The Right Investments for This Economy?

Last Friday's abysmal jobs report underscores that we're still living with an economy whose "recovery" hasn't yet made it all the way to Main Street. In fact, our current doldrums have often been called the worst economy since the Great Depression.

With that as a backdrop, you have to ask yourself whether it makes sense to invest at all, much less in risky instruments like stocks. Fortunately, if history is any guide, now might be a fantastic time to invest -- with the right kind of strategy.

Is history repeating itself?
On the heels of the Great Depression, Benjamin Graham documented a stock investment strategy that enabled him and his followers to profit incredibly. One of those followers is named Warren Buffett, who at one time was the richest person on the planet, thanks to following Graham's teachings.

Graham's strategy is known as value investing -- the art of buying companies that trade for less than they're really worth. Given today's prolonged malaise and the frequent comparisons to the Great Depression, it makes sense to dust off Graham's old playbooks and see how they can help you today.

How does it work?
In essence, every business is worth something -- although that something might be $0. That worth is based on one of two critical factors:

  • The company's liquidation value if it shuts down, or
  • The company's ability to earn money over time assuming it continues.

Your goal as a value investor is to find those companies trading for less than what they're worth, based on those critical factors. If you buy them, you improve your odds of outperforming the market.

Can you really do that?
Of course, it's tough to tell what a company's real liquidation value is until it's actually being torn apart by a bankruptcy court. By the time it gets there, its shares may no longer be trading in any form we ordinary investors can get our hands on. That said, a decent estimate of that value is the company's net tangible assets. That's the accounting value of all the physical assets it owns, minus all its liabilities and the par value of any outstanding preferred stock.

Ordinarily, companies don't trade that cheaply unless there's something seriously wrong with them. That's still generally the case these days. The only difference is that today's potential disasters in waiting include some fairly significant banks, like these:

Company

Net Tangible Assets
(in millions)

Market Cap
(in millions)

Trading at X% of NTA

Citigroup (NYSE: C  ) $134,772 $122,139 91%
Bank of America (NYSE: BAC  ) $115,325 $108,423 94%
KeyCorp (NYSE: KEY  ) $8,469 $7,854 93%

Source: Capital IQ, a division of Standard & Poor's.

It's no secret why these banks are trading at such apparently cheap levels. Bank assets often include things like mortgages and credit card balances -- the very things that cash-strapped consumers think of as unbearable debt anchors around their necks. That these banks trade for below their net tangible asset values is largely a sign that the market doesn't trust the reported value of those assets.

After all, an unpaid mortgage turns into a foreclosure. And once a bank owns a foreclosed home, it needs to maintain that property until it sells. And if that foreclosed home sells for less than the mortgage price, maintenance costs, and the bank's own financing costs? Well, the bank winds up losing money on the deal, lowering the value of those tangible assets.

So even if you are looking at a potential liquidation valuation, be sure to understand the quality and type of the assets the company holds. If they're not really worth what their accountants say they are, then that apparent value can evaporate.

A going concern
Of course, that liquidation value is really only important if the company is about to be chopped up and sold for scrap. If, like those banks, they're expected to survive for the indefinite future, investors should instead look at the companies' ongoing earnings potential rather than their scrap value.

Graham's perspective was that any going-concern company that was expected to tread water (not grow at all) should be worth at least 8.5 times its earnings. Of course, a growing company should be worth even more. So what if you find a company that's expected to grow over time, but is trading for less than that 8.5 times earnings level? It's another potential value stock. Even today, that's rare to find, but there are a few available:

Company

Trailing Normalized P/E

Forward P/E

Long-Term Growth Estimate

Unisys (NYSE: UIS  ) 7.2 6.9 8.0%
Gentiva Health Services (Nasdaq: GTIV  ) 7.7 7.7 13.7%
Entercom Communications (NYSE: ETM  ) 8.3 8.1 9.9%

Source: Capital IQ, a division of Standard and Poor's.

Of course, even these are not without risk. Unisys, for instance, is a large public-sector IT contractor at a time when the debate is over how much spending to cut. Entercom is a terrestrial radio broadcaster facing new competition from satellite and Internet services. Gentiva is heavily concentrated in the elder-health-care business at a time when even Medicare is on the table for potential cuts.

Nevertheless, if you're worried about this turning into the next Great Depression, those stocks do trade at levels that make them intriguing for the Depression-era value investing strategy. Value created billionaires in the decades that followed the Depression; maybe history will repeat itself.

At the time of publication, Fool contributor Chuck Saletta owned shares of Bank of America. The Fool owns shares of and has opened a short position on Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (0) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1518136, ~/Articles/ArticleHandler.aspx, 9/21/2014 6:39:48 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement