Do analysts ever get it right? Nowadays, everyone thinks that RIMM is the next PALM and that index fund investing is the only way to make money in stocks over the long run. The average investor also wants to own the small cap indexes because they have outperformed lately; in fact, most investors only want to own stocks that have gone up in the recent past and they choose to sell stocks that have gone down to cut their losses. My view is the oppossite: short IWM and the momentum stocks like AMZN and LNKD and go long the stocks that have already crashed and offer investors cheap valuations and strong free cash flow per share.
Why is it that so many investors buy high and sell low instead of buying low, selling high and then going short (which is what you should be doing now)? The issue is clearly one of perception rather than investing based on factual investment merit. Warren Buffett made a career of doing just the opposite of what most pundits recommend -- Buffett looked to buy great businesses at unreasonably cheap valuations. His strategy involved buying stocks when they were down (when there was blood in the streets) and selling stocks (if ever) when everyone loved the stock market and valuations become rich like they are today.
Buffett was more of a deep value microcap investor in his early days when he would purchase companies trading below their net current asset values (current assets minus total liabilities) and sell them after earning a 50% profit. This earlier microcap strategy was the game plan of Buffett's mentor and teacher, Benjamin Graham. Later on in his career, Buffett moved towards buying great businesses and holding them for the long term.
With that said, Buffett always focuses on buying companies at cheap or reasonable valuations. He knows that one of the greatest risks in investing is overpaying for a company's stock. Buffett does, however, prefer buying great businesses at a premium price to buying bad businesses at a cheap valuation in many cases because poorly run companies tend to lead to long term losses for shareholders, no matter how cheap the business looks on paper.
Personally, I believe an approach that takes half of what works for today's Buffett and half of what worked from Graham will outperform the stock market over time. By purchasing stocks that are cheap on book value in combination with purchasing stocks that are well managed, an optimal basket of stocks can be bought which should compliment each other quite well and outperform over time. Right now I think sitting on the sidelines or remaining short or fully hedged is probably the best strategy. However, some names on the following list may meet Buffett's criteria for investment over the long term.
RIMM: I believe RIMM is a good company at a cheap valuation. I also believe that the fears and panic selling the name are overdone and that investors who are long term focused can buy a 1-2% position in the stock and make money over time. RIMM is trading for just 6.2X forward earnings while the company has a proven growth track record over a long period of time. In fact, RIMM is expected to grow earnings at 18% this year which is higher than Microsoft (MSFT), Intel (INTC), Cisco (CSCO), and the Russell 2000. RIMM is trading for a price to operating cash flow of only 5X while the company has a strong foothold in the cellphone market. I like shares here and think the selling of RIMM represents a panic and not a rational revaluation of the name.
FCX: Freeport is dirt cheap at 9X trailing earnings and 7.7X forward earnings. The stock is a recent addition to George Soros's holdings as he rolled some of his GLD profits into the copper miner earlier this year. FCX is trading at a large discount to reserve values, and the price of copper is likely going to rise over the very long term as central banks around the world print money to fund deficit spending due to high unemployment across the globe. I have argued that much of this unemployment is structural in nature, but whatever the reason, central banks will likely not hike rates any time soon, which means that cash is truly trash over the longer term.
VALE: Vale is one of the largest mining operations in the world, and although Buffett typically avoids commodity businesses, VALE is so cheap that Graham might have bought some shares in the stock due to the company's low valuation on earnings, cash flows, and reserves. VALE trades for under 7X trailing earnings and for just 5.5X forward earnings. Cramer was right when he said VALE is the cheapest commodity play on Earth, and I believe this name makes sense to a Graham type of investor at current prices.
KO: Coke is Buffett's largest holding, making up some 20% of Berkshire's (BRK.A) investment portfolio. The stock is a long term no brainer for Buffett as the company now spits out a dividend which is around the same amount as his original cost basis. Coke shares are not cheap by a Graham definition of the word, but when adding in the company's brand value and future cash flow streams, Coke shares are likely quite reasonable at current levels. Investors can rent the stock by purchasing January 2012 $60 calls and selling June $67.50 calls for a calendar spread approach to investing in the name which carries significantly less risk than owning shares directly.
JNJ: Johnson and Johnson has rallied around 10% in the past couple of months, but shares are still quite reasonable at 12.45X forward earnings and 14.8X trailing earnings. JNJ shares pay a solid 3.5% dividend yield and an EV/EBITDA of under 9X. I like JNJ here, but personally would be interested in selling the July $65 call options against my stock for a partial hedge in case JNJ underperforms after QE2 is taken away. JNJ's 205 plus ROE and nearly 20% profit margins mean that the business has a wide economic moat and I feel that consumers will be purchasing products from the company well into the future. I like the name for a longer term holding and feel that shares can be added on weakness.
COP: Conoco shares are dirt cheap on earnings and cash flows, and Buffett has a position in the name and has owned the stock for several years now. COP trades for just 8.5X trailing earnings and for 8X forward earnings. The company is benefiting from QE2's boosting of commodity prices, but oil prices could head lower in the medium term. However, as Jim Rogers has argued, if the economy improves, commodities will go higher and if the economy slows the Fed will likely embark on QE3 which is clearly bullish for oil prices as well.
MSFT: Microsoft is a stock that Buffett would likely not buy because it is out of his sphere of knowledge. That said, at 9X earnings the stock is quite cheap and value investors such as Whitney Tilson and others are long the name due to the large cash position of the company and also due to the fact that Microsoft is a global leader in software, cloud computing, search, and technology in general. Microsoft can continue to do battle successfully in the tech space as they have ample cash to invest in growth markets where they may not currently have first mover advantage. i like the stock but would not buy it without covered calls sold against the position.
BRK.B: The ultimate Berkshire Hathaway type investment is, well, Berkshire Hathaway. Investors need to look no further than Berkshire's B shares to find a good long term investment at a reasonable price. I also like covered calls here and would sell the June $77.50 calls for $1.70 or so for a nice cushion while providing some solid upside between now and June 18th. Buffett's investment acumen is second to none, and although the loss of David Sokol is unfortunate, the bench at Berkshire is still very deep. At a price to book near 1X, I think BRK.B is a value investment that will compound money for investors over the long haul.