Do strategic ETFs add value to portfolios?

Near the bear market's inception in November 2007, I noted that a wide variety of "strategy ETFs" were outperforming the benchmark S&P 500. At least "strategy ETFs" had the edge at that moment in time.

Occasionally, an investor may believe a stock to be undervalued based on his estimate of the business' underlying value. If his estimate is correct, he should generate excellent returns over the next several years if the stock price converges to the underlying business' value. Sometimes, however, an announced merger transaction will allow this investor to buy this stock at an even cheaper price! Consider TAT Technologies (TATTF), which we've discussed as a potential value play.

TATTF already owns 60% of Limco-Piedmont (LIMC), an aircraft maintenance provider with a market cap of $30 million, no debt, and cash of $32 million! TATTF now wants to own the other 40% of Limco-Piedmont, and has offered LIMC shareholders 1 TATTF share for every two LIMC shares.

Here are some additional Graham style stocks that I consider cheap and potentially rewarding. As with all cheap Graham stocks, the businesses are usually broken and unprofitable which means mechanically investing in a handful may not yield the best results. What I look for are companies or business models that are not burning through cash and still have some revenues to support the business operations.

I am still trying to make positions of 5-10 cheap Graham stocks that I feel have been beaten down for temporary reasons. I only have two cheap stocks so far.

The merger arbitrage activity has been slow of late and it is no surprise. I mentioned in January that I expected mergers and acquisitions to slow down as financing became difficult to acquire.

In particular, merger arbitrage opportunities have been scarce ever since the failed Emageon (EMAG) deal with Stanford (my theory, anyway) and the spread for other mergers has not been wide enough to offer any real decent returns.

It may be time for investors to dust off their copy of Ben Graham and David Dodd's classic Security Analysis. Graham and Dodd paid a lot of attention to the liquidation value of companies as a way of lowering the risk of loss even under a worst-case scenario. They reasoned that even if a company fails as a going concern and is forced to liquidate, shareholders may get their money back -- or even make money -- assuming the company's balance sheet is strong and liquid enough to yield a material amount of cash for shareholders in the event of a liquidation of all of the company's assets.

The Financial Times argues in an article entitled "Liquidation risk grows as finance dries up" that liquidations -- rather than reorganizations under Chapter 11 -- may become more common as bankruptcy financing disappears or becomes prohibitively expensive. According to the FT,

On July 8, Bill Simpson wrote an analysis of Limco-Piedmont (LIMC). Limco-Piedmont's offering priced late Wednesday, July 18, at $11. In midday trading, the shares gained $2.45, or 22.3 percent, to $13.45. The company expected the offering to price between $9.50 and $11.50 per share, and boosted the size of the IPO, bringing the total offering to 4.4 million shares, from 4 million shares. On Friday the shares closed at $13.88.

The text of Mr. Simpson's original writeup follows:

All quotations are from the companies' most recent S-1 filings with links provided.

DICE HOLDINGS INC. (DHX)
Business Overview (from prospectus)