You'd Have to Be Crazy to Buy Now

Everyone keeps telling me that it's crazy to buy stocks right now. The market is up from last year's lows, but nobody seems to think that this is a new bull market. There are a lot of reasons to believe that the market (and the economy) could get worse before it gets better. Some of those reasons make a lot of sense.

... Don't they?

Hang on a minute
You can count me among those who think that things could get worse before they get better -- though I'll also be the first to admit that I don't have a crystal ball. But even if things do get worse, I think we can find values worth buying right now. Consider:

  • Stocks don't move in lockstep. "The market" may be up or down in a given day or month or year, but there are always individual stocks -- often less-well-known, overlooked ones -- that aren't in every index fund, and which do their own thing. In the longer term, of course, a stock's price is driven largely by the company's fundamentals -- and those definitely don't move in lockstep.
  • There's almost always value out there. There are always stocks that are underpriced relative to the overall market. That's a premise of master value investor Joel Greenblatt's famous "Magic Formula." The trick is to find stocks that are underpriced relative to their intrinsic value -- without taking the market into consideration.

The key word here is value. The best value stocks have a high return on invested capital, a manageable debt load, and a low price relative to their earnings. In the current economic environment, we should also consider a company's ability to maintain its return on capital through a tough recession, and make double-extra-sure we're comfortable with the company's debt load.

The advantage of value
Here's why value investing is particularly compelling when the market is volatile: If we can find companies that are priced favorably relative to their intrinsic value, we have a margin of safety when we buy them. Put another way: If we buy companies for less than they're objectively worth, our downside is limited no matter what the market does.

Of course, a company's intrinsic value is an educated guess at best. Even so, seeking a margin of safety keeps you focused first and foremost on the return of your capital. Profits are great -- that's why we buy stocks -- but avoiding losses should be our first priority. Value manager extraordinare Mohnish Pabrai uses the Gujarati term "dhandho" to describe this way of looking at investments -- or as he playfully translates, "Heads I win, tails I don't lose much."

So, where are these companies?
Finding these companies can require some counterintuitive thinking. Value stocks are often found in "out of favor" corners of the market, and one of the value investor's jobs is to determine whether the company is out of favor for reasons that should keep it out of your portfolio, too. Value stock screens thus tend to turn up a lot of dubious-looking candidates at first, but sometimes a closer look can be rewarding.

For instance, one of my favorite value screens turned up fertilizer giant Mosaic (NYSE: MOS  ) this morning. My first thought was, "Mosaic? Didn't they kind of get clobbered by the commodities bust?" But while the company hasn't had the easiest ride lately, a closer look showed some intriguing possibilities. Here are some key numbers for Mosaic and some of the other names that showed up on that screen:

Stock

CAPS Rating

P/E

Total Debt/Equity

Return on Equity

Mosaic

****

4.5

0.18

54.1%

Coach (NYSE: COH  )

****

7.9

0.00

46.1%

Take-Two Interactive (Nasdaq: TTWO  )

****

5.9

0.11

17.9%

Teradata (NYSE: TDC  )

****

11

0.00

39.9%

Western Digital (NYSE: WDC  )

****

3

0.18

43.2%

Manitowoc (NYSE: MTW  )

*****

3.1

0.16

22.1%

WABCO Holdings (NYSE: WBC  )

*****

4.9

0.33

41.4%

Source: Motley Fool CAPS, Yahoo! Finance.

See what I mean when I say that this can be a counterintuitive discipline? A luxury company like Coach is hardly the kind of stock that comes to mind first during lean times -- but that's part of why the share price is low. It's out of favor! If a closer look at its business and financials shows strength and the ability to weather rough economic times, Coach could be an intriguing buy-and-hold candidate at current prices.

That said, I do want to be clear about one thing: The stocks I listed above are just promising candidates turned up by a screen, not recommendations. It's essential to take a closer look before you buy.

If you don't have the time or inclination to take those closer looks yourself, but you'd like some carefully vetted value ideas to buy today, I invite you to give our Inside Value newsletter service a try. You can see the team's best ideas for new money in just a few seconds with a 30-day free trial.

Fool contributor John Rosevear has no position in the companies mentioned. Take-Two Interactive is a Motley Fool Rule Breakers pick. Coach is a Motley Fool Stock Advisor recommendation. Try any of our Foolish newsletters free for 30 days. The Fool's disclosure policy has an incalculable intrinsic value.


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  • Report this Comment On January 13, 2009, at 3:42 PM, Silverbrainer wrote:

    WDC is announcing a 2TB hard drive at the end of the week, a first in the industry, and with the recent news of Seagate exec's jumping ship, along with a new report of Seagate's 1TB having higher than expected failure rates, WDC might be worth another look if only for a quick in and out trade.

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