There can be no question that this is the most difficult environment I have seen in my 20 plus years in the markets. As I write this (Oct. 15), the market just closed with its largest one-day percentage loss since 1987. Stocks have been more volatile than ever before with multiple hundred-point moves the norm, while overall the trend remains firmly downward. The combination of the credit crisis, weak economy and hedge-fund deleveraging has investors far beyond worried. Money is being pulled out of mutual funds by the billions, and there are no buyers in sight.
It is times like these that I try to focus on the basics of investing and allow Mr. Market to work for me instead of against me. I spent some time this week rereading the writings of Ben Graham to help me achieve this. One article I revisited is an interview Graham did in 1976 with the
. In it, Graham outlined a simple approach for finding stocks that were cheap in price and offered a sufficient margin of safety. He simply bought stocks that had an earnings yield of twice the AAA bond rate and owned twice as much as they owed. At the time, he had 50 years of research showing this basic approach beat the market by a 2:1 margin. My own more limited research shows that it has done so for the past 20 years as well.
I am, in principle, a bottoms-up stock picker. On occasion, however, there will be clusters of stocks that show up in screens, and I try to apply some macro thoughts to the group to see if I can figure out why so many similar companies are trading so cheaply.
Sometimes, as in the case of financials last year, applying a macro picture will keep me away from the stocks. When I ran the Graham screen, however, I saw a group of stocks that have an incredibly strong positive outlook based on the big picture.
The Next Bubble
Not too long ago, I was asked where I thought the next market bubble would be. I said then that in my opinion, it would be infrastructure companies, as literally trillions would be spent globally to build and improve infrastructure. In the current market collapse, some of these stocks have fallen to a level where, in spite of very bright prospects, they are very cheap.
Many traders and investors think that the current weak economy will delay some spending in this area. The difficult credit markets will make it hard to fund a lot of projects, especially for state and local municipalities. They are probably right. If I was the type of investor who worried about earnings for the next quarter or two, it might be a concern. I look at stocks on a much longer basis, however, and the current price more than reflects short term difficulties.
It is no secret that the highways and bridges of the United States are in need of repair. The electrical grid needs extensive rebuilding. The average municipal water plant in the US was installed before 1960 and needs updating or replacing. Most of Europe is in the same situation. Emerging economies such as China and India will be building new infrastructure form scratch. It may be delayed, but the money will be spent.
There is a significant chance that it will get spent even sooner than the industry critics think. There is a push in the United States led by Pennsylvania Governor Ed Rendell and Speaker Pelosi to spend billions on infrastructure to help pump money and jobs into the economy. Hong Kong just announced it is going forward with 10 major projects to bolster their economy. Australia is considering using infrastructure spending as well.
There were several companies that will benefit from these trends on the list of safe, cheap stocks in the Graham screen. The first is quickly becoming one of my favorite stocks. The
LB Foster Company
(FSTR) is a classic American company. The current chairman's grandfather founded the company over 100 years ago, selling used rail to private railroads, and today is still in the rail business, as well as the transportation and civil construction market. They also sell a variety and pipes and tubular products to the oil and gas industry.
All three of these have the potential for substantial growth over the next decade. Although revenue has weakened this year, margins and earnings at the company have actually been growing in a weak economy. The project backlog grew by 7% in the second quarter as well. The company has exceeded analyst estimates for earnings in each of the prior four quarters.
In spite of the strong operating performance, Foster shares have fallen 50% in the past year. Most of the decline has occurred in the past month, and it looks like the stock may have gotten hit by the hedge fund liquidation we have been seeing. The stock is incredibly cheap here, trading at just 8 times earnings and with an Enterprise value to EBITDA ratio of just 3.5. It trades just above tangible book value, and half the share price is in cash. They have three times as much cash as total debt outstanding. As a bonus, the company is actively buying back shares.
(PCR) is another infrastructure company that showed up on the list. The company is involved in three major areas: building, civil projects and management services. They build just about everything, including casinos, hospitals, schools and sports arenas. They work on highways, bridges, mass transit systems and waste-water treatment facilities. They also provide construction planning and services to the U.S. government. Perini operates globally with operations in Iraq, Guam, Abu Dhabi and Dubai.
Operating results have been strong, with revenue up 21% in the second quarter, and earnings rising by 4%. They have a project backlog of $8 billion, and there are pending orders for $2.8 billion. The company seems to announce new contracts almost daily.
Right now, the stock is incredibly cheap. It trades at just 5 times earnings and at an EV/EBITDA ratio of less than one. The stock has been hit hard in recent weeks, partially due to the issuing of new shares to close a merger and partially as a result of the aforementioned widespread hedge fund liquidation. The company also announced earlier this year that they had $101 million in auction-rate securities that will take time to liquidate and had to reclassify as long-term investments.
These factors have pushed the stock down over 70% in the past 52 weeks. Right now, it trades at just about the amount of cash on the balance sheet. There is a negligible amount of long-term debt totaling $17 million. Insiders have been aggressive buyers of the shares, with six buys totaling over 84,000 shares.
There is no question that the market is scary right now. However, as the Sage of Omaha has pointed out on numerous occasions the time to buy is when others are fearful. The rapid market selloff is creating what I think is an enormous buying opportunity for investors with a long-term focus. There is no guarantee that prices do not fall further, but buying stocks this cheap is too compelling an opportunity for me to pass up.
Normally I am quite content to buy stocks that are cheap on the numbers with a margin of safety and disregard macro factors. When I can buy stocks that fit this definition and have powerful long-term economic trends working in their favor, I have to get excited. It was hard to buy in 1973-74 and in the aftermath of the 1987 crash, as well, but investors were more than compensated in the years that followed. I think the same will be true this time.
Infrastructure stocks are exceptionally cheap right now after the market washout.
The U.S. government, among others, has proposed rebuilding infrastructure as a means of job creation and helping the economy, directly benefiting the sector.
While the entire group is one to take note of, two companies, LB Foster and Perini Corporation, stand out as potential investment candidates.