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What Would Ben Graham Do?

As I thought about the lessons of Graham, I wondered what a classic asset-based investor like him would be doing today. The market has been rising on a steady basis since the 2009 lows and is up double digits already this year. The value screens I run show fewer names worth considering most every week, and there are few opportunities to get money to work.

Notice that I said few, not none. I think if Graham were alive today, he'd have a team working on a few sectors of the market that have not done well. Fear of sequester and defense cuts have weighed heavily on many names in the defense sector. No one expects much from them and Wall Street could care less about most names.

This makes me want to dig deeper into small companies such as Kratos Defense & Security Solutions (KTOS). Most of its business comes from defense and homeland security contracts, and one expects conditions to be awful. The truth is actually opposite that as the company works on secure programs such as drones, cyber warfare and defense as well as transportation infrastructure protection. Funding for these projects is not going away and the company should prosper as it now wins new contracts almost weekly.

CPI Aerostructures (CVU) also appears vulnerable to cuts in defense spending, but dig deeper and you'll see its key military projects include a new helicopter and drone surveillance system that won't see any sharp spending cuts. It also has a growing business providing aircraft components to commercial aircraft manufacturers. The company had a record year in 2012, and business should be stable this year and begin growing at a healthy rate again in 2014.

The stock trades at a discount to tangible book value and at about the value of its net current assets. The fascinating part is that the bulk of its current assets are cash, receivables and money earned on contracts not yet billed. The money is owed by large defense and commercial aircraft manufacturers, so there is little chance of non-collection; it's as good as money in the bank. The stock trades for about seven times earnings and is a bargain by almost any measure.

There are not a lot of cheap stocks around, and I think Ben Graham would be as frustrated as those of us who utilize his approach are today. But there are bargains worth buying in sectors of the market that are out of favor and ignored.

At the time of publication, Melvin was long KTOS and CVU
Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback; click here to send him an email.

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