RealMoney Silver - Look for Good Businesses, No Matter the Market

Look for Good Businesses, No Matter the Market
By Tim Melvin
RealMoney.com Contributor
3/13/2008 1:16 PM EDT

Sitting here removed from Wall Street and close enough to Washington, D.C. to understand it less than most people, I found Tuesday's Fed moves confusing and somewhat disconcerting. Lowering the quality of collateral and extending the lending period sounds suspiciously like how we got in trouble in the first place, but the stock market seemed to like it.

While it does add substantial liquidity to the large financial institutions, I am struggling to see how changing the makeup of the Federal Reserve's balance sheet fixes anything in the economy or markets in the longer term. This is, I suppose, why they get the big bucks.

I do wonder if Ben has to get a broker dealers license now that he is essentially making a market in mortgage-backed securities. It was quite a day for Wall Street -- Spitzer finally got his, and the Fed bailed out the horrible fundamentals of the stock market, even if only temporarily.

On Tuesday morning, I decided to do a little research and just ignore stock prices for a little while. Some of the few stocks I own got a lift from the action, but they are all stocks I own for the long term, and I wasn't about to trade around the positions. There was no way I was buying into Tuesday's actions, so I didn't feel a strong need to hover over prices.

While clicking around the Web, I found a gem of a video conference with Walter Schloss. For those who don't know, Walter was one of the superinvestors cited by Warren Buffet in the now-famous Super Investors of Graham and Doddsville article that originally appeared in Columbia University's Hermes magazine. Schloss, now 91, closed his fund in 2003 after nearly 50 years. During that time, net of fees, he beat the S&P 500 by a margin of better than 50%. For value-oriented stock-pickers such as myself, it was a reminder of what is important in picking stocks, and as a bonus, it was incredibly entertaining to watch.

During the video interview, Schloss repeated two phrases so often that it became comical. One was, "I do not like to lose money." The second was, "I do not like debt." What one could extract from the interview was that his basic approach over the years was to buy stocks selling below book vale as they were making new lows.

He liked companies where management owned significant amounts of stock and had little or no debt on the balance sheet. He didn't talk to management, as he felt that his like or dislike of an individual might color his view on the stock and allow him to make emotional decisions. He prefers to concentrate on the numbers and statistics, as well as an evaluation of the company's business. He relied on annual reports and the Value Line for information on the business. He also praised Value Line for the 15 years of fundamental statistics on each security it follows. He stressed being protective of the downside and letting the upside take care of itself.

I ran a screen using his basic criteria -- selling below book value, debt-to-equity ratios less than 0.20, management ownership of at least 10% of the outstanding shares and selling near a 52-week low. I came up with a list of 39 companies. All of them seemed cheap to me and worth a look, and it's a list that I will be spending substantial time with in the days ahead.

A couple of stocks leaped off the page as worth considering right now, though. The first is Elron Electronics (ELRN) , an Israeli electronics company. Elron does business in communications, medical devices and advanced defense electronics systems.

The stock is trading about 50% below the highs it reached last year and is just above the 52-week lows. Management owns more than 60% of the shares and would seem to have a vested interest in getting the share price higher in the months and years ahead. The company recently developed a camera pill that is expected to have substantial uses in gastrointestinal diagnostic procedures. More than 20% of the share price is on the balance sheets in cash, and debt is negligible.

At first glance, Hilltop Holdings (HTH) is a property and casualty insurance company operating in several states. In reality, it just bought the insurance business and is looking to use its cash to expand further. As a bonus, the company is flush with cash as a result of its sale of the manufactured housing unit to Farallon Partners in 2007.

Net of debt, Hilltop has $750 million of cash, more than its current market capitalization of $584 million. That makes the stock a net-net and that means that I will be buying the shares for my long-term portfolio. They appear to know how to run the business as well. The company's free cash flow is positive and has a combined ratio (losses and expenses as a percentage of premiums) of just 86.5%.

The company will be looking to buy financial and insurance companies in an environment where they are cheap and should reap the benefits of the selloff in the sector this year. It's a buy regardless of market conditions.

Walter Schloss paid attention to stock and businesses, not economic and market conditions. He made a lot of money for his investors by taking this approach, and as my screening results show, his ideas are still very valid today. I will be talking about this approach and these stocks much more in the months ahead.