Investing for Survival

Investing for Survival

Love the unloved. Most people avoid industries that are under stress.  Who can blame them?  The industry outlook is horrible; there can’t be anything good here. 

I take a different view. I believe that some of the safest plays you can make consist of buying financially strong names in weak sectors. These companies are usually cheap in comparison to their earnings and to their book values. You can find out more about how to spot undervalued companies by visiting the website of Tweedy Browne, the famous value-investing firm, and reading their excellent paper on What Has Worked In Investing (http://www.tweedy.com/library_docs/papers/what_has_worked_all.pdf).

In addition to the standard measures, I look for companies with good bond ratings.  The ratings agencies are out of favor now, because of the current furor over securitization, but they produce the best single measure of a company’s creditworthiness. The raters’ award the best ratings to companies that can generate cash well in excess of what is needed to pay all their creditors and that possess a low ratio of debt to assets.

Once I’ve bought a stock, I try to be patient, because the payoff is usually not instantaneous. In 2001, when steel stocks looked horrible, I bought Nucor, the soundest company in the industry. Steel companies dropped like flies in 2002 and the stock did nothing—until the end of the year, when enough steel-making capacity had been closed down that steel prices began to rise. Nucor flew, and I made a nice profit.

The key to making this contrarian strategy work is to not overdo it. Some industries—newspapers, say, or fixed-line telecom companies—truly do have questionable futures. You have to analyze each situation on its own merits.  At present, my favorite industries are insurance, energy, agriculture/food processing, cement, and chemicals.

My value-hunting approach means that most of the stuff I buy is not popular. I veer away from firms that are pioneering new technologies or markets. Such companies are easy to get enthusiastic about, but difficult to value because there are so many unknowns.

When I talk about the companies I own, the response is often, “You invest in obscure stuff.  What do you think about Google?” I don’t have an opinion on Google.  I can’t tell you whether it will produce enough profits over the years to justify its current price or not.  So much depends on future tastes and competition. I’d rather own cement companies; they are very difficult to make obsolete.