they are the cheapest S&P sector now, trading at 11.3 times price to earnings (P/E), or roughly a 30% discount to the market.
The chart below shows the P/E ratio of the healthcare sector relative to the S&P 500 since 2004. In my view the chart reveals an incredible discount; too much of a discount.
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Source: BMO Capital Markets[center]
Yes, whatever type of reform gets passed (and it looks like some form will definitely get passed by year-end), there will be pricing and cost pressures on a lot of healthcare companies – whether it be the drug manufacturers, hospitals and facilities, or equipment and device manufacturers.
Looking at the net effect along with the adjustments these companies are already making, though, I believe investors have penalized these stocks too much.
[center][ Enlarge Image ]
Source: The New York Times, Credit Suisse
Case in point: Look at this chart (from a recent New York Times article) that shows how much drug companies have raised prices on branded drugs this past year. Of course they’re going to raise prices before any legislation… and they did so at the highest rate in more than six years!
And don’t forget, an estimated 30 million additional people will be taking on healthcare costs because they have to! That’s more patients, more drugs, more equipment and more profits. Remember these are high-quality companies, many with great products – like Johnson & Johnson (JNJ) – and strong drug pipelines. Some offer great yields like Bristol-Myers Squibb’s (BMY) 5.4% yield or Merck’s (MRK) 4.6% yield. Most have a lot of cash that might be returned to shareholders in some form. Many companies are also benefiting from global industry consolidation, and have taken great strides in cost-cutting to offset the pending pressures from reform.
Looking out anywhere from six to 24 months, these stocks could bounce back and make us a lot of money. It’s just a matter of time. In fact, in my latest Safe Haven Investor issue that came out last week, I recommended a special situation healthcare company that provides a 12% yield and a P/E multiple under 8. This is a good sector to be looking for ideas!
Opportunity #2: For These Stocks, BUY When P/Es Are High and SELL When They Are Low…
After reading that latest heading, you must be saying, “This guy doesn’t know what the heck he is talking about: Everyone knows to buy low and sell high!”
Hear me out though – the old clichés aren’t always 100% true. That mentality is not the case, for example, in some deep cyclical sectors that traditionally have sharp earnings swings and even lose money through economic cycles. These sectors include steel, paper & pulp, construction, materials, autos and auto parts suppliers.
It’s the secret that professional investors don’t talk about much. When these cyclical stocks’ earnings are low (or even negative), the P/Es are sky-high. The stock price has probably tanked as well. Take companies like Ford (F) or Ingersoll Rand (IR), where earnings went negative or so low that the P/E went through the roof earlier this year. Well, that was the time to buy! Ford has almost quadrupled off its bottom and Ingersoll Rand has more than doubled.
As an example, material stocks have done well (up 35% YTD) but the sector’s P/E is still too high at roughly 29 times 2009 earnings. The same can be said for some industrial stocks and a few other sectors. Look at how high the relative P/E climbed as earnings declined 49% in 2008 and an estimated 21% this year.
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Source: BMO Capital Markets
There is still potential room to move for a lot of these names. Companies like Vulcan Materials (VMC) and Martin Marietta Materials (MLM) should do better as the economy improves. When earnings peak and the multiple actually compresses, that will be the time to sell. By then the stock prices will have moved substantially as the earnings come back. That’s when you take your money and run, as these stocks are cyclical and the earnings swing will repeat itself. It’s time-tested and makes sense, but is somewhat counterintuitive to conventional wisdom.
Well, I hope you enjoyed my first round of thoughts. I tried to bring a slightly different perspective today, one that was focused specifically on long-term investment and the value-oriented stock-picking process. Hopefully you were at least somewhat enlightened and intrigued – at least enough to look forward to my further thoughts tomorrow!
As my old friend Justice mentioned, I look forward to all forms of feedback.
Great Times and Great Returns,
Editor,Taipan's Safe Haven Investor