I am just finishing the new biography of Ben Graham, The Einstein of Money by Joe Carlen, and I have to say it is a pretty good read. One point that the author really brings home is Graham's belief, later adopted by Warren Buffett and other successful value investors, is that we should look at a stock as if we are buying the entire company.
All too often today, stocks are viewed as just an electronic bet on the popularity of a particular company or sector or the overall market. The average holding period for many investors is a period of days or even hours, and such pure speculation is a difficult enterprise for individual investors who compete against doctors of physics and statistics armed with supercomputers.
I view my portfolio as a conglomerate of companies, not a collection of bets. When I find a cheap stock, I ask several questions. Why is it cheap? Do the credit scores indicate a high likelihood of survival? What needs to happen for conditions to improve? And last, is this a business I want to be in for the long term? Adding this qualifier often keeps me out of value traps and companies that have no real hopes of recovery.
A list of statistically cheap stocks usually includes small biotechs that trade for less than cash but which have no viable product, and third-tier semiconductor companies that have no niche and decaying margins. My criteria also help me cast a cynical eye toward potential buggy-whip industries such as brick-and-mortar computer stores and one-hit-wonder retailers that are on the way out.
Everything starts with valuation for me. Before a stock ends up in my portfolio, it has to be safe and cheap before I will buy, no matter how much I love the underlying business. I love everything about Amazon (AMZN), but will never pay a triple-digit earnings multiple for a stock. Most of the time, I look for company valuation first, and then consider the underlying business and industry. As with every rule, there are exceptions.
There are some businesses I want to be in for the long run. I keep lists of companies in that business on my desk, along with the valuation calculations for each one. I compare my lists with the stock prices on a regular basis and look for an entry point for the stocks on a safe and cheap basis. I closely watch Mr. Market's mood regarding these companies, hoping he will enter a temporary depressive state and allow me an entry point.
One such industry is community and regional banking. The short-term headwinds facing the industry are substantial, as we all know. The higher cost of regulation and compliance combined with a seemingly permanent low net interest margin make community banking a tough business right now. However, those banks that have solid balance sheets, low loan losses and excess capital will be in the proverbial catbird seat over the next decade.
They can grow at the expense of weaker competitors, take market share from larger banks or just stay as they are and grow book value and dividend payouts. They can also just simply exit the business via a sale of their bank. Given their strong condition and local presence in their market, they should be able to do so at a sizable premium to book value in a few years. I keep a list of these banks on my desktop, and when they trade at 80% of tangible book, I buy the stock.
I also keep a list of infrastructure stocks on my desk. In spite of the current fiscal and political conditions in the U.S. and around the globe, I do not believe the world will end. Getting back on track will be difficult and will take longer than anticipated, but we will eventually. When we do, there will be enormous pent-up demand for infrastructure projects.
In the U.S., we need an upgrade of our highways roads and bridges. The water supply and disposal systems of many of our major urban areas are practically antiques and need substantial repair and replacement work. The electrical grid needs to be completely reworked to not only provide better service but to improve our national security. Keeping a list of companies close helped me jump into stocks such as Granite Construction (GVA) and Mueller Water (MWA) in last year's late-summer selloff. At some point, infrastructure will be a boom sector with rapid profit and stock price growth, and I want to buy these stocks when the hit my price levels.
I base all my decisions first and for most on valuation, but there are some businesses I want to be in and watch closely for the value to appear.