Rags to Riches, 16 March 2009

Rags to Riches
Investing Advice for the Common Man and Woman

Kenneth M. Ragsdell, PhD
16 March 2009

The Market

Last week was a good week for the market. The DOW rose 570.36 points to 7167.51; the S&P 500 rose 66.80 points to 750.02 and the Nasdaq rose 122.09 points to 1424.97. Volatility (VIX) fell 9.9 points to 41.38. Volatility levels remain relatively high. On the whole it was a solid week for the market.

Zacks Weekend Wisdom

Zacks.com offers a very useful weekend summary of events in the market. Here are some excerpts from the current offering.

“Last week, the mighty Citigroup (C), one of the nation's largest banks and a Dow component, traded briefly below $1 a share before bouncing back to trade at about $1.80. 

Other well-known names like Fifth Third Bank (FITB), Las Vegas Sands (LVS), and Ford (F) are all trading under $5 a share. 

Even blue chipper General Electric (GE), the oldest Dow component, fell below $6 a share last week before it rebounded on news that the cut to its credit rating wasn't as severe as feared. 

Are these "cheap" stocks an opportunity of a lifetime or a fake-out that will lead to disaster for your portfolio? Many investors think a stock trading under, say, $5, is "cheap." Citigroup at $1 seems like it's a no-brainer because it really can't go any lower than $1 - can it? In many investors' minds, a blue chip brand like Citigroup can't simply "go away.” and you can buy a LOT of shares for $1. And if it goes to $2, well, then you've doubled your money. 

It's easy to see how the gambling mentality takes over with low priced stocks. 

As this bear continues to roar don't get sucked into only looking at the price of the stock to determine if it is a bargain. 

The stock price is, really, irrelevant. It's all about the earnings in conjunction with the share price.

For example, fertilizer giant Potash of Saskatchewan (POT) appears "expensive" as the stock trades over $75 a share. But analysts estimate 2009 earnings around $10 per share. That would give the company a forward P/E of about 7.

That's pretty darn cheap for a company with a product that will be in demand for years to come. Potash is a Zacks #3 Rank ("hold") stock.

Or consider Microsoft Corporation (MSFT). Microsoft's stock, trading around $16 a share, is at 1998 levels, split-adjusted.

Is Microsoft "cheap"?

Many investors would answer "no", because the stock's share price isn't at $5 or $10.

But if you look beyond the share price you can find Microsoft's true value. The company isn't taking any money from TARP. There are no fears of bankruptcy as the company has billions in cash. It has avoided the "problems" that many other companies have encountered in the last year or so with credit and debt. While estimates are falling, as they are with just about every company right now, current 2009 estimates call for $1.76 per share. That would mean Microsoft is trading around 9 times forward earnings.

For Microsoft, which has historically traded closer to 25 to 30 times earnings, that's pretty darn "cheap". One caveat to consider when looking for companies that are cheap, or undervalued, is that a lot of companies, and analysts, currently have no idea what earnings are going to look like for the remainder of 2009. Estimates are being cut every day. Some companies have been revising every few weeks.

What looks like a value right now may not be if the company earns less than expected. Investors should look for companies with solid businesses that will continue to generate cash flow even if things get rockier. Microsoft, for instance, continues to generate plenty of cash even as its business has slowed. Same with Google (GOOG), some of the agriculture companies like Monsanto (MON) and cash-rich large energy companies like Chevron (CVX).”

This is good advice. Thanks to Zacks for giving such sound advice. Notice the emphasis on knowing the intrinsic value of a stock. Can we identify stocks that will continue to generate earnings even during the current downturn in the market?

Advice

This seems like a good time to pay close attention to the movement of the market in general, and specific trends exhibited by stocks and ETF’s in our watch list. The billions of dollars being poured into the market by the US government will have an effect. Unfortunately, no one knows the exact effect or the timing. Have we reached a bottom? Will we have a significant and lasting rebound? Pay attention boys and girls; the next two years should be really interesting.