When the Good Fruit Has Been Picked

As the market appears very overpriced, I look at shorting ideas and stocks to hold long-term for an economic recovery.
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I am not a green shoots kind of guy. I will leave that to the growth and momentum kids. As a value and distressed investor, I wait until the fruit is ripe for the picking and hanging low on the branches. It is not only easier but also far safer than trying to figure out which green shoot is a fruit tree and which one is poison oak. I am continually amazed by those who throw their hard earned money into the market in response to hope and unrealized potential.

Right now I have to say most of the low-hanging fruit has been picked over. There were a lot of bargains around earlier this year but many of the beaten-up stocks I favor have doubled and even tripled off the lows. The market has skyrocketed off the March lows and is now slightly positive for the year.

Stocks are once again looking pretty expensive to me. Depending on whose estimate you want to use, the S&P 500 is trading somewhere between 16 times and 22 times expected 2009 earnings. In my opinion, that is far too rich for stocks in an economic environment of little-to-no growth for this year and into 2010.

While it has been difficult to find stocks to buy in recent weeks, it is getting increasingly easy to find stocks to sell. Wall Street-related companies such as investment banks, exchanges and asset management have had a tremendous move in the last quarter.

Goldman Sachs

(GS) has doubled in that time frame while

The CME Group

(CME) has risen more than 50%. Both of these are great companies with dominant positions in their industry, but that's just too far too fast. It may be too early to short these stocks but if I would them I would be taking some off the table.

One I think you can short if you have such inclinations is

Greenhill and Company

(GHL) the investment banker. Considering continued weakness in global financial markets and a moribund merger and acquisition outlook, the stock is pricey. At 45 times trailing earnings and 25 times the estimates for 2009 the stock is simply too rich.

When I run my screens for cheap stocks, I still find a lot of banks on the list. I have been investing in regional and community banks for most of my career and it is killing me not to take advantage of what appear to be very cheap stock prices. For most of the industry, however, it is still too soon.

Even though many of the banks have raised capital and taken additional steps to shore up their balance sheets, I suspect tangible book values in the industry will take additional hits from falling real estate prices. There is a chance that real estate values may stabilize by the end of the year so I am taking some time to reacquaint myself with some of the better names in this area. If high-quality, conservative banks like

TCF Financial

(TCB) and

Danvers Bancorp

(DNBK) slip back below their tangible book value, I will probably start to be a buyer.

Earlier this year you could use the shotgun approach to finding stocks selling below asset value with a decent margin of safety; now you have to use the rifle approach. Even then with the market up 40% from its lows, I think a cautious approach is best and positions should probably be kept small with the idea of averaging in at a later date. As MIT Professor Andrew Lo said in a recent article, the primary goal of a long-term investor is to survive. Keeping positions small after a huge up move in the stock market is one way of increasing the odds of being around for the next bull market with enough cash left to benefit.

One stock that has slipped down to a point where I think long-term buyers can begin to buy a little is an unlikely name in a weak consumer environment. However,

Callaway Golf

(ELY) is in an industry that is not just a sport for most participants, but an addiction. A dedicated golfer will have trouble sleeping when he or she has to delay a desired new club or accessory. When the economy recovers I think there will be a lot of pent up demand for golfing equipment.

Revenue will be weak for the rest of the year and there is not a catalyst for the share price to move in the near term. It probably will not take off anytime soon, but I want to own some when it does so I would start accumulating the shares. The stock trades for less than tangible book value and has no long-term debt on the books. Callaway just completed a private placement of preferred shares to pay down the balances on its revolving lines of credit to retain maximum financial flexibility.

The company also slashed the quarterly dividend from $0.07 a share to just a penny, a move that saves $15 million annually. Callaway is committed to maintaining the liquidity to allow it to survive the recession. This company will be around when we finally see a real economic recovery.

Addiction to a lifestyle plays into another stock that has traded down to a discount-to-asset value. Much as golfers have to get on the course, boaters have a need to be on the water. I live on a boating-obsessed island in the Chesapeake Bay so I am well aware just how slow the industry is. Marine-related business owners I have spoken with tell me that they are shocked by how hard the industry has been hit this time Just on this little five-mile-by-eight-mile island we have seen several boat dealers and supply stores close down for good in the last year.

Although it a short-term obstacle for

West Marine

(WMAR), the slowdown is one of the things I like about the stock. Simply put, they are in a position to survive at a time when many of their competitors are not. One of their largest competitors,

Boaters World

has already been liquidated as a result of the

Ritz Camera

bankruptcy earlier this year.

Business is not great for the boating supplies retailer right now but it is improving. Revenue were down 10% for West Marine in the first quarter but profits actually improved over the year-ago period. The company has used aggressive cost-cutting and inventory management to improve gross profit margin. Like Callaway, it is managing the balance sheet to survive the tough times. West Marine paid down debt by 14% in the first quarter alone. The shares trade at 80% of tangible book value and have enormous recovery potential.

These two stocks are counterintuitive suggestions. The economy is horrible and discretionary spending is down and leisure spending almost nonexistent. That is exactly why you want to own some at these prices. Golfers golf and boaters boat. They both want the newest and best equipment to indulge their addictions. They may have to delay new purchases right now but at some point the economy will recover and the pent-up demand will be enormous.

Investors with a long-term horizon and a patient attitude could see huge returns from these stocks in the years ahead.

As a value and distressed investor, I tend to ignore the green shoots for the low-hanging fruit, and most of that has been picked - stocks are looking too pricey.

In particular, many banks are trading at high price-to-earnings ratios, making many targets for shorting.

A smart move is to invest a bit in addictive lifestyles such as golfing and boating; while these stocks are not going up soon, when the economy recovers people will indulge in their obsessive hobbies.