Look for Margin of Safety

With all of the fear going on in the stock market over the last year it is even more important then ever to invest in companies with a high margin of safety. The near term future of the global economy is still murky. Nobody in their right mind can tell you when the bloodshed will subside. You will have a hard time sleeping at night if you have your money invested in a company with a weak balance sheet. Companies with large cash positions is vital right now. It is important because normally if a company gets in trouble they can sell of some assets for cash or they can issue their own stock. However, asset prices are so low right now that it is very difficult to turn a struggling balance sheet into a stellar balance sheet.

A company is not always safe just because it has a lot of cash on hand with very little debt. That can evaporate very quickly if a company is burning through cash. Although, I normally like to see a company put that cash to use via a stock buyback or an acquisition, I am very content for the time being to see a company hold onto their cash. An even worst case to see would be the cash rich company burning cash through their operations. At least when a company is using cash to make investments, that money does not dissappear. Cheap multiples are around everywhere. It is important, however, to limit your downside risk and look for companies that will have the ability to emerge from the downturn even stronger when the economy begins to recover.

Buy China

Many investors should be looking to buy into China because of the growth and stability in the Chinese economy.  The consumers in China are starting grow and have not been too effected by the downturn because of their very high savings rate.  The Chinese government would actually like to see the Chinese people consumer more goods.  The best way to invest in the Chinese market is to buy American companies that have a strong presence in China.  I would disagree with those that would rather buy Chinese equities. (although they are finally a bit more fairly priced)

American companies can not only be trusted more then their Chinese counterparts, but they are much more efficient as well.  The heavily centralized government should definitely make an investor think twice about owning common stock in a Chinese company.  American companies are usually much more diversified and also have proven management that is used to competing on a global stage.  With the markets severely down, I see many quality companies with heavy Chinese exposure that can allow investors to finally get into China without paying a "premium" price.

Stock Pick

Roughly every week or so I'm going to come out with a stock pick to follow. That doesn't mean I think it is going to go up within the week. However, it does mean that I think over time it will greatly outperform the market.

News Corp (NWSA): $6 a share....Owner of Fox News, 20th century fox, myspace, wallstreet journal and many other media outlets. Run by Rupert Murdoch

This stock is greatly undervalued due to the unprecedented slowdown in advertising spending. It will stay undervalued if you believe that advertising will never recover. I happen to be in the camp that feels advertising will live to fight another day. Given that, Rupert Murdoch's company has a war chest of cash to cope with the downturn and is taking pro active measures via cost cutting. One of the greatest investors in the history of the United States, Seth Klarman, has bought a substantial stake in the company. The good news for somebody like you is that you can get in News Corp at prices 50% lower then Seth Klarman was buying at. Downward risks include that the newspaper business takes up too large a portion of their revenue stream.

DOW at levels not seen since 1997

Its funny that people refer to Japan's economic situation during the 1990's as the "lost decade" when the United States has not fared to well over the past decade as the DOW is relatively unchanged from where it was 12 years ago. To be honest, I don't feel too comfortable with the macro conditions and what government has attempted to do to solve the problem. That being said, I am still a buyer of stocks.

Back when I started investing real money after I graduated high school I remembered wishing that the DOW and S&P 500 would get out of the bull market they were in so I could get into equities at depressed levels. I thought it would never happen as it was around 2006 and the bull market was just heating up. I have been very fortunate over the past year as I had a strong cash position in my portfolio blunting me from much of this downturn. In fact, my portfolio sits around 10,000 dollars, up from the 8,0000 dollars that I started with almost 3 years ago. Now my wish has finally come true as I am able to buy stocks at very depressed levels. I guess I am one of the few investors out there that looks at the market and sees opportunities, and has the funds to take advantage.

Best time for Value Investors

The current market conditions are what value investors live for.  Stocks all over the spectrum are trading at well below their intrinsic value.  I doubt that any one of us will be able to guess when the market will bottom, but that is not what we are concerned with.  Timing is of least importance.  Our major concern is of buying stakes in companies at prices well below their fundamental value.  If you had a long term investment horizon, wouldn't you rather be buying stocks when the DOW is at 8,000 rather then at 13,000.  

Most market participants, however, are in a lot of trouble during a market bottom.  Back in 2007, many people were fully invested in stocks as euphoria flooded the market.  Therefore, at the worst possible time to be invested, (when stocks are priced high) almost everybody was a market participant.  Unfortunately, they have no capital left over to invest when prices are cheap towards the end of the bear market, which is precisely the best time to be in stocks.

The best example I can think of right now is billionaire value investor Seth Klarman. Throughout most of 2006 and 2007 Seth Klarman had no more then 50 percent in stocks because he thought stocks were overvalued.  He wasn't worried about timing, as evident in the fact that he was probably over a year late on his call that stocks would greatly diminish in value.  He was worried about capital preservation and that the downside risk was much greater then the high price of equities.  Sure, he could have had greater returns in 2006 and 2007. (although he still generated over 15% return on investment...which is phenomenal given the fact he had only 50 percent of his money in stocks)  However, his returns have drastically beaten the market over the past year as stocks have come off the highs to now multi-year lows.  The best part about it is that Seth Klarman now has ample cash to deploy to currently buy stocks when they are at their lowest levels.  Ironic isn't it.

Number 1 Reason to Buy Stocks Now

Analysts estimates have finally been cut enough to come in line with the earnings that the companies are reporting.  Next quarter we aren't really going to be getting any crazy surprises. Companies, through cost cutting, have been able to make the proper adjustments.  The drop in commodities prices have also been a positive for companies because transportation costs are down as well as basic material costs.  Stocks have to be bought at this level because pessimism has nowhere left to go but up.

Warren Buffett's Portfolio

A lot of critics of Warren Buffett have been complaining that he has been contradictory as of late with his portfolio.  He wrote on op-ed in the New York Times several months ago saying buy American stocks now.  When looking into his recently filing with the SEC, we see that he has in fact trimmed stakes of some major American companies such as Procter & Gamble and Johnson & Johnson.  People are looking at this from the wrong perspective.  The fact that he is selling his stakes in P&G and JNJ actually do signal that he is bullish on US equities.  Most people buy stocks such as P&G and JNJ as defensive stocks because they generally hold up well during a recession.  Buffett is adding shares to some of his oil holdings and financial companies signaling that he is putting his money to work in companies that do well in a growing economy.  Buffett's critics are looking at his recent moves from the wrong point of view and in reality Buffet is sticking to the strategy of buy American.

The Right Manager for These Times

First of all, I always like to see the CEO of a company have a substantial amount of shares in the company.  The CEO will have more of a vested interest in the company.  The next major quality that I like to see is when the CEO takes more of a long term view on the company's success rather then worrying about making the numbers each quarter.  The perfect CEO for these times is Richard Woolcott, the CEO of Volcom.  

Richard Woolcott just so happens to be the founder of Volcom and is currently the Chairman and CEO.  He owns over twenty percent of the company and therefore is on the same team as the common stockholder.  Times are tough right now and almost every company is making job cuts to come in line with the depressed revenue base.  Volcom, not being immune to this crisis, just came out with a reduction in the workforce of around 10 percent.  Richard Woolcott also took a 15% reduction to his salary, which is already under industry standards.  This tells me a lot about the kind of person Mr. Woolcott is and that he is interested in the long term success of Volcom.   A good amount of cost cutting that takes place in the corporate world can greatly impact the long term success of a company.  For example, Volcom can cut some costs by ending some promotional events.  This can effect the long term success of the company. (although probably moderately). Instead, Richard Woolcott decided to take a cut in pay, a move that does not at all impact the long term prospects of Volcom.  For that I greatly respect him.  Especially in a time where all we read about in the news are greedy businessmen with scams happening left and right.

Valuation of the S&P 500

I constantly hear the bears in the market stating that the market is still overvalued.  They point to the fact that earnings for the S&P 500 will probably come in at around $45.  That leaves us with a P/E of around 17.  To the naked eye that does seem overvalued because most believe that a P/E of 17 is expensive when the economy is in free fall.  However, the successful investor sees opportunity in these numbers.

The investors that beat the market continuously might look at these valuations and see the glass half full.  Although earnings for this year will be terrible, eventually the market will recover and things will begin to improve.  Therefore, we like to use normalized earnings, which means how earnings generally are in a normal investing environment.  Basically an environment similar to that of Goldilocks and the 3 Bears.  The porridge is not too hot and not too cold.  In normal economic conditions, the S&P 500 will probably clock in around $100 in earnings. (rather then the $45 that the S&P will probably report)  That leaves us with the S&P having a P/E of 8 rather then the current P/E of around 17.  Now the market looks dirt cheap.  That means that the average company in the S&P is probably trading at around 8 times normalized earnings.   Call me crazy, but at 8 times earnings i'm going to be buying as much stock as I can get my greedy hands on.

Why is the Market Down??

As I am sitting here, the DJIA is sitting at a six year low. As Larry Kudlow says, "earnings are the mothers milk of the stock market." Sure earnings are terrible. But let's dig deeper. There is no clarity in the market. In fact, I don't know if there has ever been a time when there has been less clarity in our nations history. Is the stimulus package too big? Can our nation hold this much debt? When is there going to be a clear and effective plan for getting us out of this financial meltdown?

I believe that as an investor, if you have cash on the sidelines then now is the best time to deploy it into the market. Take advantage of all the fear running amuck on the street. The key is look for companies with strong balance sheets (lots of cash) that will be able to come out stronger when the downturn ends. It's just that simple. Try to block out the fear and uncertainty going on in the market and get into stocks that are trading at valuations we may never see again for the rest of our lives.