Value Investing Questions

By J, Royden Ward, Chief Analyst, Cabot Benjamin Graham Value Investor
Originally published in Cabot Wealth Advisory 9/12/08 Sign up for the free Cabot Wealth Advisory

I receive a lot of email questions from Cabot Benjamin Graham Value Investor subscribers. Thank you to all of you who have taken the time to share your questions and comments. I learn something from every email you send me—either from your remarkable knowledge or from the research that I conduct to formulate a deserving answer. Your emails keep me on my toes and I learn something new every day.

I recently received the following thought-provoking questions.

Question: I have just switched from the Cabot momentum-driven Top Ten Trader to your Graham Value Investor, which I find much more compatible with my investment style. And, I have a question to pose ... which could become the basis of one of your special features.
Many of the "TV talking heads" and analysts believe there could be a slowdown or mild recession at worst and maybe we are even through the worst of it already. Further, if they are troubled at all they seem to be more troubled by the possibility of "stagflation"... stagnant growth and inflation at the same time.
I have a different "take" on the situation. And, let me say up front that I'm not a "doom & gloomer." In fact, I was a bull during 2003-2007. However, over the past year, I have been anticipating an increasing Bear market with an occasional "relief rally" (like the current market) thrown in resulting in the Dow hitting 10,000-10,500 during mid-2009 to early 2010. Most recently, I have been wondering about the Dow starting with a 9 during 2009-2010.
But, that's not my problem because I know what to expect with "stagflation" market, i.e. declining growth, profits & P/E ratios. My problem is what happens to stocks and sectors in a longer and deeper bear market like 1968-1973-1980 with deflation...I would be interested in your thoughts about what kind of stocks listed in the 275 list [in Cabot Benjamin Graham Value Investor] would prosper in a market declining 30%-50% with deflation.—Stephen P.

Answer: Your thoughts regarding further declines in the stock market certainly could become reality. As a value investor, however, I avoid trying to predict the future of the stock market, instead focusing on finding and investing in stocks that are clearly undervalued. 

When the direction of the stock market is clearly down, as it is now, even value investors become defensive. Therefore, I recommend consumer staples and health care. Two of the stocks that I now like are CVS Caremark (CVS) and SUPERVALU (SVU).

I think technology will perform well for a while, but could underperform in 2009. I continue to avoid financials, because the outlook is so uncertain. Utilities usually don't go down as much as the stock market, but I don't like their heavy debt loads. Energy and commodity stocks have had a great run, but are vulnerable. And I don't like retail.

Question: I started buying value stocks in May and June and some of those are already down more than 20%. I know that we are on buy and hold but in the Cabot newsletters Tim Lutts [Cabot Chief Investment Officer] emphasized selling stocks that have lost more than 20%. Your thoughts?—O.T.

Answer: Thank you for your email regarding selling stocks with losses greater than 20%. Tim and others are referring to growth or momentum-type stocks. I do not recommend selling a value stock because it has declined by a certain percentage. In fact, unless a negative long-term event has taken place, I usually advise buying more shares at the lower price. If a stock is a bargain at the price you paid, the stock is a better bargain at a lower price, rather than a candidate for a quick sale at a loss. Investing in value stocks requires a lot of patience and longer holding periods, but the end results are often spectacular. Buy low and sell high, regardless of what other investors are doing.

Question: I have owned Transocean (RIG), for a while, and while I know it is a very volatile stock (why, I don't know), when do you expect it to get over the $200 mark? I don't see what's holding it back.—Bob B.

P.S. How can you want to own both WAG and CVS? They're competitors! That sounds like you're playing one against the other.

Answer: Thank you for your email regarding Transocean (RIG), Walgreen (WAG) and CVS Caremark (CVS).  Sales and earnings at RIG are growing rapidly. The drop in oil prices caused the stock's price decline from a high of over 160 to the recent 115. Oil drilling companies are not as affected by oil prices as producers and refiners, but the stock prices of drillers seem to always follow oil prices anyway. I expect stock valuations of drillers to remain relatively low in the future because of the uncertainty of whether oil will continue to provide most of the world's energy needs in the future. But you are right; RIG should be selling at 200 rather than near 115, where it has been lately.

I switch my recommendations of stocks within an industry sector quite often. I base my decisions for the Model stocks on which stock in a sector is more undervalued and/or has the brighter outlook. Currently, I believe CVS has a better outlook because of an aggressive acquisition program that has produced excellent results during the past several years. In that regard, the companies are quite different, because WAG has chosen to grow from within.

Question: I bought Garmin (GRMN) at 44. Shortly and suddenly, it went south about 10 points to 35. What surprise caused such a precipitous drop? I read that they are stacking up inventory instead of sales, and their new phone product is not ready on time, and they have competition from others cell phone products.
I just subscribed recently and this is the first recommendation from you that I bought. What do you think of the company's ability to climb out of this hole? Should I sell and move to something else, or hold, or double my investment and average the price down?
Why didn't the Graham screen pick up this company's weak position regarding earnings growth?—Tim H.

Answer: Thank you for your email regarding Garmin (GRMN). Your summary of the company's problems is accurate. GRMN declined sharply after the company made several announcements. Garmin expects slower growth during the next several quarters mainly because of the slower economy in the U.S. and elsewhere. The company also announced that its smart phone, dubbed Nuvifone, won't be released until the middle of next year. This is a disappointment, but I believe it is better to be well prepared for Nuvifone's launch rather than introduce a product with problems. I am disappointed, though, that Garmin will not launch this important product before the Christmas season because this allows Apple's iPhone and others to get a big head start. At the current price, GRMN sells at 8.8 times my 2008 EPS estimate, which is a bargain. I recommend holding your Garmin shares, because the stock could double within the next two years. Garmin surprised investors with their announcement of the Nuvifone delay. Unfortunately, it was impossible to know what was coming, without "insider" information. My faith in the company is diminished only slightly, because the GPS market provides huge opportunities for future growth.

Question: I would like to buy IR at 38, when would I sell if it kept on going down?  Thanks.—Brad A.

Answer: Thank you for your email regarding Ingersoll-Rand (IR). The stock has been selling at a bargain around 34 recently. You have chosen an excellent company that will hopefully become a solid long-term investment for you. The volatile market that we are in will probably cause some volatility in IR shares as well. If IR drops 15% to 31.25, I advise buying more shares. I doubt very much that the stock will go that low, but it is good to plan your strategy ahead of time. IR's objective to sell off cyclical, low margin businesses and to buy businesses with faster, steady growth is working well thus far. The purchase of Trane is a big move, and I will be monitoring IR's progress as the company integrates Trane. If IR management falters in any way, I will issue a sell recommendation. Since that is unlikely, I expect my sell recommendation will not be issued until the stock reaches its Minimum Sell Price. I do not recommend selling your shares if IR declines in price.

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