Finding Value in the Great White North

 | Jun 05, 2013 | 3:00 PM EDT  | Comments
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rfp

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FRFHF

The pace of predictive behavior is picking up. I have gotten more phone calls, emails, and tweets about stock market direction over the past few days than I have in some time. Everyone has an opinion about what the stock market is going to do – and, horrifyingly, many of them are willing to back their bet with cash.

Predicting market behavior more than a few hours into the future is a fool's game. Over the past 30 years, I have never met anyone who could do it consistently. The worst thing that can happen to a trader or investor is to have his guess be right a time or two. This builds up a sense of confidence that predicting markets can be successful but it's always followed by a severe losing streak and a fast developing sense of confusion. It usually ends with borrowing money from friends and relatives and a new career choice.

I am well aware that the economic news does not support the stock markets. The total market capitalization is currently higher than GDP and that has marked periods of over valuation in the past. I am probably more pessimistic about U.S. revenue and earnings growth than even my most bearish friends. I am skeptical that the Fed will ever manage to taper or end to quantitative easing (QE) without disastrous consequences.

I am also aware that these conditions can last far longer than anyone anticipates. I hope the market does melt down because I have a lot of cash and a strong desire to move to the islands 10 years from now. However, I am not prepared to bet that it will happen before I run out of cash and margin.

At a great cost to my account balances and peace of mind, I have learned over the years to react to what the stock market does rather than predict what it might do. Rather than run complex models or study simplistic lines of charts to guess what might happen in the markets, I focus on what has happened and where market fluctuations have created bargain issues with recovery potential. I run a series of screens daily looking for bargain issues.

One of the screens I run on a less frequent basis searches for stocks around the globe that, based on tangible book value, are quite cheap. I omit many smaller emerging markets (such as Vietnam) and avoid those that I view as outright hostile to the U.S. (Russia, China, Venezuela and, for now, Argentina). Over the years I have found some super cheap stocks outside the U.S. that have provided huge returns and I see no reason why this would change.

Resolute Forest Products (RFP) shows up on my current global cheap stock screen. Formerly known as Abiti Bowater, the Canadian company makes paper products including newsprint, pulp, commercial printing paper and coated mechanical paper. A bloated cost structure and high debt levels sent the company into bankruptcy during the recession but it emerged in 2010 with a leaner balance sheet and more shareholder friendly attitude. According to the company, more than $1 billion in costs were eliminated by the restructuring process.

The company has seen some weakness with the global economy but is taking steps to streamline operations and cut costs. It has closed marginal assets and reduced overhead substantially. The company is also cleaning up the financial side of the ledger as management has repurchased or refinanced higher cost debt issues in the past year. It has a $100 million buyback plan in place and as of the end of last year had repurchased $67 million of stock.

The stock is cheap right now. The shares trade at just 50% of tangible book value right now and are at about half of their post-bankruptcy highs reached back in 2010. The enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA) ratio is just 4.43 right now. Its valuation has attracted some smart investors to the stock, including Prem Watsa's Fairfax Financial (FRFHF), Donald Smith and company and John Paulson, who hold large stakes in the company.

The short-term outlook for the stock may not be spectacular but a long-term recovery in the economy and housing markets could easily send the stock back to the previous highs. I like the stock at this level and will start buying it on a scale in the next few days.

To sum up, my time is better spent looking for bargains the market has created. Trying to predict what might happen is usually a non-productive activity, so I try to avoid the temptation to make or trade forecasts.

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