With the Standard & Poor's 500-stock index up 60% from its March lows, should value investors lay low and hope for a double-dip recession? The rapid runup in stock prices—and the lack of evidence pointing to a major correction in the wings—no doubt has caused some sidelined investors to lament having missed out on a slew of great bargains.
But maybe they shouldn't fret. There are still stocks that the rally has left behind—mostly due to company- and industry-specific issues—that present tantalizing buying opportunities. Be warned, however: Some names won't pay off for a couple of years and will require patience.
At the fifth annual Value Investing Congress, held in New York on Oct. 19 and 20, there was no shortage of recommendations of stocks that haven't benefited much from the rally. The ideas ranged from companies slammed for misunderstood capital structures to ones poised for future outperformance based on management changes.
Despite the reputation most value investors have for picking stocks based on careful examination of individual company balance sheets, business strategies, and market opportunities, speakers at the conference gave a fair amount of attention to the extraordinary macroeconomic circumstances that may make bottom-up stockpicking a less effective strategy than in the past.
Still, it was assorted bottom-up strategies—not the gloom-and-doom warnings of how a renewed housing market slump and runaway inflation could stifle an economic rebound—that were the main draw for investors.
Kian Ghazi, managing partner and portfolio manager at Hawkshaw Capital Management, which he co-founded in 2002, looks for stocks that are fairly valued on current earnings, as opposed to the future earnings the market is projecting based on an economic recovery. Ghazi is a proponent of bottom-up stockpicking based on his own investigative research. With a bias toward companies that have high-quality, one-of-a-kind franchises and historic returns that indicate a competitive advantage, he asks questions like "Who would miss the company if it was gone tomorrow?" and "What could cause the stock to drop 30% and not cause investors to lose confidence in it?"
One of his current picks is Core-Mark Holding (CORE), the second-largest distributor to U.S. convenience stores, behind McLane, which is owned by Berkshire Hathaway (BRKA). At 28.82, the closing price on Oct. 21, the shares trade at 7.2 times estimated 2009 earnings.
Convenience stores, notes Ghazi, are generally recession-resistant because of the habit-forming merchandise they sell. While he weighs risks such as an accelerating decline in cigarette sales and a move to self-distribution by its big customers, Ghazi thinks the stock is worth 45 to 50.
He approves of the company's efforts to increase sales of fresh food such as sandwiches, salads, and fruit cups, which provide gross margins between 15% and 25%, compared with the 4% margin on cigarettes. Cigarettes account for 30% of all convenience-store sales. West of the Mississippi River, where it dominates in market share, Core-Mark serves a more densely concentrated store base, which helps it stretch fuel costs. As the company's fresh-food offerings increase, fuel costs will rise since perishable food requires a second delivery each week, but margins will rebound as Core-Mark layers in additional customers for its fresh foods in the future, Ghazi predicts.
Laboratory Corp. of America Holdings (LH), the No. 2 player in the clinical testing market, behind Quest Diagnostics (DGX), also has a compelling valuation, according to Zeke Ashton, the founder and managing partner at Centaur Capital Partners. The stock trades at less than 11 times free cash flow per share, with free cash flow projected at $670 million this year. Over the past seven years, free cash flow has ranged from 13% to 15% of revenue—and that's understated because the company has increased capital spending in recent quarters to attract additional customers and expenditures will be lower in the future, says Ashton.
Together, Quest and LabCorp control 66% of the clinical test market, with hospitals accounting for the other 34%. Ashton likens the two companies' market dominance to Coke (KO) and Pepsi (PEP) in the beverage industry. "We think LabCorp is better run, so that's where we go," he says.
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