As 2007 draws to a close, a volatile stock market may present opportunities for investors seeking undervalued stocks, because many other investors expect the worst.
If harsh punishment doled out to some stocks turns out to have been excessive, then bargains abound.
"We like volatility and market dislocations and are finding more things to do today than a few months ago," said Larry Pitkowsky, co-manager of the $4.9 billion Fairholme Fund, with a one-year annualized return of 11.7 percent and three-year annualized return of 15.5 percent. "We're very happy with the current climate."
The cheaper that stocks become in troubled times, the less risk in buying them, Pitkowsky said.
Investors should examine each company as they would a small business, he said. Find out how much the firm has in free cash flow, which is cash from operating and investing activities that can be used to pay shareholders. Decide whether those running the firm are smart, honest and treat shareholders well. Then see if shares are available at a low price relative to the cash generated.
Canadian Natural Resources Ltd., which has been volatile, carries considerable debt. The Province of Alberta also recently hiked royalties it must pay for exploration projects there. Yet Pitkowsky keeps adding to his position in the stock because he considers it deeply undervalued in light of its enormous cash generation.
"Buy very selectively now," said Tom Jacobs, co-founder and portfolio manager of the Complete Growth Investor newsletter in Marfa, Texas. "We are seeing prices that offer multidecade opportunities."
Jamba Inc., holding company for the Jamba Juice Co., which sells fruit smoothies and juices, dropped in price on concerns about slowing retail expansion. Jacobs is convinced Jamba's strong history in California, the trend toward healthy foods and considerable cash generation make it undervalued. The stock could triple in price in three years, with virtually no downside risk, he said.
Meanwhile, First Financial Fund, a closed-end fund specializing in financial services stocks, is selling at a 13 percent discount to its net asset value. Despite that sector's troubled condition, portfolio manager Nick Adams is a top financial company manager and definitely "a jockey to back in the financial debacle," Jacobs said.
"Aside from [the] aftermath of Hurricane Katrina in 2005, the last time consumer sentiment was as bleak as now was March 2003, which was one of the best times to buy our recommendations in the past three decades we've been published," said John Buckingham, chief executive of Al Frank Asset Management in Laguna Beach, Calif. "Housing, financial and retail have taking the biggest hits this year, a sizable thumping that was definitely merited."
His objective is to recommend stocks trading for 50 percent or less than his determination of their three- to five-year value, which are common in periods of low confidence.
For example, upscale retailer Nordstrom Inc. has seen its price fall significantly in the dour economic climate.
Buckingham has used the opportunity to add its stock to his model portfolio in recent weeks, based on the firm's solid reputation and potential.
The stock price of American International Group, the global insurance and financial services giant, has been down since its debt rating was downgraded to AA from AAA on worries about mortgage insurance and other credit vehicles.
Buckingham recommends the stock because of the firm's global reputation and competitive advantages.
Whether a stock is undervalued is in the eye of the beholder. Some think it too early to buy aggressively because the movement of the economy hasn't played out yet.
"In historical terms, the Standard & Poor's 500 is still about 12 percent overvalued, so you can't say it is undervalued," said James Stack, president of InvesTech Research and editor of the InvesTech Market Analyst newsletter in Whitefish, Mont. "Valuations can be misleading, and, for example, the low valuations of home-builder stocks still did not prevent those stocks from falling."
He would stick primarily with late-stage bull market sectors such as health care and consumer staples.
UnitedHealth Group Inc., which provides health services to 70 million people, is an excellent example, he said. It had a stock-options scandal, made financial restatements and remains subject to ongoing regulatory investigations. Yet even though the share price suffered, the firm has market leadership, an array of products and strong operations.
Although Coca-Cola Co. hasn't suffered a stock swoon, its share price compared with sales is lower than the 10-year median for that measure, Stack said. And, because it derives 80 percent of earnings from international sales, its stock price holds up well in U.S. recessions.
Among other stocks believed to be among the most undervalued of 2007, Buckingham likes Arkansas Best Corp.; Allied Defense Group Inc.; Alaska Air Group Inc.; Citizens Republic Bancorp Inc.; Empire Resources Inc.; Intevac Inc.; Tollgrade Communications Inc.; and Trinity Industries Inc. Jacobs recommends Cheung Kong Holdings, Hong Kong's largest company, whose holdings include retailing and real estate, while Stack recommends the health-care-products giant Abbott Laboratories.
Andrew Leckey is a Tribune Media Services columnist.Copyright © 2014, The Baltimore Sun