Neil Macneale, is well known for compiling an ongoing model portfolio based on companies that have a...
5 Bottom-Up Bargains
11/23/2012 8:00 am EST
It's been quite a bull market run over the past four years, even though it hasn't felt much like a bull run. By looking at specific companies, you can still find value in some of the top sectors moving forward, writes Roger Conrad of Personal Finance.
By the end of the 1990s, chasing growth stocks’ momentum was many investors’ strategy of choice. Companies with reliable revenue and low debt had enjoyed their best run in history. But by that time, few paid attention to dividends or value, which had been popular early in the decade when fear rather than greed was the dominant market emotion.
The good news is, we’re about as far away from that kind of bubble as is possible. There’s still value to be had in many corners, but after nearly four years of good times, you won’t find it unless you take a bottom-up approach—i.e., scrutinize companies’ underlying businesses on their own merits.
The best values are always in unloved sectors that investors have abandoned because they look bad from 30,000 feet. Sector affinity and aversion have become particularly pronounced in recent years, as exchange traded funds have proliferated. Stocks in a sector get bid up and sold off in unison to a much greater extent than was possible in the past.
One sector that’s taking hits now is energy, the subject of our second article. But I see many positive trends in energy, which is why I’m adding a new energy company to the Income Portfolio: super oil Total (TOT).
Energy has been in an uptrend since 1998, when oil prices bottomed at less than $10 a barrel and natural gas last sold for less than a buck per million British Thermal Units. However, global growth worries and the North American shale boom have raised doubts about energy companies from wellhead to burner tip.
Energy still has a lot left in the tank. With large and reliable companies such as Total underwater for the year and featuring growing yields of 6% and up, you get plenty of bang for the buck while still playing it safe.
The 2008 crash provides the best possible crucible for determining companies’ reliability and safety in the worst possible environment. Nearly every company’s stock lost ground during the worst of that crisis. But companies that held it together as businesses then are very solid bets to do so in a future crash.
As noted above, revenue reliability comes in handy during a crisis. Some investors (as well as regulators) were surprised that regulated gas, electric, and water utilities demonstrated this reliability in 2008. But their strengths won’t be so easy to ignore the next time around, especially since nearly all have spent the last four years cutting debt and operating risk.
Energy midstream companies also sailed through 2008, thanks to long-term contracts with major oil and gas producers. Management has ensured similar resiliency in any future crisis by never building unless revenue is assured beforehand in writing.
However, once you get past these obvious safety sectors, you’re well advised to exercise considerably more discretion among companies. For example, Income pick Verizon Communications (VZ) and AT&T (T) are increasingly grabbing market share in the US, even as smaller rivals such as Sprint (S) post larger losses. Real estate has been a disaster for many US REITs and banks, but others have scored big by adding valuable assets at the expense of their weaker rivals.
Pharmaceutical and consumer staples companies are generally thought of as enjoying recession-proof businesses. But here again, revenue reliability has boiled down to how individual outfits have secured demand by making products indispensable—and not every company has succeeded.
The starkest intra-sector contrasts are no doubt in the natural resources business. Master limited partnership Linn Energy (LINE), for example, has locked in prices for all of its expected oil output through 2016, and through 2017 for gas. Even in the extremely unlikely event that oil fell to $20/bbl, Linn would still make its baseline revenue
Meanwhile, BHP Billiton (BHP) produces a range of resources from multiple sources serving a multitude of markets. These are among the highest percentage bets in their industries, come what may.
Just as important as revenue reliability is debt, and particularly what’s coming due in the near future. If lawmakers in Washington DC fail to reach an accord on spending and taxes and the economy plunges off the fiscal cliff next year, the resulting economic contraction and credit crunch will almost surely have done their worst by the end of 2013. Therefore, companies that aren’t absolutely compelled to access credit markets between now and the end of 2013 should be immune.
On this score, entire sectors are potentially vulnerable. The mortgage REIT sector, for example, is particularly dependent on credit markets, as the wave of bankruptcies in 2007-2008 can attest. Nonetheless, companies across a wide range of industries have immunized themselves from near-term credit refinancing worries, including many that operate in capital intensive and highly leveraged sectors.
In corporate America, the new “cool” is to be fiscally conservative. That suits me just fine, as I search for bargains in a market where investor fear is still creating value.
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