The Perfect Investments for This Market

Last year's market crash knocked the stuffing out of many stocks. Many of the beatings were well-deserved. Money-losing car companies such as General Motors, and overleveraged investment banks such as Lehman Brothers, had serious debt problems that meant their demises were likely only a matter of time.

But many companies were knocked down for reasons other than the collapse of their financial house of cards. Some fell because the overall economy slipped into recession, taking their businesses along with it. Some dropped simply because the overall market was tanking, and as people pulled money out of mutual funds, those funds needed to sell anything that had liquidity in order to raise cash.

In other words, while some "cheap" stocks deserved their haircuts, others are now serious bargains.

It's time to imitate Benjamin Graham
It's no coincidence that value investing -- the strategy that made Warren Buffett rich and famous -- was perfected on the heels of the Great Depression. With stocks trading as if financial Armageddon were just around the corner, it took a special kind of courage to buy during that meltdown.

Yet that's exactly what value investing pioneer Benjamin Graham was busy doing -- fine-tuning the concept of value investing and making his own fortune along the way.

These days, though the economy isn't quite as bad as it was during the worst of the Depression, the parallels are certainly strong enough for you to stand up and take notice. Unemployment is in the double digits in much of the country. This current recession has lasted longer than any since the Great Depression itself. And of course, the stock market's 2008 plunge invites way too many comparisons to the aftermath of the 1929 crash for comfort.

Whether or not we're really in the middle of the second Great Depression, it makes sense to study investors like Graham who were successful then. If history is repeating itself, his strategies provide a tremendous road map on how to invest successfully amid an otherwise nightmarish economy.

And if this isn't Great Depression: Part Two, well, disciples of Graham -- such as Buffett -- have certainly been successful enough investors to suggest that value investing works outside of depressions as well.

The cheaper, the better
Perhaps the best part of the value investing strategy is that it's so very straightforward. In essence, value investors look to buy stocks for less than they're objectively worth, and then simply hold on to their investment until the market realizes that fact.

There's no rocket science involved, but you do need to be willing to buy what the rest of the market is busy selling as garbage -- provided there's really treasure buried there.

One way to tell whether the market has mispriced a company, thus creating a value opportunity, is to look for companies selling for less than their tangible book values. Take a look, for instance, at these:

Company

Price-to-Tangible Book Value Ratio

Price-to-Normalized Earnings Ratio

Nippon Telegraph and Telephone (NYSE: NTT  )

0.95

7.54

Valero Energy (NYSE: VLO  )

0.55

3.33

Ameren (NYSE: AEE  )

0.85

8.49

Royal Caribbean (NYSE: RCL  )

0.48

9.98

Sunoco (NYSE: SUN  )

0.96

2.72

Terex (NYSE: TEX  )

0.97

3.75

Armstrong World Industries (NYSE: AWI  )

0.89

7.69

Data from CapitalIQ, a division of Standard and Poor's, as of July 7, 2009.

They're all trading below what they might fetch in a liquidation sale. Yet they've all posted positive normalized earnings over the past 12 months, which indicates that they may not be quite as dead as the market thinks they are.

While these aren't official buy recommendations, they -- and stocks like them -- are good places to start looking for opportunities to begin building your own value-focused portfolio.

Are you ready to buy?
At Motley Fool Inside Value, we're salivating over the tremendous bargains now available in the market. As disciples of Graham and Buffett, we know that buying the survivors during a panic sale is a great way to make money as investors. If you'd like to follow along with us in the footsteps of those amazingly successful investors, then join us today for your 30-day free trial. Simply click here to get started.

Already subscribe to Inside Value? Log in at the top of this page.

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta did not directly own shares of any company mentioned in this article, but his wife owned shares of Valero Energy. The Fool owns shares of Terex and has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (35)

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.

  • Report this Comment On July 08, 2009, at 2:53 PM, leohaas wrote:

    "In essence, value investors look to buy stocks for less than they're objectively worth..."

    Therein lies the problem right now. What is a stock objectively worth? You use price-to-book value as one of your measurements. But if one thing has become clear during the crisis and its aftermath, is that book value is not reliable. Especially now we have moved away from mark-to-market, who can trust a company's books? Just depends on who is cooking them!

    By the way, didn't Inside Value recommend FMD a few years back? I am still reeling from my loss on that one. Needless to say I did not renew my subscription...

  • Report this Comment On July 08, 2009, at 8:32 PM, wolfhounds wrote:

    Right on Leo.

    Book value under any circumstance does not equal liquidation value. Book value is an accounting term. A simple example is the book value of a building; it's purchase price less depreciation. Most office buildings built years ago are still worth much more than book, but more recent construction is more likely not reflecting depressed market prices. That's why book value is generally not useful. You have to consider each class of assets, not the mechanical math on the balance sheet.

  • Report this Comment On July 13, 2009, at 7:53 PM, jgrichard wrote:

    I have not found anything or any scheme that works except to buy common stock, preferred stock or closed end funds that pay huge dividends. Out of necessity, I leaned to pick the good ones and I learned to diversity in case I was wrong about a particular investment. . So far, (Oct 97 thru July 09. It was a wild ride, but I am even. I do not know anyone else that can make that claim. Do You?

  • Report this Comment On July 21, 2009, at 9:38 AM, valuevulture999 wrote:

    It's not enough to just buy cheap. Most stocks that sell below book value are priced that way because of certain problems in their financials. It is important to separate the true value plays from the value traps. Don't fall into Bill Miller's mistake last year when he loaded up on bad financial stocks because the prices looked cheap. It is important to understand your underlying risk which creates your safety of margin.

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