(Editors' Note: This article covers micro-cap stocks. Please be aware of the risks associated with these stocks.)
"I've had it! There are no cheap stocks to buy right now!"
During research to find good Top Buy picks over the past 2-3 months, I must have repeated this line to myself at least a dozen times.
It's true, we are no longer in the fertile investing hunting grounds we have enjoyed since late 2008. The current P/E ratio of the S&P 500 is about 19.5, which is at the high end of the market's long-term historical average. Indeed, even combing through a value focused screen like Magic Formula® Investing (MFI), I've had substantial difficulty finding stocks that provide an acceptable margin-of-safety for investment.
But we can't give up. As Jim Cramer likes to say, "there's always a bull market somewhere!". The worst thing we can do is stray from our investment plan. But we can still stick to the plan, roll up our sleeves, and focus on these 5 ideas when there seems like no cheap stocks are out there to invest in.
Invest in Foreign Stocks
Many strategies (MFI included) consider only the stocks of U.S. based companies. But there is a whole universe of stocks located outside of the U.S. to apply value investing criteria to. Many of them are listed as American Depository Receipts, or ADRs, making purchasing them almost the same as buying a U.S. stock.
We can approximate the MFI screening methodology using a good online screener like the one at Finviz. I set up one with the following criteria:
- Country: Foreign (ex-USA)
- PE: Low (< 15)
- Return on Investment: Very Positive (> 25%)
Consider Micro Cap Stocks
The "official" Magic Formula screens let you find stocks all the way down to a $50 million market cap, which is pretty small. But there are stocks under that threshold, some of which have intriguing value metrics. Micro caps have their own unique challenges - low liquidity and trading volume, customer concentration, lack of scale advantages, etc. - but they are an asset class to consider when other wells run dry.
Using the MagicDiligence screener, with a minimum market cap of 1 million, I found a couple potentially interesting micro-caps to look into (there are others as well):
- Envirostar (EVI): $21 million market cap. Makes industrial laundry and dry cleaning equipment. 67% below its 52 week high. Grew revenues 64% last year, tripled operating income. Founder and CEO Michael Steiner controls over 70% of the shares.
- MIND CTI (MNDO): We've seen this one before in the "official" screens but its valuation today puts market cap at $38 million - below the threshold. The firm sells billing software for telecom and pay TV operators. While there's not much growth, the business is stable and MIND pays out all of its cash flow in the form of a dividend. The current yield before Israeli taxes is 11.8%!
Focus on Dividend Yield and Cash Flow
The great thing about dividend stocks is that we know we are getting paid a certain rate, even if the stock doesn't go up very much. When value is hard to find, dividends are a nice way to find reliable returns. If we can locate dividend paying stocks that are at least slightly undervalued, we may be able to benefit from capital gains as well!
The Magic Formula has some decent yield plays at present that look fairly valued to slightly undervalued. A few starting points:
- Several tobacco stocks are all part of MFI, pay good yields, and have fairly valued stocks. Altria (MO) has a 5.1% yield, Reynolds American (RAI) 5.2%, and Lorillard (LO) pays a 4.4% dividend yield. The adventurous might even look at Vector Group (VGR), where the trailing yield is an enticing 9.8%.
- Several "big tech" firms sport decent and growing dividends, and several are in MFI: Microsoft (MSFT), Cisco (CSCO), and CA (CA) all have 3% yields at low payout ratios, and histories of dividend hikes.
Consider Alternative Investments
Stocks are not the only thing out there to invest in. While outside of the scope of this site, maybe this is an opportunity to take some time and learn about investment real estate, investing in preferred stocks, or even hunting for some attractive, tax-free in-state municipal bonds. The more adventurous may even be tempted by peer-to-peer lending's attractive track record of double-digit yields.
Repeat this to yourself: "There is nothing wrong with holding cash!". Market is overvalued? Fine, harvest your gains, build and add to your "dry powder" stash of cash, and wait until the market makes one of its inevitable turns south. When those opportunities arise, you will be ready to put a lot of cash to work in assets with lower risk and a higher rate of potential return.
There's a reason Warren Buffett said "be fearful when others are greedy and greedy when others are fearful". Right now the former statement is most applicable. But there will be a time, and it will be sooner than most think, when the latter rings true. Prepare yourself up to be ready for that time.