Like storms, investing styles come in all flavors. Yesterday, I covered high-yielding Category 1 investments that have historically held up well in softer markets. Today, I turn the intensity up a notch to look at the wide world of value-stock investing.
The term "value" conjures images of the clearance rack in the back of the store, and value investing isn't much different. Deep value investors crave yesterday's fashions -- the more out-of-style and neglected, the better.
That's where the market's best bargains can be found. If you're patient enough to wait for either a corporate recovery or a return to fashionability for your beaten-down investment, the returns can be pretty sweet, with limited downside. The catch: You must make sure you're not buying broken stocks on a collision course with zero. A fashion analogy: It's a good idea to snap up vintage Balenciaga in good condition if you can get it at a good price, but it's probably not so wise to stock up on electric blue parachute pants -- at any price.
The cheap-chic investor
Loading up on companies that have disappointed analysts, cheated shareholders, or surrendered market share doesn't seem like a very safe practice. The key here is that you are buying into these companies at steep markdowns, after the share prices have the malaise baked in.
You'd be surprised at the number of successful companies that once teetered on solvency. Apple Computer (Nasdaq: AAPL) was basically trading for the amount of cash and investments on its balance sheet before the iPod shot the stock back to more realistic valuations. Intuit (Nasdaq: INTU) was swarmed by rival competitors in the mid-1980s, and tested again a decade later after the government blocked its deal to be acquired by Microsoft (Nasdaq: MSFT).
Microsoft just happens to be a pretty good example of a fallen growth stock that's making a home in many value-investing portfolios these days. Remember when everyone was on the lookout for the next Microsoft? It was the poster child of growth.
Microsoft isn't a broken company these days. It's still the world's largest software company. Earnings growth continues. The company's cash-rich balance sheet remains a thing of beauty. There are some legal hang-ups, product delays, and slow-growth concerns holding the stock in check, but the company's not likely to go away in our lifetime. Growth investors overpaid for Mr. Softy a few years ago. Value investors, like Philip Durell, now consider the stock a bargain here in the low $20s.
Philip has taken advantage of Microsoft's historically cheap price to recommend the stock twice to Inside Value newsletter subscribers during the past year. The company's release of its Windows Vista operating system in a few months could be the perfect catalyst to reintroduce the stock to mainstream investors. Philip is making sure he locked up his cheap seats early.
Riding out the storm
Category 2 stocks provide clear market exposure, but often without the volatility of the headier growth stocks that we will explore as our financial storms intensify later this week.
Value investors appear to be brave souls, running into burning buildings and swimming over to sinking ships, but it's a methodical kind of courage. They will buy into Tyco (NYSE: TYC) -- another Philip selection -- but only after the Dennis Kozlowski toga parties and tax-evasion accusations. They don't fear the monsters under the bed -- or Monster Worldwide (Nasdaq: MNST), for that matter.
Philip loves to value companies, digging deep into SEC filing footnotes and performing discounted cash flow calculations from a decidedly cynical standpoint. Such due diligence landed him on the doorstep of companies like Tyco, Microsoft, and Intuit when they were seemingly out of favor.
Philip wouldn't necessarily buy Starbucks (Nasdaq: SBUX) or Research In Motion (Nasdaq: RIMM) these days, but he must have been sorely tempted when the Blackberry maker saw its stock tumble earlier this year, as its very existence was threatened by a menacing patent-infringement lawsuit. I don't think Starbucks has ever traded cheap enough for Philip's taste, but let's see how he feels about the java giant if we ever hear breaking news that gourmet coffee beans can cause rabies and back hair.
So hold your head up, Category 2 investors. It's the best way to catch falling quality companies on the way down.
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Longtime Fool contributor Rick Munarriz can be pretty cheap at times, but he doesn't own any of the stocks in this article. Starbucks is a Motley Fool Stock Advisor pick.The Fool has a disclosure policy. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.
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