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the boom or bust portfolio, is this the greatest opportunity in todays market?

February 06, 2009 – Comments (7) | RELATED TICKERS: NCX , OSK , RCL

A few months ago I sold my businesses in some part due to the opportunity that the crashing stock market represented.  Since mid-december I've been paying attention to the markets myself and making some selections.  My tendency is to not pretend to be prescient and know what growth stock will be the next CSCO, but to play the basic odds, namely:

-historically stocks with lower valuations have offered higher returns.  I look at p/b, p/cf, p/e, forward p/e.  This is no great secret and various books have documented this over various periods of time.  Counting bankruptcies and all, low valuations outperform.  CAPS definitely has a value-oriented eye, which is alot of why I like to browse it. 

-coming out of bear markets, stocks that fell more tend to rebound more, and smaller cap stocks tend to outperform large (>10B) stocks.  Those from various motley fool articles and other places.

-bankruptcy is bad. Eliminate the bankruptcies from the "lowest p/e" category and you'd presumably have considerably market-beating returns

Todays bear market features concern over the availability of credit, over the ability and willingness of banks to loan pepole and businesses money.  And it features a recession, which gives rise to concerns that companies earnings will be severely depressed or absent.  And those two things combine to create a situation where companies carrying debt, particularily companies carrying debt in cyclic industries, have been pummeled to extremely, extremely low prices.  Many companies that made an aquisition in recent history are priced in the sand, as are companies that This creates a situation where many stocks are priced so that only three realistic options exist for the share price:  they become multi-baggers (2, 3, 5, 10x your money), they go bankrupt, or someone buys them.

Todays market has myriad "cheap" stocks and nearly limitless value plays.  Commodity-related stocks are low, luxury stocks are low (casinos, cruises), energy stocks are low (including recent high fliers like solar), automotiv stocks are crushed, industrial equipment is crushed, banks are crushed, REITs are crushed and on and on.  And among the crushed stock prices are tickers carrying low debt with little realistic chance of short-term insolvency.  I like those stocks, and buy examples of them with real money every day, but I think that in 5 years when we look back at this period we'll find that many of the biggest returns were had in stocks that HAVE debt now, because the combination of debt+banking system problems has resulted in unbelievably low prices for many such companies.  In a matter of months leverage has gone from being considered a tool businesses use to grow to being considered a death sentence by wall street.    Some examples that I am interested in include: 

-OSK.  Oshkosh, heavy truck maker extraordinaire.  OSK might have overpaid for JLG, and its carrying $2.7 billion of debt largely related to that aquisition and has an uninspired debt/equity ratio of 2.  Heavy equipment isn't have the best time of it lately, adding to OSKs troubles.  And to top it all off they recently said they expected to be in violation of a loan covenant by the second quarter of 2009.  They are beholden to US Bancorp.  So things are bad for the Wisconsin truck maker.  However, mistakes aside, OSK is a great company.  4 stars in caps, 1st in many of its business areas, 2nd in others.   Will USB force OSK into bankruptcy, would that help USB?  Or will USB work with them, preserve their customer, preserve their profit, and probably raise some rates and take some penalty fees and make some money on it themselves? 

-MTW.  Similar situation in most ways.  Did MTW overpay for Enodis?  In my opinion they did, and worse Wall STreet doesn't view that transaction very favorably.  Are cranes off the peak of their cycle?  By all accounts they are.  And so MTW faces some challenges.  But this is not a bad company.  Its a leader in most of its business areas with a good track record of growing and making money, and whats out of cycle now will one day come back in.  If MTW can simply survive until its cranes and food service equipment get hot again the stock will mutiply by several times from its current levels.  And as with OSK above, I just don't see how anyone benefits (banks, shareholders, companies) from forcing these companies into chapter 11, and I think some second chances will be given.  GGP got an extension and some second chances, and they are REALLY in a tough spot.

-ASH.  Ashland has a long track record of being a good company.  They made a Fool articles list of companies that treat shareholders the best, they have a plan for the future, and purchasing Hercules worked towards that.  If a company has been well managed in the past, is it that big of a leap of faith to think that its well managed today, and that the purchase might ultimately benefit it?  Beyond that, unlike OSK and MTW above, ASH retains a positive tangible book value (meaning goodwill resulting from the purchase doesn't completely dominate the balance sheet).

These are just 3, and perhaps not even the most interesting of the 3.  Nova Chemical is a good company with a fundamental advantage in a commodity market that historically has proven relatively recession proof - polyethylene.  Their 4th quarter loss was due to the radical drop in the value of inventories, their inventories of chemicals and product dropped sharply in value as oil and other commodity prices free-fell last fall.  Their outlook for the current quarter and 2009 is positive, while Wall Streets is decidedly negative.  And they have some challenges and those challenges are pretty short-term (the need to raise $100m by February 29 in order to keep access to their credit facilities).  But I bought shares recently under $1.10, or about 30 times lower than the average price in recent years.  NCXs debt relates to expansion rather than aquisition, but its the same situation:  debt + cyclic = crushed stock.  It either goes to zero or it goes up 10 times eventually.  Do you believe a company with a fundamental advantage (read about the "Alberta Advantage" will be forced into bankruptcy, or do you think that ultimately lenders will work with it or someone will step in?

Teck Cominco has aquisition related debt and is alot of the same story.  Good company, overpaid for Fording, stock priced for oblivion.  But the overall macro-economic long term picture still favors commodities.  India, Russia, Brazil, and China will still eventually one day become consumer nations, and that will require alot of coal, copper, zinc, iron, you name it.  If TCK can survive and refinance it will live to see a new high somewhere down the road.  Again, its several times your money or zero. 

XL Capital (XL), Royal Carribean (RCL), Limited Brands (LTD), Office Depot (ODP) are all other companies priced so that they will either become multi-baggers or they will go to zero.  Each has some distinct rays of hope in its overall picture.  In fact, all of these companies are expected to make money in 2009.  Office Depot is profitable, carries low debt, has a plan to cut out some unprofitable stores, is expected to make money in 2009 and bankruptcy just doesn't seem plausible.  But its priced several times below its 15 year low.  Is ODP going away?  If not it will rebound 10 times.  CHK, SD, ACI, MTL, NOV the list is nearly endless. 

Never mind the banks.  BAC, IRE, even WFC and USB (two fairly stable banks) are down several times.  I've largely avoided banks because I don't really understand them.  The fact that they are so radically out of favor probably implies that they are good buys however.

If you own 10 stocks and 5 go 5 times the money, and 5 go bankrupt, you wind up with 2.5 times your money.  Not a bad return, even if it takes 5 years. 

These aren't the only stocks in this position, and I have made these types of stocks a significant portion of my portfolio.  It could be said that this amounts to gambling, but in my view its simply contrarian thinking.  In all of history, the sky has never fallen and the worst case scenario has never come to pass.  And we've been through a similar real estate + banks problem before if you recall, when I was a child in the 80's and 90's.  The sky has never fallen before, folks, and in my opinion a well diversified (diversified because, of course, any one of these companies could drop) portfolio of these type of stocks is destined to shine. 

For a disclaimer I own alot of these tickers with real money.