Value Investing: 12 Stock Ideas for the Last 2 Months of QE2

by: Hedgephone

Since the start of QE2, the big banks have rarely failed to make a trading profit, utilizing the tax dollars from the bailout and QE2 to move the market higher. Meanwhile taxpayers, who live in the real world where the economy is sucking wind, are either short the stock market or sitting out of arguably the greatest stock rally in United States history.

Is it just great trading acumen or is it something more insidious that has allowed JP Morgan (NYSE:JPM), Bank of America (NYSE:BAC), and Goldman Sachs (NYSE:GS) to have positive trading days in nearly every single day of the first quarter? Is the stock market even worth looking at for the average American? The answer to the second question is most likely no -- playing against a rigged deck never makes sense in poker and investing against the big boys is essentially the same thing unless you can front run the POMO desk and buy stocks ahead of liquidity injections and sell into the rallies.

So what should investors do here? For the past year I have emphasized commodities as being safer investments than stocks because of this liquidity transfer, but I have also suggested buying index puts on the overvalued indices and purchasing stock in undervalued companies that have foreign exposure or very low price-to-free-cash-flow ratios relative to growth and market cap. This has not worked at all -- the commodity thesis was correct, but the stock market has shot up faster than I predicted.

Every day the bankers get this free money from the FED, the market shoots up. When the FED doesn't hand the banks free money, the market either goes down or stays flat. Clearly a strategy that front runs the POMO days is a smart one, but what will happen to the stock market once POMO ends? My guess is that the stock market is breathing its last bull market gasps presently and once the POMO leaves the market, stocks (as well as business in general) will decline.

Here are 12 stocks that are dirt cheap now, which should do well for the next two months or longer:

JASO -- JA Solar was out with earnings of $71MM or $.41 cents per diluted share. For a stock at $6.48, this was a pretty amazing quarter. JASO has a fully booked log of business this year so earnings could surprise to the upside to a large degree. While cash flow from operations has been soaked up by capital expenditures, I view growth capex for the company as a plus and feel that JASO is one of the biggest bargains in the global equity market. That said, the stock carries a beta of 2.6 or so and investors may want to sell a call option against the stock for a hedge. Although our central planners hate China and Chinese Solar companies generally, China's centrally planned economy desperately needs these companies to compete. In other words, in this cold war, solar power likely eeks out a win.

HAST -- Hastings Entertainment is just too cheap here at a ridiculous 40% of tangible book value and 4X free cash flow multiple. Wise long term value investors can buy the stock on the cheap at current prices and sell stock back to management at current prices -- last year the company repurchased $6.4MM shares at a price over $6.50 a share. Hastings is a low float name with around 50% of the shares owned by management and company insiders. The business has been a favorite shopping destination and holding of mine over the years -- my way to play this is to buy anywhere near half book and sell anywhere near book value... This value investment round trip has worked for me three or more times in the past and I think it has at least one trip back to book value left for a longer term investor.

NWLI -- Like HAST my favorite way to play National Western Life Insurance is to buy around half book and to sell around 80% of book. This type of value arbitrage has been very profitable for investors in this name over the years as management has been able to create substantial longer term value for shareholders. NWLI is trading for less than half of book value ($355 in net book) and for a price of just $157... NWLI has a PE under 9X earnings.

ACE -- Sticking with the cheap insurance theme, ACE Ltd. is a dirt cheap insurance name that makes the Magic Formula Screen as well as a larger holding for investment guru David Williams of UMBIX. ACE trades for just 7.5X trailing earnings and a small discount to book value. The company has been able to grow profits substantially over the years and carries a respectable 14.5% return on equity. Net profit margin of just under 20% seems high, but the company has a good moat from a longer term fundamental perspective.

AMX -- America Movil is another Magic Formula/David Williams holding that looks reasonable at 11.5X forward earnings and an EV/EBITDA multiple under 6X. AMX is a large position for Billionaire Carlos Slim and the stock should benefit if dollar weakness continues. With the way our central bank is printing money, dollar weakness seems fairly obvious over the longer term and AMX is one of the best managed foreign names available to U.S. investors.

PEP -- PepsiCo has rallied a bit lately but the stock is still quite reasonable at a 14.5X forward earnings multiple and an EV/EBITDA multiple under 11X. I would personally wait to buy PEP around $65 or under because the name has had a tremendous run this year compared with earnings growth and to the overall stock market. PEP looks to be valued similarly to Coca Cola at this point so I would personally favor Coke because of the company's stronger balance sheet position.

KO -- Trading for under 16X forward earnings, Coca Cola is trading at a small premium to the overall market, yet the company has proven to be one of the best businesses on the planet over the longer term. Personally, I would take risk off the table by purchasing the January 2012 $60 KO calls for $7.95 and sell the June $67.50 calls for $1.00 and hope and pray that Coke stock falls a bit as it did in March so that you can pick up shares of the company via a longer term buy and hold approach. Coke is still the largest holding for Buffett and the stock appears fairly cheap relative to technology names or small and mid cap stock indices.

MCD -- McDonald's has outperformed in recent months and I have closed out my bull calendar spread with a nice profit. With that said, I am hoping for a small correction in the name to repurchase the January 2012 $70 calls at a better price and sell front month at the money calls for a truly hedged position in the name. I do think MCD could break $80 because the forward PE of only 14.5X seems undervalued relative to the economic moat the company owns in fast food. Buying calls on MCD seems like a reasonable approach for a lower risk entry, but buying and holding the stock for the long haul also has many merits for non IRA investors who want long term gains over the years.

PBR -- Petrobras is falling into the too cheap to ignore category at under 8X earnings and an EV/EBITDA ratio of under 7. PBR is a bit confusing for sure after the big offering with the government, but the stock is dirt cheap and is another David Williams favorite, which investors can hold for the longer term without losing much sleep over. Although oil prices have corrected recently, I don't see this blip as breaking the longer term uptrend in the "stuff bull market."

RIMM -- Research In Motion is one of the most hated and begrudged stocks on Wall Street, which is a big reason I am bullish on the name. The other big reason I like RIMM is that the stock is a dirt cheap value name on PE and free cash flow and a GARP name all in one. With earnings pegged at $7.50 this year and a stock price of just $45, look to get long RIMM any way you see fit here and scale into the position slowly via dollar cost averaging.

SDRL -- Seadrill is another too cheap to ignore name, which is trading for just over 6X earnings. Seadrill is benefiting from the high cost of oil as well as the missteps by its competitors in the offshore drilling business. With a 6% dividend yield, this stock appears to be a good hedge against the dollar and a nice "picks and shovels" approach to investing in the oil and gas space. With one of the newest deep sea fleets, SDRL is well positioned for success in the future.

NEM -- Gold is way up but Newmont Mining Corp. is stuck in neutral. The stock just can't catch a bid, and even though the company is listed as one of the most undervalued gold miners based on proven reserves, the stock is trading for just 12X earnings. Investors looking to hedge their fiat currency risks should consider Newmont as a core position in their portfolio and can sell longer dated put options against the stock as a way to "get long" at a better price.

Disclosure: I am long JASO, RIMM, HAST, NWLI, KO, PEP, NEM, AMX, ACE.