Subprime woes got you singing the blues? Ready to run for the hills or trade in your carefully chosen portfolio of growth stocks for a precious metal, so you can bury it in the backyard?
I say phooey on that! Foolish investors must never forget the admonitions of Warren Buffett. One of my favorites is from an article he wrote for Forbes in 1979: "You pay a very high price in the market for a cheery consensus."
Sure, the subprime lending market is in for a rough spell. Lending lots of money to people who have a checkered history of paying it back was never a good idea in the first place. And, yes, chances are good this will have a ripple effect on the economy and the market. But that definitely doesn't mean "game over." There remain plenty of opportunities for disciplined investors.
Control your risk
So, where should you put your money during a spell when the markets are in for increased volatility? Here's one investing theme you could consider. It offers:
- Large companies with strong competitive advantages and good growth prospects.
- Companies with P/E ratios very near to below the market average to limit downside risk, especially when compared to their long-term growth rates.
- A nice kicker: Companies that are currently out of favor -- ones that are 10% or more off their high of the past 12 months. Remember, if everyone else loves the stock, you won't be able to buy it at a discount.
Here are four companies that meet these criteria. I limit myself to retail companies because that's the sector I know best.
The players
Wal-Mart (NYSE:WMT) has an incredibly dominant brand because of its amazing logistics alone. No company in the retail sphere is as good at moving product from point A to point B more effectively or at a lower cost. On the management front, there has been more turnover than usual at Smiley Face, but bench strength is incredibly deep.
The stock is out of favor for several reasons. Growth is slowing. The company is a big target for unions. Smiley Face has also made some uncharacteristic marketing and merchandising miscues the past few years. But don't forget Wal-Mart will do nearly $1 billion in sales every day this year. Less-than-robust consumer confidence will only make Wal-Mart stronger, as stretched consumers look for value.
Keep in mind that my investment theme here isn't searching for the next 40-bagger like Starbucks (NASDAQ:SBUX). It's about value, excellent long-term prospects, and limited downside risk.
Wal-Mart is currently trading at 17.6 times TTM (trailing-12-month earnings), with a PEG ratio of 1.0. The stock closed Wednesday 9% off its 12-month high -- a little low there, but it's Wal-Mart!
My second selection is Best Buy (NYSE:BBY), another company with a dominant brand. No other large electronics retailer truly competes with Best Buy on selection, price, and customer service. The competitive advantage I see here is the company's push into computer service. I know Geek Squad is a pretty, well, geeky name, but I'm convinced Best Buy is onto something here -- and years ahead of anyone else who sells consumer electronics. Add to that the company's multiyear effort at customer segmentation, which few companies in retail do well. I don't know of a retailer that understands its customer better than Best Buy.
For evidence of management strength, note that Sears Holdings (NASDAQ:SHLD) hired a Best Buy executive this past January for the role of Sears CCO -- chief customer officer.
The company has been out of favor since the third quarter last year, when it reported revenue growth of 11% but surprised analysts with earnings growth of only 8% and a 90-basis-point decline in margins. The concern is heated competition in key categories like flat-screen TVs. OK, competition in the consumer electronics world is fierce, but my contention is that only makes the best companies get better.
Best Buy is currently trading at 19.5 times TTM earnings, with a PEG ratio of 1.07. The stock closed 16% off its 12-month high.
Finally, I offer up the choice of either Lowe's (NYSE:LOW) or Home Depot (NYSE:HD). This is a little bit of a different story, and a longer-term play than either Wal-Mart or Best Buy. Troubles in the housing market have had a significant effect on the earnings of home-improvement retailers. After gangbuster years in 2004 and 2005, both companies hit the wall during the second half of 2006 on slower revenue growth, compounded with prior-year comparisons that included the effects of Hurricane Katrina. Both stocks had been recovering nicely, but have taken big hits the past month on worries that subprime woes will prolong the real estate slump.
Perhaps that's true, but there are only two real players in the home improvement sector. Both are great companies with excellent track records. The home improvement business will be back in favor when the real estate market improves, which looks to be six to 12 months out. I wouldn't wait until the future looks rosy. If you do, you're likely to miss a buying opportunity.
Which company to choose? I prefer Lowe's for two reasons. Prior to 2006, its growth rates were higher than Home Depot's, thanks to (I believe) superior price, assortment, and the perception that its stores are easier to shop. I also think Home Depot may wander for a while after the exit of CEO Bob Nardelli, but it's probably a toss-up. Choose the company you think offers the best value and forget about it for a year.
Lowe's is currently trading at 16.3 times TTM earnings, with a PEG ratio of 0.89. The stock closed Wednesday 10% off its 12-month high. Home Depot is trading at 13.9 times TTM earnings, with a PEG ratio of 1.05. The stock closed Wednesday 12% off its 12-month high.
The Foolish bottom line
Not enough compensation for the risks being taken is what got subprime lenders in trouble. I think these four companies, over the long haul, will more than compensate you for the risk taken by investing in them in 2007.
What do other Fools think of my choices? Check out these articles to find out:
Wal-Mart and Home Depot are Motley Fool Inside Value recommendations. Starbucks and Best Buy are both Motley Fool Stock Advisor selections. Both newsletters are available for a free trial.
Fool contributor Timothy M. Otte surveys the retail scene from Dallas. He owns shares in Wal-Mart, but none of the other companies mentioned in this article. He thinks value is a virtue and welcomes comments on his articles. The Fool has a disclosure policy.
