Some Concrete Ideas for Your Portfolio

I'm a value investor, and that is a more varied profession since the time of Ben Graham. We value investors span different philosophies, from John Neff and Marty Whitman to Bill Miller and Warren Buffett. I admire them all and follow a method that borrows from all of them. (And I would advise that you read Arne Alsin, Robert Marcin and Mohnish Pabrai as well -- all excellent investors.)

Part of being a value investor is running a portfolio that looks significantly different from the market indices. My portfolio is different in both its valuation characteristics and its industry concentrations.

Valuation characteristics:

Median price-to-book -- 1.3 times

Median price-to-earnings -- 12 times

Median market capitalization -- $2 billion

Biggest Industry Concentrations:

Timber

Life insurance

Cement

Oil/gas production

Running an indexlike portfolio is a recipe for mediocre performance. Buying index-like actively managed funds is a recipe for worse-than-mediocre performance. It's better to buy an index fund, unless your fund manager is willing to make investment decisions that are presently unpopular in the consensus opinion of the market.

Solidifying the Case

When I choose investments, I review the industry before I review specific companies. I prefer to buy companies when their industries are out of favor. It's my opinion that industries revert to the mean; in other words, industries that have done badly will take corrective actions and improve, whereas industries doing well will enter into competitive wars.

My industry of the day is cement. I have three cement companies in my portfolio: Centex Construction (CXP - commentary - Cramer's Take), which I bought in 2000, Cemex (CX - commentary - Cramer's Take), bought in 2001, and Lafarge (LAF - commentary - Cramer's Take), which I bought in 2002.

Seven percent of my portfolio is in cement companies. It probably seems like overkill, because cement isn't as large a part of the economy as it is in my portfolio. During the time that I bought the cement stocks, the industry was cheap compared with other industries with similar growth prospects.

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At time of publication, Merkel and/or his fund was long Centex Construction, Cemex, and Lafarge, though positions may change at any time.

David J. Merkel, CFA, FSA, is a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. Previously, he managed corporate bonds for Dwight Asset Management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Merkel cannot provide investment advice or recommendations, he welcomes your feedback.