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Cheap with a Catalyst, just what I look for in a stock



December 08, 2012 – Comments (1) | RELATED TICKERS: GD

Cheap with a catalyst.  That the sort of stock that one of my favorite investors, Mario Gabelli, looks for when he invests his clients' money.  I just came across an excellent CFA Institute interview with Mr. Gabelli in which he explains what sort of investments he likes.  My investment style is almost exactly the same as his.  I love cheap stocks, particularly ones that pay holders a dividend to wait until a particular catalyst unlocks value at some point over the next couple of years.  

Here's a link to the interview for anyone who's interested.  To me it's a much watch:

The stock idea that I want to talk about right now seems to fit into this cheap with a catalyst mold quite nicely.  It comes to us courtesy of this week's Barron's, specifically its annual article on the top stocks for next year.  It's the defense contractor General Dynamics (GD).  Defense contractor you say, bah humbug the government has no money and is going to slash defense spending.  Well, that may be at least partially true, but guess's already priced into most defense stocks.  Plus, there's more to General Dynamics than just defense.  The company also makes Gulfstream corporate jets.  While I don't personally own one, I'm sure that you're shocked to hear that, they're pretty popular.  General D's Gulfstream division delivers nearly 30% of the company's total profits.  And it has a brand new model in the pipeline (the G650) that should help to boost that percentage even higher.

If one applies a 14 earnings multiple to the Gulfstream division, it would be worth $30 per General Dynamics share, which current trades at $67.  This means that the defense business is being priced like it's a complete mess, which it's not.  Some analysts actually believe that its products are so good that it may be able to grow even in the face of serious government cuts in defense spending.  

OK, so the company appears cheap, but what's the catalyst that I was talking about?  Well, for one General Dynamics has a new CEO scheduled to start at the beginning of 2013.  There's lots of levers that this new CEO, Phebe Novakovic, can use to unlock value in the company, including increasing its buybacks, raising the dividend (which I personally prefer to buybacks) or the icing on the cake which General Dynamics has denied interest in doing but may reconsider - a spin-off of its Gulfstream division.

As I said, this is just the sort of company that I like.  General Dynamics trades at less than ten times earnings and it pays a solid 3% dividend for us to wait for it to unlock value.  I'm adding GD to my CAPS portfolio today at $67.19/share.


1 Comments – Post Your Own

#1) On December 08, 2012 at 6:46 PM, TMFDeej (97.66) wrote:

Here's even more on catalyst-driven investing from another famous investor, Thomas Kahn from the Kahn Brothers Group:

 "Undervalued stocks can remain misprinted indefinitely if nothing happens to them.  We always ask ourselves what the catalysts are that can turn around these fallen companies.  Coming up with an answer is a qualitative exercise that involves our experience, knowledge and insights. There is no right or wrong answer to the question but it is nevertheless an important part of the research process."


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