Bet on the Horse and the Jockey

Editor's note: This was originally published on RealMoney. It is being republished as a bonus for TheStreet.com readers. To subscribe to RealMoney, click here.

One has to wonder if valuations really matter anymore. Mr. Market doesn't seem to care about whether a stock is trading at a P/E of 10, 7 or 4. If earnings continue to drop off a cliff, a price to earnings ratio doesn't do investors any good at all.

Yet fundamentals do ultimately matter. A company that can navigate through this environment with a lean operating structure and a strong balance sheet has a very good shot of surviving the storm. And as businesses shut down due to the difficult economy, those that endure could find themselves among a handful of participants in a particular industry.

However, fundamentals alone should no longer be enough for investors. Now more than ever, investors need to focus on the jockey steering the horse. This combination offers the greatest probability of not only getting through this economic catastrophe, but also a high chance of future stock price recovery.

Leucadia ( LUK) is a quality horse and jockey bet. Chairman Ian Cumming owns nearly 10% of the shares. I wrote about Leucadia last week when shares were trading in the $13 to $14 range. Today the shares trade around $12 and not much has changed. The company reported a huge 2008 loss but that was due primarily to income tax expense. The company's mark-to-market losses on its securities were large, but that was expected given the market selloff.

But the company trades at a significant discount to the value of its assets even at today's prices. And the company has announced that it is now authorized to retire the company's outstanding indebtedness when management deems appropriate.

It's also interesting to note that some of Leucadia's biggest investments, iron ore miner Fortescue and farming company Cresud ( CRESY), are commodity-related. These are the types of businesses you want to own when the dollars that our government is pumping out begin to have an inflationary effect.

ATP Oil and Gas ( ATPG), once a market favorite, has been hit hard as oil prices have plummeted. The company has a market cap of $110 million, but debt of about $1.3 billion. However, over the last several months the company has announced asset monetization deals and most importantly, the deals have gone through. Proceeds have been used to pay down debt.

The company is still run by the founder and insiders own over 20% of the stock. Last week during a company presentation, the company announced that it was seeking out other initiatives to help maximize the value of the company's assets. Several days later, the company announced a $150 partnership deal with a unit of General Electric ( GE).

Yesterday Mar. 2, the company announced it had earned $3.34 per share in 2008. The company replaced 214% of its 2008 production, an impressive metric by any standard in the oil industry. The market can't seem to get over the debt, but the biggest portion, $1.04 billion, is not due until 2014. The company is in fine shape to meet all debt covenants for 2009.

Insiders haven't been selling at all and with 20% insider ownerships, the executives are behaving just as they should be -- like shareholders. Each share of stock today represents over seven barrels of proved and probable oil reserves.

Finally, Goldman Sachs ( GS) has weathered the storm exceedingly well relative to peers. If we are going to blame the top brass at Citigroup ( C) and Bank of America ( BAC) for the disasters those banks are facing, then it's only fair to give Lloyd Blankenfien some credit for steering Goldman away from complete meltdown. It's been the only financial to raise outside capital from Warren Buffett.

While book value has been a trap for the financial industry, Goldman's appears more solid than the rest. Even though it is now a bank holding company, Goldman uses mark-to-market to value its holdings and the valuations currently applied reflect the grave fears in the marketplace today.

According to a Fortune piece, a 10% bounce in Goldman's most "opaque" assets would shoot book value up to $102 vs. a stock price of $88 today. And several years down the road, if Goldman continues to grow its business at the expense of the fallen, it could easily again become the darling of the financial sector.

Also, Goldman has indicated that it is very interested in paying back the government TARP money it has received. I doubt a company would consider making such a statement during this credit crunch if it wasn't comfortable with its capital position.

This market is not for the faint of heart. Now more than ever, able and competent management must lead their respective company's out of this crisis. But the company must also be sound, because even a great jockey can't ride a dead horse.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider ATP to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

This was originally published on RealMoney on Mar. 3, 2009. For more information about subscribing to RealMoney, please click here.

At the time of publication, Gad was long ATP, although positions may change at any time.

Sham Gad is the managing partner of the Gad Partners Fund and the Gad Partners Offshore fund, value-centric investment partnerships based in Athens, Georgia. Gad has written extensively for the Motley Fool and was a securities analyst for UAS Asset Management, a small, value-focused fund in New York City in 2007. Previously, Gad managed assets for the Gad Investment Group. For additional information, please visit www.gadcapital.com.

Gad also runs a value-investing blog inspired by the teachings of Benjamin Graham and Warren Buffett. Additionally, he is currently working on a value investing book to be published by John Wiley & Sons in the fall of 2009. Gad earned his BBA and MBA at the University of Georgia. Send Sham Gad an email. You can reach Gad at sham@gadcapital.com.

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