Make no mistake about it -- this is still a very scary market. Despite the market surge off the early March nadir, the S&P remains at the same level as it was last November. While the CBOE Volatility Index (a.k.a. the "investor fear gauge") has fallen sharply from its record highs in October, it still remains near 25, which, on a historical scale, still indicates investor anxiety.
Last fall, I advocated the importance of keeping a long-term focus and strategically avoiding the media blitz of bad news. But keeping your cool in this mess doesn't apply only to panic selling, but also to panic buying.
Just because a number of stocks, such as iconic photographic equipment company Eastman Kodak, have fallen considerably in the past year, that doesn't mean they've reached the point of maximum pessimism and are worthy of buying whole-hog right now. In fact, I would argue that Eastman Kodak is one "value" to avoid in this market.
You don't own me
For one, Kodak is heavily reliant on debt to fuel its respective operations. As of March 31, it posted a 196% long-term debt-to-equity ratio. Simply put, debtholders, not common stockholders, all but run the show at the company. Those debtholders care most about getting their money back, plus interest; they don't necessarily have any interest in long-term earnings growth.
Additionally, with all that's happened in the credit markets this year, companies like Kodak will find their continuous need for debt increasingly costly and difficult to fulfill. When a company has a "junk" rating on its debt, as Kodak does, it has to offer higher interest rates on its debt to attract investors, so its interest expenses remain high, leaving less left over for shareholder earnings.
This brief analysis doesn't even consider Kodak's intense competitive landscape as it competes with the more efficiently run Canon (NYSE: CAJ), making margin growth, market-share expansion, and overall recovery even more difficult.
While there's always a remote chance that Eastman Kodak will miraculously turn itself around, I wouldn't bet hard-earned money on it. There's simply easier money to be made in the market.
Like how?
When the market is scared and the debt markets are unpredictable, it pays to start your search by looking for superior companies whose stocks may have been unfairly punished. In short, this means seeking out stocks with these qualities:
- More than 30% off their 52-week high
- Manageable debt
- Return on equity above 10%
- Positive free cash flow
- Cash in the bank
Here are some examples:
|
Company |
% Below |
Return on Equity |
|---|---|---|
|
Biogen Idec (Nasdaq: BIIB) |
36% |
14% |
|
National Oilwell Varco (NYSE: NOV) |
57% |
20% |
|
Terra Industries (NYSE: TRA) |
50% |
39% |
|
Medtronic (NYSE: MDT) |
38% |
18% |
|
Honeywell (NYSE: HON) |
34% |
24% |
|
Sysco (NYSE: SYY) |
33% |
33% |
Source: Capital IQ, a division of Standard and Poor's.
Like Kodak, these companies have been beaten down in this market, but their futures are much brighter. Since they generate enough cash by themselves, they don't rely heavily on the debt markets to maintain operations, and they can remain focused on shareholder interests.
Buy them now?
Even though you now know which values to avoid and which ones to consider in this market, that doesn't mean you should invest all of your savings right now. Although the market has rallied in recent months, we may not be out of the woods just yet. Nevertheless, now is a great time to begin (or keep) adding money to great companies trading at great prices.
The last time the market was this scared of equities, as measured by the CBOE Volatility Index, was August through October 2002. During this period, Fool co-founders David and Tom Gardner picked six stocks for Motley Fool Stock Advisor that have since returned an average of more than 200%.
Cautiously investing in this market is understandable and smart, but the most important thing is to keep adding money to your portfolio. Rather than chasing potential value traps like Kodak, focus on companies with strong business models that will serve them well when the market finally comes around.
These are the types of stocks we look for at Stock Advisor. If you'd like to learn more, consider a free 30-day trial. There's no obligation to subscribe.
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This article was originally published Oct. 20, 2008. It has been updated.
Todd Wenning likes his sugar with coffee and cream. He owns no shares of any company mentioned. National Oilwell Varco is a Motley Fool Stock Advisor recommendation. Sysco is an Inside Value and Income Investor recommendation. The Fool owns shares of Medtronic. The Fool's disclosure policy fights for its right to party.
