Wall Street Meets Omaha

03/26/2004 12:00 am EST


Marc Gerstein

Editor, Forbes Low-Priced Stock Report

"Imagine a conference room with a bunch of brokerage firm analysts on one side of the table and devotees of Warren Buffett on the other," says Marc Gerstein, director of Investment Research at Reuters. Here, he searches for stocks that meet the requirements of both.

"Assume that this group of Buffett-type investors and Wall Street analysts work together as an investment committee and be responsible for generating investment ideas. What do you think would happen? Do you think they'd kill each other? Might their strife cause their portfolio to implode? Actually, I think they'd do a wonderful job. That scenario need not be purely hypothetical. In fact, our Favored Value Plays screen acts as a virtual value/sell-side committee, combining the value-obsessed rigor of the Graham/Buffett crowd with the short-term zeal of a stereotypical Wall Street analyst.

"Here are the tests used in the screen: 1) Trailing 12 month p/e is less than industry average; 2) Forward-looking PEG ratio (forward-looking p/e divided by projected three- to five-year growth) is less than or equal to 2.00; 3) Trailing 12 month Price/Sales is less than industry average; 4) Average analyst recommendation (1 = best; 5 = worst) is less than 2 and less than or equal to where it stood four weeks ago; 5) The estimate of earnings per share for the current quarter was raised in the past four weeks

"Many investors believe that the only good values out there are to be found among stocks Wall Street rejects or ignores. That's not so. And this screen helps you find reasonable value plays that are well regarded by the investment community. As you can see, all stocks that get through have to be acceptable to both camps. As to whether or not this potentially lethal mix of personalities can work well together, consider that from January 2000 through last month, the stocks that passed this screen gained 217% versus a 15.8% loss of the S&P 500." Meanwhile Gerstein highlights several of what he considers the noteworthy stocks to survive this ‘favored value’ screen.

"Where do you go when you need to buy a new personal computer or some sort of related equipment? If you're thinking as an individual, Best Buy or Circuit City may come to mind. If you handle procurement for a large corporation, you may go directly to Dell. But the in-between segments attract little attention. And in terms of available business, they amount to quite a lot. And this is where CDW Corp. (CDWC NASDAQ) is most strong. It's a multi-brand direct sales organization that also features 24/7 tech support. Needless to say, the IT slump in recent years has been tough. But CDWC held up amazingly well, and it seems well positioned to benefit from an improving business climate. CDWC's valuation ratios aren't rock bottom, but its fundamental quality ratios are outstanding.

"If you like simple, straightforward companies, skip ESS Technology (ESST NASDAQ). But if you can handle some uncertainty that's attached to this fast-emerging market leader in a potentially hot industry, ESST may be worth some sweat. It makes integrated processor chips that power digital audio and video players. In the past, it sustained some big market share losses. But following a major 2003 legal victory, ESST has been on a tear. The way things are going, it looks like ESST is well positioned to become a major player in supplying key chips for new-generation emerging digital home systems. Investing in tech requires more elbow grease than other situations. But it might be worth the effort because right now; ESST's valuation metrics are lower than they'd probably be if everyone had a clear-at-a-glance picture of exactly where the company stands.

"Switching gears, casual seafood restaurants are a heck of a lot easier to understand than digital chips and Landry’s Restaurants (LNY NYSE) has been on a roll of late, with comparable store sales gains being aided by successful promotions of higher priced menu items. Two newly acquired chains, Chart House and Saltgrass, have contributed nicely. And let's not forget seafood itself, which is diet friendly; seafood is naturally low-carb, and can be made low-fat. LNY's core fundamental ratios aren't as high as I wish they were. Hopefully, that will improve as the acquisitions pick up steam. Cost structures at the new chains are higher and margins could contract a bit going forward. The good news: the Street already knows this, and likes the stock anyway.

"RC2 Corp. (RCRC NASDAQ) makes toys and collectibles for children of all ages, with a hefty dose of products based on NASCAR-related licenses. Other licenses are from the National Hot Rod Association, Harley-Davidson, John Deere, and Case. Notice how unlikely the core licenses are to excite interest among those living in and near major financial centers like New York City (where many sports fans would struggle to even spell NASCAR). I'm sure that frustrates the daylights out of management in terms of garnering more recognition for the stock. But it's likely to be better received by investors who appreciate modest share valuation metrics. And let's face it; this is the information age. Sooner or later, even New Yorkers are likely to figure out what RCRC is up to.

"I assume you've heard the expression ‘as exciting as watching grass grow.’ The Toro Co. (TTC NYSE) makes a living helping that happen more effectively. So for TTC, I can't really say there's a problem in getting people to understand what this very-well-branded firm does. Instead, the challenge is to get them to stay awake while thinking about it. Anyway, results are moving ahead nicely thanks to good demand in both professional and residential segments, optimism among dealers that better economic trends in 2004 will result in more customer activity, and continuing benefits from the company's aggressive cost-efficiency program. But at the end of the day, the boredom factor is making its presence felt. Analyst sentiment, though favorable, is small (only two covering analysts), and valuation metrics are modest. For value investor, though, that may be anything but dull."

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