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BOSTON ( TheStreet) -- With stocks in a slump -- the benchmark S&P 500 has fallen 5% from a peak two months ago -- individual investors are trying to figure out which companies may rebound because they offer value and which may continue their slide.
In this topsy-turvy world -- even hot-gadget maker
Apple(AAPL) and defensive stalwart
Exxon Mobil(XOM) are down -- emulating private-equity investors' approach to evaluating companies may be the smartest move.
Stocks are barely up so far in 2011 after two years of strong gains as higher commodity prices crimp corporate profits, consumer spending is lackluster amid high unemployment and the Federal Reserve is ending its second stimulus program this month. By focusing on corporate balance sheets and private-market valuations, investors may be able to navigate volatility in these summer months.
A stock's price isn't always indicative of value, and the difference between the two can lead to hefty profits, says Mark Travis, chief executive officer of Jacksonville, Florida-based Intrepid Capital Funds. One of his top picks is
Tellabs(TLAB), a beaten-up communications-equipment maker that is among the worst performing stocks on the S&P 500 this year.
Travis tries to determine the price that a rational buyer, paying in cash, would offer to acquire a company. With companies holding a record amount of cash -- more than $2 trillion -- following Travis' strategy makes more sense today than ever. Many companies he follows are growing fast and generating a lot of cash, but retail investors know very little about them because they fly under Wall Street's radar.
The strategy also takes advantage of the recent mergers-and-acquisitions frenzy. Through May, there were 1,276 announced deals with a total value of $454 billion, a 39% increase over the same period in 2010, according to a report by advisory firm PricewaterhouseCoopers. U.S. M&A activity will "continue to pick up steadily through the balance of 2011," PwC says.
But after a two-year rally in equities since the March 2009 bottom, aided by the Fed's bond-purchasing programs that boosted asset prices, Travis says the challenge in finding takeover targets has been made tougher. "Higher prices don't mean more opportunity, but more risk," he says. "A lot of the businesses we found were closer to fair price."
That has pushed Travis to be defensive in his posture. He says he couldn't find many businesses that had characteristics that private-equity investors would like, namely an unlevered balance sheet, lots of cash generation and downside protection in the share price. As such, the
Intrepid Small Cap Fund(ICMAX) had 34% of its $777 million in total assets in cash equivalents, as of March 31. The
Intrepid Capital Fund(ICMBX), meanwhile, had 12% of its $345 million in cash equivalents at the end of the first quarter.
Travis says his firm was invested in one takeout that occurred in late March, and that he has started to find some companies that carry both merit and risk for investors who can stomach the investment. "To find something in this environment where prices are up 100% over the last 24 months, you're going to have to buy something that has some ugly characteristic to it or it wouldn't be cheap," he says.
While investors focus mainly on S&P 500 companies, Travis and Intrepid Capital tend to be buyers of small-cap stocks. Travis says smaller companies that generate cash consistently attract suitors, either larger companies in their industry or private-equity firms. If neither comes forward, Travis is happy knowing the investment will continue to grow as the company's cash builds up.
For those investors looking to capitalize on the gap between price and value, Travis offers three stocks that he owns through Intrepid Capital Funds.