The Search for Safe and Cheap

 | Jan 07, 2014 | 5:00 PM EST
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Let's continue our search for cheap stocks worthy of serious consideration despite these lofty market levels. It should be no secret to anyone that a rising market such as we have seen the past few years makes it very hard to find ideas that qualify as deep-value investments. I read an interview with a principal of a deep-value firm this morning who said he was 60% in cash because ideas are very thin on the ground. That's consistent with where I am in new-money portfolios now, while older ones are between 40% and 50% cash. There aren't many safe and cheap stocks, but that doesn't mean we should stop looking for them.

Today I ran my basic Walter Schloss screen, looking for potential deep-value stocks. It's based on the trading philosophy of the legendary investor, and it has turned up fantastic ideas over my career. In November 2009, I ran the screen and came up with 41 names that I put into a tracking portfolio. This list of safe, cheap stocks has handily beaten the market over that time, returning 51% vs. the S&P 500's 31.8% over the same time. It has been a fabulous tool over the years for deep-value, asset-focused investors.

The screen looks for stocks that trade for less than tangible book value and have little debt. Strength of the balance sheet provides the margin of safety in these stocks, and along with the discount, form asset value. Schloss liked to invest alongside the people running the company, so we added a criteria for insider ownership. For the purposes of our screen, we used 10% insider ownership. We ended up with a list of 46 non-financial companies and just five of them had more than $50 million of total market cap. When I made slight tweaks to the criteria to allow for financial companies, I found just another eight names, and only four of them were worth more than $50 million in total market value.

(As an aside, once I removed the insider ownership criteria, the list of potential candidates swelled to 464 stocks from 54. I find it sad that the people running corporations do not have higher ownership stakes. I ran a simple screen against a universe of almost 7,000 stocks and found that fewer than 1,000 have insider ownership of 10% or more. It seems investors and managers are rarely sitting on the same side of the table these days. The only good thing about this lack of ownership is it makes it difficult for poorly run companies to fights off activists or vote down takeovers.)

The list is made up of familiar names. Both of our core safe and cheap stocks, Trans World Entertainment (TWMC) and Lakes Entertainment (LACO), pass this screen. So do our long-term insurance picks, National Western Life Insurance (NWLI) and Kansas City Life (KCLI). I have also written about California First National Bancorp (CFNB) and have owned the bank and equipment-leasing company's shares for some time. Intervest Bancshares (IBCA) has been part of the Trade of the Decade small-bank portfolio for some time as well.

Alpha & Omega Semiconductor (AOSL) is another stock I have talked about previously. The company makes semiconductors for power management, storage and delivery. The shares trade at just 70% of tangible book value and more than half the share price is in cash on the books. Its products are used in a wide range of end-markets, including consumer electronics, flat-panel TVs, notebook and laptop computers, wind turbines and solar inverters. The company is growing its market share in key parts of the industry. As the economy improves, this stock has the potential to give patient investors returns in multiples, rather than percentages.

There aren't many bargains, but there are a few even after the extended rise in the overall stock market. These stocks are safe and cheap, and you can buy them at current levels. As always, I prefer to stay small and move slowly, following Walter Schloss' advice to scale into stock positions.

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