Look to Buffett's Teacher

 | May 03, 2013 | 1:00 PM EDT  | Comments
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Stock quotes in this article:

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I want to wrap up my theme for the week and the resulting investable stock ideas. As the annual capitalist Woodstock approaches, my overriding thought is that most investors would be better off paying attention to the man who taught Warren Buffett the important concepts of value investing than to Warren himself. Most of us cannot do what Warren does. If we try to do so with a portfolio of less than several billions and billions of dollars of free money in the form of float, we are pretty much doomed to failure. However, we can easily adapt the principles of Ben Graham that Warren used to pile up the first few hundred million of his fortune.

I ran a screen earlier this week that identified issues that were bargains based on asset value and that also had strong fundamentals, which offer a margin of safety. It has been an interesting and revealing exercise. In The intelligent Investor, Graham mentions that often investors will find businesses for which they have no particular enthusiasm but the bargain nature and margin of safety make them worth buying anyway. That has certainly been my experience with this list.

Trans World Entertainment (TWMC) is a company for which I have no enthusiasm at all. The company operates video and music stores, which is just not a very good business. The company is undergoing something of a transformation with more focus on selling trendy products, including clothing, and it has developed an online presence as well. The founder and CEO still owns about 50% of the stock, so he has a vested interest in getting things turned around. In the meantime, the stock trades at 75% of tangible book value and has an F Score of 6. The Z-score is 3.4 and the company's market cap pretty much equals its cash balances.

There are some signs of a housing turnaround, although I suspect hedge fund buying of single family homes is skewing the numbers. If housing does rebound strongly, then the furniture business should improve markedly. That will be great news for two of the companies on our list of cheap stocks. Flexsteel Industries (FLXS) trades at 99% of tangible book value (TBV) with an F score of 5. Its rock-solid balance sheet gives it a Z score of over 6. Basset Furniture BSET comes in at 98% of TBV with an F score of 6 and a Z score of 3.8. I am something of a skeptic on housing and the consumer but these stocks are safe and cheap.

I have mentioned before that I am not a huge fan of small semiconductor companies. However, Pericom Semiconductor (PSEM) is the second such company to make the list. The company makes chips that are used in networking, as well as in data and telecom applications. Its business has basically been flat because global PC sales and IT spending remains weak. The company has introduced a range of new products that give it exposure to higher growth markets such as smartphones and cloud computing that management hopes can ignite growth. In the meantime, the stock is cheap, as it is trading at 75% of tangible book value. Most of that is in cash as the company has over $5 a share on cash and liquid securities on the books. The stock gets and F score of 5 and a Z score of 4.3. The company is buying back stock and, as much as I hate buybacks above book value, I love it at this deep of a discount.

Our final selection is another of those "Gee, I really hate this business" stocks. Rex American Resources (REX) is in the ethanol business. The company has interests in seven ethanol plants and also has a real estate division. The real estate division still owns 11 former retail locations they are attempting to lease or sell. When you add up all the cash property and equity interests in the plants, the company is selling at just 60% of tangible book value. The stock has an F score of 6 and a Z score of 3.6, so there is a decent margin of safety in the shares. They are also buying back stock at a healthy discount to asset value.

You and I cannot do what Warren Buffett does today. We can, however, follow the investing strategies Benjamin Graham taught him and which became the cornerstone of the vast fortune he controls today.

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