Darned Cheap Stocks

Young men of the ’50s and ’60s typically had grease under their fingernails – an indication of what was both a pastime and a necessity, working on their cars.

Today’s car parts do not seem to wear out the way the old ones did. What’s more, today’s automotive machinery tends to be too sophisticated and difficult for the average backyard mechanic.

I could practically stand up under the hood of my ’54 Chevy. It was a relatively simple machine that invited tinkering. But I do not even open the hood on modern cars. Why bother? I have no idea what goes on in there.

Young men seem to have lost interest. Instead, they spend their time connecting hard drives to CD burners. It’s cleaner work, and you don’t scrape your knuckles.

This trend has not gone unnoticed by investors. Auto parts manufacturers have been pounded by Wall Street. In fact, so beaten down are their prices that they have begun to look attractive.

My source for the auto stocks is James Grant’s Interest Rate Observer . What water pumps and differentialgears have to do with interest rate observing, I don’t know. But Grant’s revealed a group of companies that have roughly the same effect on extreme contrarians as free Guinness has on Irish housepainters. They make me a little giddy.

Tenneco, reports Grants, can be purchased for just 2.68 times earnings and half of book value. Tenneco, by the way, is no micro-cap. It has sales of more than $3 billion annually.

Another parts maker is Visteon – selling at 3 times earnings. While Delphi, formerly of GM, has nearly $30 million in sales and a P/E of only 7.7.

Visteon, by the way, sells for less than one tenth of sales. This, I don’t need to point out, stands in remarkable contrast to many tech and net stocks, which often sell for hundreds of times sales. The Nasdaq’s P/E is about 30 times greater than that of these ‘old economy’ stocks, and Visteon’s p/e is about 1/25th of Intel’s.

The difference is that Intel represents the technology of the future, while Visteon, Lear, Dana, and Delphi carry the banner for the technology of the past.

I do not argue that this distinction is entirely incorrect…just that it is exaggerated.

Automobiles have been around for a while, but they do not appear to be disappearing. Most of the world’s people still do not have them. And even in America, I did not notice that the traffic had thinned noticeably since my last visit.

What’s more, the future may hold a surprising boost for these ‘old economy’ companies.

“Over the next five years,” Grant’s quotes an industry analyst, “over 50% of the UAW workers are eligible for retirement… That is the best time that the automobile companies will have to shift to outsourcing…”

Whether that will happen or not, I do not know. I cannot say what the future will bring. But when billion-dollar (in sales) companies sell for less than 3 times earnings… there is less future to worry about.

While the automotive parts stocks have the misfortune of time working against them (that is, the future) …another group of stocks has the misfortune of space. They are in the wrong place. I’ll give you more Darned Cheap Stocks tomorrow…

Until then,

Your jet-lagged correspondent, wishing you well…

Bill Bonner

Baltimore, Maryland July 20, 2000

*** Everything fell in price yesterday – well, almost everything. Bonds were down. Henry Kaufman says bond yields will fall to 4% in the not-too-distant future. Bond traders didn’t seem to care. They were focused on Greenspan’s testimony today. If the Harry Potter of central banking seems worried about inflation – bonds might fall further.

*** Yesterday, I reported the latest inflation figures from the Bureau of much-Labored Statistics. Bill King reminded me that even the alarming number put out by the BLS – showing inflation at a 7% annualized – probably understates the situation.

*** The price of computers has gone down 24.4% year over year, says the BLS. As I’ve explained to you before, the numbers aren’t crunched at BLS – they’re extruded. The figure for computers depends on a “hedonic adjustment,” in which product quality is calculated as though you actually paid for it. More computing power for the same price is regarded as the same as a lower price.

*** And then, the quants decide that people shift their purchases towards lower prices – so the computer number is weighted more heavily…because it is declining. The numbers that finally emerge are no more reliable than sworn testimony from the president.

*** I landed in Paris this morning, after an uncomfortable flight from Washington. If the BLS applied its hedonic measures to air travel, prices would be rising steeply. Air travel seems to get less and less pleasant – or maybe it’s just me.

*** Paris is beautiful… And the dollar rose yesterday – knocking the euro briefly below 92 cents. The dollar still has not made a new high – but it’s not far off. With the dollar at 7.1 francs – it’s summertime and the livin’ is easy here in Paris. More about the dollar… tomorrow, after I wake up.

*** “Periodic rallies convince people that ‘all is well’.” Ray Devoe reminds us. “…[they] keep people wondering, ‘if we are really in a bear market.’ CNBC and other stock market cheerleaders are doing their part, too. The bear’s mission is… to destroy those with negative attitudes on the market and discredit or humble prudent professional investors.” Richard Russell in Barron’s: “…the bear will make himself obvious after he has lured the most people into the market in order to lose the maximum possible amount of money.”

*** Stocks fell along with bonds. The Dow lost 43 points. The Nasdaq ended the session down 121.

*** Intel fell more than 4 points. MSFT was down more than 5. These two companies – even following recent declines – still represent nearly a trillion dollars of market cap (give or take a hundred billion or so). Intel sells at a p/e of 59. MSFT has a p/e of 43. These numbers signal fast growth – why else would investors be willing to pay such high prices? Yet, Intel’s operating income has been flat for the last 12 months. MSFT actually had declining income from operations. These tech giants are going to fall.

*** As the dollar rose, gold fell. It lost $3.50. You can now buy an ounce for $279 – or nearly a third of the nominal price when Ronald Reagan was sworn in as president. Even platinum went down – $1.20.

*** There were 1125 declining stocks on the NYSE yesterday… 1674 rose.

*** On this day in 1944, an assassination attempt on Adolf Hitler failed. A bomb was exploded at the Fuhrer’s Rastenburg headquarters – but Hitler suffered only minor injuries. Following the attempt, the German army was purged of officers unsympathetic to the Nazi leader. The old Prussian aristocracy was booted out. Rommel was allowed to commit suicide.