Sometimes Mr. Market doesn't take the time to figure out which stocks should really be priced higher or lower. That's an inefficient market. When the market moves up and down, sometimes stocks that have no real relationship to the news or events affecting the market get caught up in the overall swings. Stocks can be guilty by association.
This simply creates opportunities to buy stocks at attractive prices. This happened in March 2009, and now it is happening again with this minor correction year-to-date. This is good for value investors like me, who search through the downtrodden market to find hidden gems that will be great for the long term.
Last week, concerns about a weak domestic recovery and a debt crisis in some of the smaller eurozone countries called the PIIGS (Portugal, Ireland, Iceland, Greece and Spain) have beat up the U.S. markets. The easiest way to explain it is to say that the U.S. dollar, which has been strengthening, is considered a safe haven for global investors. And of late, the U.S. stock market has historically moved opposite of how the U.S. dollar performs, having an "inverse correlation."
Far From the Turmoil
But does that mean an outstanding, consistent midwestern company with an improving business outlook and minimal exposure to the global environment should be beaten down like the market? No.
Otter Tail Corp. (OTTR) is a U.S.-based company that can be thought of as part utility (roughly two-thirds of earnings) and part industrial and manufacturing - with exposure to a variety of sectors.
OTTR is an example of a cheap stock that happens to be in the Safe Haven Investor portfolio. It's trading at a discount of 15 times 2010 earnings (compared to 18 times for the market) and is undervalued on price-to-sales and price-to-book-value metrics - other common methods to value a company. Further, the stock is quite cheap compared to historic and normalized valuation levels.
The company's stable electrical business is based in the states of North and South Dakota and Minnesota, a long way from Greece and China. The non-electrical business is diversified to end markets such as manufacturing, infrastructure (e.g. wind towers), health services, and food ingredient processing.
It's a solid combination of balanced income and growth. The steady cash flow from the electric business and earnings growth potential from the non-electric businesses create an impressive long-term track record. While earnings were off in 2008 and 2009 just like everyone else, improved earnings growth is forecasted to at least 2012.
OTTR has been increasing dividends annually since 1975 and now yields 5.75%.
After grossly underperforming the market by 25% in 2009, the stock is under continued pressure this year, down 18% vs. a market down 7%, both from their peak a few weeks ago. Why?
Defensive stocks (such as utility companies) should be doing well as investors are nervous and uncertain. Solid operations and lower borrowing rates offset concern about restricted rate increases and soft end markets. While industrial and manufacturing business struggled in 2008 and 2009, the turnaround has clearly begun.
Also, for most of last year, investors were not risk averse. They were more risk seeking, trying to make up for horrendous 2008 returns. Well, as we speak, a shift towards the risk adverse end of the spectrum is taking hold.
But my key point is that OTTR, like many others, has either been neglected or is deemed guilty by association. This stock has been depressed... and with an improving outlook, not a deteriorating one, it should be outperforming rather than going down more with the market.
The company reported fourth-quarter earnings on Monday (after this piece went to press). With such mixed earnings news, it's hard to figure out what OTTR will report or how the stock will react. But, unless there was a material change in the outlook or in its businesses, I would research the company further and think about it as a long-term attractive idea.
Searching for Cheap Gems
How do you find attractive stocks like OTTR in a market that is relatively dangerous? Aside from subscribing to Safe Haven Investor and other Taipan products, with a little research you can find overly depressed stock ideas on your own when Mr. Market behaves inefficiently.
Several sites like Yahoo Finance, Google Finance, MSN Money, MarketWatch and CNBC offer fairly good stock screening capabilities, each with some pros and cons. Business and finance magazines are also a source for solid companies worth investigating.
If you do stock screens, searching for high-dividend yielding stocks or cheaply valued stocks based on earnings or cash flow or other metrics is one place to start. But you have to do the research on the company to understand what drives its profitability, and to make sure the stock price is not beaten down for ominous reasons. Make sure that the fundamentals and the investment thesis are still compelling.
I guess you can tell that I have a favorable bias towards Otter Tail Corp. But there are many attractive stocks, and even a few sectors out there, that are worth researching and potentially buying in this uncertain investing environment.
Just as Mr. Market can be a source of good returns, he can also be brutal, sometimes taking no prisoners. When that happens, have the confidence to research and invest in cheap stocks that were incorrectly beaten down like "babies getting thrown out with the bathwater."
Great Returns and Great Times,