Tom A's Stock Picks

Value vs. Crisis Investing - 2008

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Most commentators that I have read are noting that value investment did not work well in 2007 and suggesting that it will not work well in 2008. At the same time, various articles on the subject, and interviews with well-known value investors, seem to have the common theme that 2008 will be a year where there will be extreme bargains available - the chance to make investments which will earn fabulous 3-4 year returns as recovery develops.

This brings me to the topic of crisis investing. The situation with housing/mortgages/credit is a crisis. Price behavior of affected stocks is that they get down to extremely attractive levels, based on long-term metrics, then they keep going down, sometimes another 30 or 40%. Prices go from the basement to the sub-basement. The question comes up, will this or that sector, industry or company survive as we know it? Every week an article in the WSJ, Barron's, or whatever you read examines the possible dire implications and consequences.

The value investor feels like Floyd Patterson fighting Ingamar Johansen - he takes a hit, a nine count, gets back up, and takes another hit. Maybe it would make more sense to just get out of the ring, throw in the towel, say "no mas", and do something easier, perhaps real estate in Florida. Sometimes I feel like that.

After watching and participating in this process for a while, I have come up with the following advice for myself, which you could share if you like or add to it if you want to make a comment.

Make commitments in small increments of your total permissable position in any given stock.
Remember, your bargain may have another 30 or 40% decline still to come. You need room to add to your position without being overlined.

Develop an opinion on as many stocks in the affected sectors as you can. All stocks in a given industry are not peas in a pod. Sometimes bad news on one stock carries the rest of the sector down, creating opportunities to buy less severely affected merchandise at a discount. As an example, last year JNJ and AMGN traded up and down in unison as the bad news on Procrit/Aranesp/Epogen came out. But JNJ only had a 4% of their sales involved, while for AMGN it was 46%.

Hold ample cash reserves. If your treasures go down that final 30 or 40%, you want to have resources available to back up the truck. Margin is not permitted on SLO and is a no no in my personal portfolio. Remember a margin call (or a panic attack) with your treasure in the sub-basement can expeditiously get you out at the very bottom.

Have a watchlist and monitor it regularly. Often a good stock dragged down with its sector will recover relatively quickly - the window of opportunity may not stay open very long.

Diversify. Much of the bad news is real and some of the fear is justified. If you have too much on one of the losers, you could incur serious losses. As an example of how not to do that, I have too much of my SLO portfolio in two bond insurers - I would (and will) do better to spread the sum out over other bond/mortgage insurance companies, also various banks and other financial stocks are or sooon will be trading at steep discounts, not to mention building materials, etc.

Have a measure of value. Some investors are using normalized earnings, some are using book value, tangible book value, or adjusted book value. As long as you are reasonably confident that your value is intact, today's price is meaningless. If your value diminishes, whether by dilution, unexpectedly larege writedowns, or permanent change in long term prospects, take another look at the holding and make any changes needed.

Pursue some amount of alternative strategies. Many successful SLO participants use a mix of growth, value and core strategies, weighted according to their natural style or preferences. I am going to be adding some growth to my mix for 2008, on the grounds that if it works for others it will work for me.

Do a little short-selling, if you're comfortable with it. In my case, I went over my short-selling results for the past three years (a wash) and noticed that where I made money it was more market timing than an accurate call on the stock's long-term price movement. SLO does not permit short-selling per se, although ultra-shorts are legal and since my results have been market timing anyway I might dabble in short-selling.

Do not panic. All of us know that emotional control is important, at least when real money is involved. Fear when properly harnessed is Prudence. A sense of humor helps. So on and so forth.

Some of this applies insights gained from reading (and rereading) Chapter 12 of David Dreman's book, "Contrarian Investment Strategies: The Next Generation." It is on crsis investing, includes a discussion of banks, and contains ideas that are very helpful in today's environment. I notice other people cite gurus by referring you to a website or a blog, but most of the gurus I follow have good old fashioned hardcover books in print, or available used. In favor of the websites or blogs, they give info on what your guru (if still living) is buying or selling today.

I'm looking forward to hearing who are the finalists and (suspense, suspense) who's the winner...also to competing in the next round. I guess we can all just keep blogging along until then...

Happy New Year,

Tom