Crust central
We at the Fool recently moved to a new office space, and I'm starting to think that the cube farm I share with colleague Nate Parmelee should have a warning sign near the entrance. Something like "Beware: Grumpy Old Men."
Lately, our water-cooler talk has been of the type that many investors would find odd. Very odd. Because we're nervous. Spooked, even. Why?
The markets are flying these days, right? The S&P 500 looks good, as do the Dow and the Nazz. What we have here is a rising tide, and it's lifting a lot of boats.
And to me, that's precisely the problem. This is the kind of market that makes a monkey with a dartboard look like a good stock picker. And while other investors might look at their recent portfolio gains and congratulate themselves on their astounding cleverness, I try not to wrench my arm patting myself on the back. In fact, I like to keep open the possibility that I might be doing well simply because I am just a monkey with a handful of darts and a very large bull's-eye. I think it's entirely possible, even likely, that over the past few months I have been lucky, not smart. Yes, lucky money spends the same as smart money, but not if you don't take it off the table while the luck holds out.
But I'm not sure that the luck is going to hold, that the tide is going to continue to lift all those boats, or that the bull's-eye will stay this large. (You pick your metaphor; I'll stick with the monkey.)
When everything rallies for not much of a reason, I get a twitch. Lately, the happy vibes are rumored to come from the Street's interpretation of recent Fed minutes that seem to indicate that rate-tightening will soon come to an end.
But this monkey doesn't quite buy it. I see rising gasoline prices as a big potential spoiler for the economy. I see inflation rearing its ugly head, especially since the consumer price index jumped by 0.4% last month, and even the Labor Department's bogus inflation-minus-the-inconvenient-stuff "core" index made a 0.3% move. I'm betting the suits at the Fed are going to have to put the brake on borrowing for longer than Mr. Market believes, and I think there's even more potential for havoc with the end of the great house-swapping, housing-ATM, "it's not a bubble" bubble. What will Jane and Joe average -- whose real wages are stagnant or falling -- use as coin for their $300 True Religion jeans and Coach backpacks, not to mention those once-a-year iPod upgrades, if they can't tap the ready cash of pretend equity?
Manic monkey
At first blush, this sounds like a good argument to head for the hills entirely -- to close up shop, sell the whole portfolio, and hunker down, waiting for judgment day. But I wouldn't go that far. After all, my fears or predictions are only as good as the next guy's, which is to say, they're not worth much at all. The economy may continue to steam along just fine. People may figure out ways to fuel their lives without spending their way into the poorhouse. And that means they may just keep spending on all of those other things that will keep my portfolio happy and fat.
So my solution is simple: Look for opportunities to cut the flowers and water the weeds.
Monkey in the garden
You heard me. I'm looking at all my holdings with an eye toward shedding some of my recent winners and bringing the watering can over to those prickly little survivors that have yet to bloom.
Heresy, you say? Don't the master investors tell you to do the opposite? Haven't we often advocated holding on to your superior companies forever? Sure, that's the goal. But I think there's a very good reason to contradict this advice from time to time, and it's a little thing called value.
If you're familiar with some of my other cheapskate mini-rants, you'll know that I prefer to try something called "value investing," otherwise known as "investing." This requires the simple (in theory) task of finding stocks that are selling for less than my best guess of their real worth.
Like my colleagues at Motley Fool Inside Value, I believe that it's possible to evaluate a company's profit trends and future growth rates, and then come to a reasonable estimate of the true value of any stock. (I also believe that it's possible to find these bargains right out there in the stock market.) Conversely, that means I believe it's possible to realize that you're sitting on a stock that's fully valued and ripe for the picking.
The pruning knife and the watering can
Of course, figuring out which flowers to pull means taking a hard look at a stock's current valuation and what that says about the market's implicit growth assumptions. In a recent column that's worth a read, my colleague Nate discussed working backward from stock prices to growth assumptions.
I use a similar method via simple spreadsheets I've put together, but there are online cash-flow-valuation calculators (including one for Inside Value subscribers) that do some of the more annoying math for you.
The goal is simple: to find out what your stock prices say about the market's growth assumptions for that company. Then you ask yourself, "Do I believe this?"
For example, as much as I like what's been going on at Guess? (NYSE:GES), I don't believe it can simply grow at 15% to 20% forever -- maybe not even for five years, especially if consumer spending goes south. Based on what I consider a reasonable growth assumption, the shares are worth about $53 per stub to me, and should they get back there in the near future, I'll be "trimming the flowers."
I feel the same way about SanDisk (NASDAQ:SNDK). Provided there's nothing too spooky hidden in Thursday night's earnings release, I believe the shares are worth between $80 and $85 each, and if they rise to that level -- and they already visited that area a couple of months back -- I'll be trimmin' the winnin's there as well.
What would I do with the proceeds? I'd probably water some of the market's weeds. There are plenty of companies out there with stock prices that have done little over the past year, while the underlying companies have done much better.
Johnson & Johnson (NYSE:JNJ) is a consumer staple and heath-care provider (read: it's relatively recession-resistant) that looks to be trading at about 80% of my fair-value estimate. 3M (NYSE:MMM) is a similar company, and it's one of my portfolio "weeds." Its returns for me over the past few months have been less than spectacular (about 15%), but I still believe the shares are worth about $105 each, and I believe that any impending economic troubles will trouble it much less than it would my trendy retailers. That's why I'm thinking about watering this one.
If you're more interested in watering some of the flowers out there, I think that integrated oil giants like ExxonMobil (NYSE:XOM) and even PetroChina (NYSE:PTR) have plenty of growing left to do, despite their recent rises.
Foolish bottom line
To be sure, trimming the flowers can sting. Stocks on the way up tend to keep going up, until they don't. But at the bottom of things, investing is about paying less for something than it's worth and then selling it to the next guy for more. If you've purchased stocks (as I try to) with a 20% to 30% discount, swapping them out of the portfolio for a fair price can lead to consistent, market-beating returns.
Yes, it's fun to hold past fair and hope for more, but remember that stocks that get ahead of themselves tend to give it back later. When you think the odds for market jitters on the horizon are good, there are much worse policies to follow than putting your winnings to good use in safer, undervalued stocks.
If you'd like to take a look at good, cheap stocks worth watering, a free trial to Motley Fool Inside Value -- with access to stock picks, valuation discussions and tools -- is just a click away.
Seth Jayson doesn't necessarily believe in holding stocks forever. At the time of publication, he had shares of Guess?, SanDisk, 3M, and PetroChina but no positions in any other company mentioned. View his stock holdings and Fool profile here . 3M is an Inside Value pick. Fool rules arehere.
