Friday, August 8, 2008

The Fifth Portfolio Pick

It doesn't make sense to me to seek significant returns from stocks everyone already thinks are good investments. I do see some intelligence, however, in the practice of finding stocks that are underappreciated and then waiting for the rest of the market to come around to my way of thinking. This contrarian approach is usually called "value" investing.

I want securities that have these five characteristics.

A cheap price. I like to look for companies trading at or below their book value. I like stocks with very low earnings multiples. I want to look at stocks that are at least 25% off their 52-week high.

Trouble. Nothing makes me happier than seeing a perfectly good industry take it on the chin, especially if its difficulties arise from trouble most people don't understand. Why? Fearful investors sell valuable things for less than they are worth. Embattled industries are target-rich environments.

Prospects. Times change, and some sectors won't ever bounce back, The financial sector, for example, absolutely will survive in its current form -- it's just temporarily out of favor. Newspapers, on the other hand, aren't going to make it in their current form. Look for companies with good prospects.

Position. If you're going to go Dumpster-diving, you might as well do it in a nice neighborhood. It makes sense to buy the leaders in a market: Don't buy Pepsi if you can get your hands on Coke. (If you're looking to buy an up-and-comer, you're not oriented toward value but toward growth. That's perfectly fine, it's just a different approach.)

Management. I want managers who can make tough decisions, weather criticism with Bush-like resolve and who have sweet dreams about building shareholder value. When their stock tanks, they buy it with their money and with the company's.

Pick Five: It's General Motors.

The General meets all of my criteria. It's cheap -- down 60% year to date -- it's hated, it has strong long-term prospects and it has the enviable position of being the No. 1/No.2 automaker in the world. Saying GM is in an enviable position takes some brass, but don't you think it makes sense? Honda and Toyota have nowhere to go but down. GM and Ford have nowhere to go but up. (And Ford has the benefit of a CEO with a degree from the University of Kansas.)

GM chief Rick Wagoner, for his part, has done a brilliant job hoeing a tough row: He axed the dividend, cut jobs, is buying out Hummer, and he's been positive in the media no matter what happens, including a full-throated counter to a bunch of bullshit bankruptcy rumors. He just keeps getting better at a hard job. (He should also kill Saturn, by the way, which has never made a dime of profit.)

Design czar Bob Lutz --a true automotive genius -- is building cars people want to drive, and GM has decided to sell them for more than it costs to make them. (Amazing what passes for revolutionary thinking in Detroit.) Labor has lost a lot of its bargaining power, which could go a long way to smoothing out the global playing field. And GM's so-called "legacy costs," the huge expense of paying and caring for retirees, is only going to get better in the next five years -- call it a "positive actuarial tilt."

GM has inked some serious losses, but it also has some serious cash on hand to withstand them. In fact, GM has $32.22 in cash on hand for each share! You get the GM brands, its assets and $22.22 for free when you buy a share for ten bucks. That's my kind of deal.

For the very patient and risk tolerant, GM's a great hold to $30. For active investors, GM's immense volatility -- its beta is 2 -- makes it a great stock to trade in the meantime.

Here is my entire "Deep Value Portfolio" and the entry price for each (as of last Friday):

Merrill Lynch $26.85
CIT $8.76
CarMax $14.10
MGM Grand $29.78
General Motors $10.23

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