Some investment ideas for 2010
December 27, 2009
– Comments (27)
I thought that as the new year approaches, I would offer some ideas and thoughts for 2010.
First on the market(s) in general. I shouldn't even pretend to know where the markets will head, but I will offer that in general I do not think they are overvalued, nor do I think they are cheap, they hover around something like what I estimate fair value to be.
However, inside the markets it is still possible to find stocks that are cheap, especially when compared to historic valuations for their sectors or to normalized earnings. I think we are very far from bubble territory, something that perma-bears love to state. That said, I think the easy money has been mostly made in the markets.
Obviously alot of where the markets go will depend on whether we experience a "double dip" recession, something that could have a distinct negative impact on the markets, of course. I think a fair bit of good news is priced in right now, basically the markets price in a sustained recovery (although not a glorious or V-shaped one).
Looking at what has happened in the past, history suggests that we are in for a bit of a sideways slog. After the vicious dip in the mid-70s, the S&P recovered violently, rallying nearly 70% over the next year. From there, however, it slogged sideways for several years. In 2003-2005 the market had lnearly doubled in a few months, but then slogged sideways for a couple of years before taking off again in 1935. A similar sideways slog was seen after the rally in the Dow from the WW2 low to the just-after WW2 high. Each enormous ramp out of a bottom seems to be followed by a period of consolidation.
I consider that the most probable outcome for the markets over the next year: a generally sideways slog with a fair bit of sector rotation.
For specific sectors... right now big-cap "quality" stocks are in favor. Since September financials have stalled, small caps have underperformed, and big-caps have done well. This flood to "quality" is touted by myriad professionals in their writings. Its definitely, today, the "in" thing. Generally when something is the "in" thing, while it may outperform for a while, and maybe a good long while, it will eventually underperform as the trend changes. So I am going to go out on a limb and say that over the next 1-3 years financials will be at or close to the top performing sectors. Even after how far they have come (they are still, generally, far from where they were). My reason for this thought is that A) they are the stocks that remain farthest from their historical prices. Many big cap "quality" names are at or around their historical highs. B) they are the stocks that continue to have the lowest valuations and lowest valuations relative to historical valuations. and C) nobody seems to like them very much still, skepticism abounds and all of that.
And for some specific stock picks...
MCGC. MCGC is in by far the best shape of any of the deep-value BDCs. BDCs, like REITs, have to pay out 90% of taxable income to shareholders as dividends. Right now MCGC is not paying a dividend, but I suspect that it will be restored in 2010, which should have a positive effect on share price. MCGC is trading at roughly 1/2 of book value. I think that the dividend potential based on current operations is around 10-12%, and that they have a fairly well thought out plan to increase income and, hence, the dividend. I think a share price of 8-10 dollars and an annual dividend of 60-90 cents are feasible here.
FSC. FSC is another BDC (business development company) that, like all BDCs, is in the business of loaning money to private companies. They have zero debt, a chunk of cash on hand, a current 10% dividend and a couple of things (like deploying the cash on hand and a deal with the SBA that would provide them with some financing) that should allow them to raise the dividend going forward. I think share price will move with the dividend. They seem very conservative.
PSEC, ALD. PSEC is another company I like in the BDC space. Big insider buying, cheap valuation, big yield, great purchase of PCAP earlier in the year. ALD shares are interesting because ARCC, a very high quality BDC in good shape, is buying them for 0.325 shares of ARCC per share of ALD. ALD is trading at a fair discount to 0.325*ARCC's price per share and I think the odds that the transaction goes through are very good. This is one arbitrage play I like!
CNO. Conseco, a company that John Paulson of hedge fund fame has taken a stake in. CNO is profitable, and is priced at around 1/2 of book value. They have made enormous progress towards resolving the financial problems that sent the shares under $1 earlier in the year. With a foward p/e of 6 and a price/book of well under 1, CNO is very cheap. A director recently bought $2 million worth of stock.
HIG/XL/GNW. More insurers with cheap valuations. GNW has the cheapest valuation by price/book, but it isn't yet clear what GNW's earnings potential will be going forward. I do think they will go a fair bit higher in time. XL is in the best shape, is profitable, is growing book, has a current dividend worth mentioning, and a valuation well below historical averages. Dividend raises and more evidence of improvement are potential catalysts here. HIG is a tarp-baby, is damaged, but is making progress and has a very low valuation by either price/book or price/normalized earnings.
BAC. Of all the big tarp-baby banks I like this one the best. It has monstrous institutional support (its a hedge fund favorite), probably $2.50-3/share of normalized earnings potential, and the highest capital levels of any huge bank except Citi. Citi is also worth a look at these prices (low $3s). In time BAC should go to $25-30.
Risks to these financial stocks include a double dip recession, another crash in one or more financial markets, and the fact that they have not historically traded at high multiples of earnings, etc. In general, financial stocks are always a bit cheaper than others and as such it may not be prudent to consider a financial with a price/book of 1 on a par with a manufacturer that has a price/book of 1.
RJET. My favorite stock right now hands down. RJET, historically, has flown regional airplanes for other airlines. However, this summer it aquired Midwest airlines and Frontier airlines for next to nothing. Midwest is not doing very well, Frontier is doing extremely well, and Republics formerly-core business of contract flying seems to be stalled but doing well enough. The future of the contract flying business is probably not as great as it once was, but... I like management here, and I think the profit potential of the company is just huge relative to its market cap. Its trading at a a price/sales of about 0.1, a price/book of under 0.5, has very little debt except debt collateralized by aircraft, has some cash on hand... And Frontier has been operating at around $10M/month of profit, the contract business made about $19M last quarter (similar to its performance in 2007/2008), and they feel they can get Midwest profitable by the end of 2010. That adds up to profit potential of around $200M when all of the organizing is done and accounting noise relating to the buyouts settles. The market cap is about $250M right now. Risks with RJET include them failing to accomplish their goals, airline stocks in general being hated by one and all, they now have fuel cost exposure, and all of that. We'll see. It definitely is off the radar, behavees randomly and erratically, and nobody likes it.
I also like DOW (Dow Chemical), which is trading at about a 5.5% yield based on what the dividend was before they cut it, and with the aquisition of Rohm & Haas should wind up with a new all-time-high dividend at some day in the future. I think this one works well as a buy and hold, especially if the shares retreat a bit... And I think that whoever gets small regional banks right (timing and selection) makes out like a bandit! I blew it big time on BOFL so maybe i shouldn't comment on these.
These are no doubt not the whole list of stocks that are worth owning out there. Not at all. But I think they are decent picks.
Don't take my word for it, though...
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