Money Matters - Simplified

This Stock Is a Bargain

Do you realize that even after the massive 50% run up in the S&P 500 since the March low, we have gone over 10 months since the last time there was a positive 10-year return on the broad market?

Granted, today the stock market is closer to where it was 10 years ago than it was in March. But it is still down more than 20% over the past decade. No wonder people are nervous about investing in stocks.

So why am I telling you that now is still the best time in a long time to invest? Simply put, it's when stocks are on sale that they're most worth buying.

Ronald Muhlenkamp, value investor and manager of the Muhlenkamp Fund, had this to say on the subject:

All the average investor knows about stocks is the
price. They buy everything else in life -- their cars, their house,
their clothes -- based on value. They look to buy everything on sale
because they have a pretty good idea what fair value is. In fact, they
don't get excited about a 10-percent-off sale. They might take a look
at 20 percent. At 30 percent, they start to get interested. But most
people buy stocks the way teenagers buy clothes. They buy whatever is
the current fad.

30% off men's wear!

In other words, when the stock market offers a sale, instead of
people slugging it out at the bargain bin, they refuse to buy. It's
completely backwards from every other time there's a sale! You should
be spending money to buy something of value cheaply, be it a pair of
socks or shares of stock, as Warren Buffett quipped recently.

Instead, most people wait until a sector becomes popular, like
commodity stocks were in early and mid 2008, before buying.
Unfortunately, that doesn't work out too well when you're looking to
build wealth. You often end up buying when the shares are the opposite
of "on sale."

Price is what you pay, value is what you get

So how do you overcome that aversion to buying we often feel after the market has fallen hard?

One way is to change your outlook. When prices fall hard, especially
over broad sections of the market like it has, it's likely that people
are not acting rationally and this is one of Mr. Market's depressive
states. When he feels this way, he's willing to sell you shares of
valuable companies at bargain bin prices.

I set up a simple screen recently to see if I could find some of
those bargain-bin stocks. It looks for two things: First, companies
that have grown earnings by at least 15% per year over the last several
years. Second, what might be irrational drops to the price those
growing earnings are fetching today compared to last fall. In other
words, I want something valuable -- companies that grow their earnings
consistently -- at a lower price.

Here are a few that this screen unearthed:

Company

5-Year Annualized Earnings Growth

P/E Before the Meltdown

Recent P/E

Canadian Natural Resources

(NYSE: CNQ)

39%

22.1

6.9

Cliffs Natural Resources

(NYSE: CLF)

69.4%

17.6

11.5

Companhia Siderurgica Nacional
(NYSE: SID)

29.7%

15.7

8.5

GameStop

(NYSE: GME)

43.1%

18.0

10.1

General Dynamics

(NYSE: GD)

17.2%

14.5

9.4

Mosaic

(NYSE: MOS)

100.6%

18.0

9.5

Noble Energy

(NYSE: NBL)

43.2%

16.9

10.7

Source: Capital IQ, a division of Standard & Poor's. P/E is trailing.

Now, you have to be careful; passing a screen should not be the only
reason to buy. Logic tells us that some earnings will be lumpy --
Mosaic's, for instance, recently exploded upward.

So let's skip that one for now and look more closely at a recent recommendation of Motley Fool Inside Value: General Dynamics.

The company operates in essentially two divisions: aerospace
(Gulfstream corporate jets) and defense. While the defense contractor
side is a steady performer with many long-term contracts -- it has
submarine orders out through 2018 and is still receiving contracts --
the Gulfstream side is more cyclical. The Inside Value team
noted this, writing, "Demand for the jets usually follows corporate
profits, so it's no surprise that Gulfstream's outlook is weak right
now, but over time, we expect growth in this market."

Increasing gross and operating margins have translated to annual
earnings growth of 11.6% to 27% over the past five years. Plus, the
company has a steadily increasing dividend. Yet the stock price is
about where it was four years ago and is down 36% from its high last
August.

Just a couple of months ago, the Inside Value team put the value much higher, about $75 per share.

[Defense and Gulfstream] are valuable businesses
with long-term growth potential, a fact the market is ignoring as it
sputters over Gulfstream. The aerospace unit's short-term future will
be challenging, but at General Dynamics' current market cap of $21.5
billion -- the value of the company's defense business alone --
shareholders are effectively getting the Gulfstream business for free.

Right around the current price, they still think this stock could indeed be a bargain.

A deeper look

Philip Durell, the advisor for Motley Fool Inside Value,
and his team certainly know the difference between value and price. And
they use more tools than that simple screen, so be assured that they
looked much more deeply into General Dynamics than I could in this
article. To read the entire recommendation thesis, and to find out what
new company they think is on sale this month, possibly even more of a
bargain than General Dynamics, take a free 30-day trial. There's no obligation.

 

Copyright 2009 by United Press International.