Research in Motion (RIMM) taught me a valuable lesson. Guidance means absolutely nothing -- CEO's lie, misinform, are filled with hubris, or are generally just dishonest many times. What bothers me so much about RIMM's guidance of $7.50 being reduced to $5.25-$6.00 was the fact that they did not warn the street much earlier -- clearly, the $7.50 number was, well, total hogwash from the start.
The lesson learned here is that "cheap" tech stocks are too hard for me to understand and therefore because they are out of my area of expertise, there is really no reason for me to follow these names anymore, and that also includes Microsoft to some degree. Although I like Microsoft (MSFT) and believe in the stock at 9X earnings because I can't get my arms around their business from a fundamental analysis approach I must make it a 2% position and not a 5% position. I can get my arms around an oil and gas stock, a healthcare provider, a retail operation, a cyclical stock, but technology is too dynamic and complicated to really grasp from a PE ratio basis.
Therefore, hedgephone.com will likely not cover stocks like Intel (INTC), RIMM, Ingram Micro (IM), MSFT, Cisco (CSCO), etc., etc ... as much as we have in the future because even though these stocks look dirt cheap, the experience with RIMM was enough to sour us on "cheap tech" stocks for the foreseeable future because we recognize that the industry is more or less out of our circle of expertise. Hopefully, company insiders can learn from RIMM's collapse that providing overly optimistic guidance is a longer term mistake. In defense of the value investor out there, many a company burned those like me who like buying stocks with low price to earnings and price to cash flow ratios (high earnings yield) -- China MediaExpres (CCME), RIMM, etc., etc. ... were stocks with extremely low PE ratios and low price to cash flow ratios that absolutely crushes fundamental, bottoms up value investor. From now on, I will put much more emphasis on tangible book value per share, defensible long term competitive advantage, and above all else economic moat.
RIMM's collapse shows that a low price to earnings valuation is not enough because Wall Street tends to know more than the average investor about these stocks and many times the industry experts find the skeletons in the closet long before the rest of the world does -- in other words, if you are not an expert in a particular line of business, you should avoid investing in that industry for the most part. Index fund investing (although a bad deal at present considering the macro backdrop and valuations) simply works better because you can avoid major blowups like RIMM -- at 4X earnings pre earnings the stock looked too good to be true. In hindsight, that's because it was!
In the end, finding dirt cheap stocks should be done by researching the balance sheet more than the income statement because when a business erodes from a profitability standpoint investors need a margin of safety from an asset value perspective to protect their capital and manage risk.
RIMM was at a 4.8X forward PE ratio and a 6X trailing twelve months PE before the disaster quarter, and just like the poker table, if you don't know who the sucker is in the room -- it's you! I was certainly in the sucker camp on RIMM as I wanted to believe that the company would earn at least $6 a share this year and more next year and in future years to come. I would have a lot more confidence in that hypothesis if management was honest with their shareholders.
Given the fact that Wall Street knew the guidance was way off before they let the whole world in on their little secret is a huge red flag for me and my longer term hypothesis on the stock but on low PE ratios in general -- I exited a third of my position in the after hours market and still have a little over 1% of my assets long the name, but I am no longer interested in the stock on a PE basis because of the low visibility of the earnings guidance.
In other words, low price to book value is a better strategy than low PE/growth rate in my view and Hedgephone will be adapting accordingly. Right now, the markets have held their 200 day moving averages and we are likely to see a bounce in the short run With that said, we will be keeping an eye on the 200 day and will be adapting to market conditions according to valuations and fundamentals in the deep value names we own and our hedge positions against them. Just because there aren't many cheap stocks on liquidation value at present does not mean we need to change our stripes and buy growth at reasonable price names in industries that we don't fully understand -- lesson learned: we like to buy either great businesses at reasonable prices or stocks trading below net current assets. Here are 20 good investment ideas to research that meet this criteria:
(JBSS) -- John B. Sanfilippo and Sons is a cheap name with a strong balance sheet. The company's net balance sheet does consist of a high amount of property plant and equipment, however the stock has been free cash flow positive over the past year. This business has exhibited a cyclical element but is a name which you can buy cheap and sell dear if you have patience and the guts to buy when the stock is trading for a low price to book value ratio. JBSS is currently trading for half of book, and around 55% of tangible book.
(VOXX) -- Audiovoxx is a Net Net stock which has been under pressure from a recent acquisition. We don't have too much color on what the new financial statements will look like post acquisition, but from a margin of safety perspective, Audiovoxx looks quite cheap to me.
(NWLI) -- National Western is a dirt cheap stock at .40X tangible book value, but rising debt to equity as well as a high amount of deferred long term assets makes this stock a tough buy for many value investors. We like the name and think it could trade for book value at some point in the future which would represent a 100% increase from current prices.
(AIG) -- AIG common is trading for a large discount to tangible book at around 50% of assets minus liabilities. The stock has been under a great deal of pressure, but Bruce Berkowitz has reportedly been adding to his large, concentrated position in the name and we view his research as resolutely bullish for this stock over the longer term.
(DUCK) -- Duckwall Alco Stores has had a rough couple of years, as sales of higher margin products has fallen compared with lower margin products such as food. We like the grocers at this point as a way to play falling commodities, but over the longer term we think commodities will rise if QE3 is announced. DUCK shares trade at just .35X tangible book value and we think the discount to intrinsic value is unwarranted. The company has reported losses recently, but cash flow remains positive.
(HAST) -- If you like Coinstar, you should look at Hastings Entertainment, which rents movies for just fifty cents per day. Hastings is very cheap on net asset value at a price to tangible book value of only .34X and a price to operating cash flow of around 1.8X -- we like the company as a diversified way to play discount retail.
(ASI) -- American Safety is a holding of Aegis Value Fund which looks cheap on book value at .60X net tangible assets. The company is growing currently, and that has produced above average book value per share growth over the past five years. We like the name here and think that the stock has a long way to run from current levels.
(BQI) -- Oilsands Quest is a company which is a venture capital style investment in the Canadian Oil sands market. If you think oil prices are headed higher over the longer term, this stock could be a bargain at less than half of tangible book. That said, the company has lost a significant amount of money for investors over the past few years. I view this as a speculative play, but the assets are there to back up this call option on the oil sands.
(KEP) -- Korea Electric is a utility in South Korea which trades for under 20% of book value and a reasonable PE ratio of 13X forward earnings. The stock has been treading water for five years now, but we think the large discount to tangible assets is unwarranted and like the stock regardless of the overall direction of the stock market.
(KO) -- Coke is a stalwart investment which falls under the high quality business category and is the largest investment holding of Warren Buffett. We like Coke, but would rather buy the leap calls and sell front month calls for a calendar spread right now because we feel the overall market is expensive and could sell off substantially right now.
(TGT) -- Target is another quality franchise which sell for a reasonable valuation at 10X forward earnings and just 6X EV/EBTDA. We like Target but would consider the same call spread approach as discussed on KO.
(JNJ) -- Johnson and Johnson is a reasonably priced business with a strong competitive advantage and huge moat. We like the name and with a 3% dividend on the name, we think the stock is a good value, but also a high quality business. We would like to sell the calendar spread calls on this name as well, picking up the Jan. $50 calls and selling the front month at the money calls against the name.
(BRK.A)(BRK.B) -- Berkshire is always a good investment. The company is the best run business in the entire world and we think the current sell off in the stock is a buying opportunity. It's hard to bet against Warren Buffett, and as they say if you can't beat them, join them. BRK.B trades for 17X earnings and 1.16X book value. Buffett has grown book value by an incredible amount over the years and we think this growth can continue for years to come.
(ACMR) -- AC Moore is a cheap name at less than half book value. The business has been in decline for some time, but at the right discount to asset value investors can make some money in the stock as the discount to net current assets provides a margin of safety.
(HWG) -- Hallwood Group is cheap at around half of net current assets. We like the name but realize that textiles are a horrible business to invest in over time. The stock is cheap enough that investors have a good margin of safety here and the dips should be bought in our view.
(GBR) -- New Concept Energy: Speaking of dips and undervalued assets, GBR is a dirt cheap name which has $18MM in net book value and just $4MM in market capitalization. The stock is down some 60% in the past two months and we feel the worst case is already priced in -- we like this little senior living and natural gas drilling business, but we recognize the fraud risk that comes with nanocap investing.
(KCLI) -- Kansas City Life is a cheaper name which is a stock owned by ABC Funds who is a value investor with one of the best longer term investment records in history. Clearly, 2008 was a difficult period for investors in the nano cap low price to book value category, but over the past 30 years this strategy has outperformed almost all others. Hopefully the "take under" and bad regulatory oversight issues will be dealt with by the SEC as no one (besides thieving insiders as opposed to activists who help outside investors and pensioners) benefits when managements steal from their shareholders.
(AYR) -- Aircastle Limited: This aircraft leasing company is trading for a nice 40% or so discount to book value and a reasonable multiple to earnings. We like the name but would prefer to write the $12.50 calls against our stock position, or in our case we have sold the $10 put options expiring in January of 2012.
(AWX) -- Avalon Holdings is a dirt cheap name trading at just 25% of tangible book. The issue with AWX is whether the value will be unlocked for shareholders, but we think the wide margin of safety makes this an interesting long term investment candidate. We would sell the name at 50% of tangible book, however, which is almost a 100% return from current prices.
(COP) -- Conoco is cheap stock, but with oil dropping like a rock it may be cheap for a reason. We like this name because Buffett owns it, but he did admit that this was one of his worst investments back in 2008. We think selling the January $70 puts would be a good way to play the stock.
Disclosure: I am long VOXX, JBSS, NWLI, BRK.B, AIG, TGT, KO, RIMM, ASI, HWG, AWX. I'm long Hastings Ent.