Not a Popularity Contest

 | May 09, 2012 | 4:00 PM EDT
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According to my email inbox, Twitter feed and Facebook stream, the world is ending today. The stock market is going to be down again today and the apocalypse is nigh. I have never seen so much panic in a market that is still up for the year and less than 5% off the highs.

If you own all Italian or Spanish shares I could understand a certain measure of panic, as those markets are flirting with 30% declines over the last year, but U.S. investors are experiencing a hiccup -- at best -- so far. I guess everyone was chasing the popular names like SodaStream (SODA) (kudos to Tim Collins on this one), Green Mountain Coffee Roasters (GMCR) and Fossil (FOSL). I have good reasons for  avoiding popular high-multiple stocks. The past week is a prime example of why I won't buy the stocks everyone loves. When the market falls out of love, it turns viscous quickly.

When I buy a stock, I am not entering a popularity contest. I am trying to buy a business that is safe and cheap, so I can own it for many years. Unless something changes in the fundamental nature of the business or the financial take an extreme turn for the worse I am not looking to sell for a long time. I am not a fan of the "buy what you use" or the world-changing product school of stock picking. I favor the "buy safe and cheap so you can afford to purchase things you like and world changing products with your profits" school.

I sat down this morning and ran a few screens for stocks that are safe and cheap. I looked for companies that are trading well below tangible book value that scored high on my two major credit and financial metrics. I searched for stocks with an Altman Z score above 2 and a Piotroski F score of 6 or higher. This should give me a list of cheap stocks where bankruptcy risk is not an issue and highlights those that have the potential to return my purchase price many times over in the long term.

There are some old friends on the list. I have mentioned Kimball International (KBALB) in the past, which is a stock I am very comfortable owning. The company has two divisions, furniture and electronic manufacturing services. The EMS division has lost a major customer and revenues and profits have fallen as a result. The division has exposure to some markets with strong growth potential including the automotive and medical electronics industries so they should be able to replace the revenue over time. The furniture division is seeing conditions improve as both office and hospitality markets have improved. The hotel sector should see continued improvements as many major chains have announced plans to refurbish properties this year.

Trading at just 70% of tangible book value, the stock is very cheap. The company does very well on my scoring metrics with an Altman Z score of 3.94 and an F score of 7. This indicates that not only is there diminished risk of financial distress, the fundamentals are improving and the stock price should as well. A focus on efficiency improvements and cost-cutting during the recession should allow for rapid cash flow and profit growth when revenues begin to improve. At the current price, the stock pays a 2.9% dividend so you get paid a little to wait for the stock to improve. I am highly confident that as the economy improves over the next five years, the stock price can approach the highs of the past five years I plan to sell the stock for 3x or 4x what I am paying for the shares today.

Serious market declines provide inventory creation when you focus on safe and cheap. Keep in mind , however, that so far, we have not seen a serious decline.

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volatility is quite low here, and we could see some downsides here in the short term. ...



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