I came across some old computer files last night that were very interesting. In 2008, I kept a portfolio of my Real Money picks during the first part of that volatile year. That August, just before things really went south, I formed a model portfolio and tracked it. After a while, I moved everything to the cloud and forgot about the file. When I stumbled on the old file last night, the evidence for asset-based investing was compelling.
The portfolio returned about 16.7% annually compared with a market return of just 2.45%. I was sufficiently impressed with this number until I noticed a tracking error. The portfolio of 39 stocks had experienced a fair amount of takeover activity, with eight companies being merged or acquired. The program was counting them all as a 100% loss since the tickers no longer existed. After adjusting for this minor mistake, I recalculated the asset-based portfolio of returns and came up with an annualized return of 21% -- almost ten times the markets return over the same period.
Digging deeper into the portfolio I found it was actually a well-diversified mix of companies. There were small banks, retailers, drillers, refiners, grocers and insurance concerns. The portfolio was not assembled for diversification but on valuation. The one trait all these stocks had in common was that all 39 traded at less than 70% of tangible book value at the time of inclusion. A focus on valuation and survivability has paid off in spades for patient and disciplined investors over the past four years. There were eight takeovers, but just one corporate failure in the 39 stock portfolios. Many of the stocks suffered quotational losses, with some dropping as much as 50% during the holding period, but eventually recovered to prices more reflective of asset value.
Looking at companies that trade very cheaply based on assets, you can put together an interesting portfolio of too-cheap-not-to-own stock today. It is not as long a list as it was in 2008, but if you are starting with a blank slate there are names worth considering. I have written several times in recent weeks about temporary staffing leader Kelly Services (KELYA, KELYB). A weak economy has the company out of favor with the Street. At 70% of tangible book value, the stock is worth owning right now. With no long-term debt and an Altman Z score of almost 5, the company has a high survivability factor. In spite of the weak employment environment, the company has been profitable and is producing reasonable cash flows.
I have talked about Hercules Offshore (HERO) recently, as well. The oil and gas driller is not as financially strong as Kelly is, but it is the largest shallow-water driller in the Gulf of Mexico. It is also the largest lifeboat and inland barge provider to the drilling industry. Hercules will lose money this year but should see a return to profits as the global economy firms and energy demand begins to grow again. In the meantime, the stock trades at just 60% of tangible book value and insiders have been active buyers in the open market recently.
There are also banks worth considering. Banner Corp. (BANR), with offices in Washington, Oregon and Idaho, currently trades at just 70% of tangible book value. Mid-Atlantic based First Bancorp (FBNC) is currently trading at just 60% of tangible book value and seeing strong insider buying activity. There are dozens of small community banks that trade below 70% of tangible book value that could be considered by long-term investors.
If you are already invested, the best thing to do now is nothing. If you are starting a portfolio, it is best to concentrate on those few too-cheap-not-to-own stocks. History and experience have shown that this approach works and works extraordinarily well for patient, disciplined, asset-based value investors.