Bear Market Opportunities

ADVERSITY BREEDS OPPORTUNITY. That’s how financial markets work. I’m not sure if the global stock markets have suffered enough adversity lately to create really great opportunities, but I’m keeping a close eye on the situation. And I’d advise you to do the same. It’s time to make a shopping list.

Back in 1986-1987, Bank of America wrote off $1.5 billion in bad loans, wiping out its reported earnings. Analysts asked Sam Armacost, the bank’s president, where the problem areas were. Sam’s classic response: “Have you got a globe?”

That’s how it feels with today’s mortgage bubble finally popping. Problems seem to crop up everywhere, with a long list of financial firms taking a beating from subprime losses. It’s so bad out there that central banks around the world have been pumping tens of billions of dollars into the short-term credit markets.

Okay, so we know it’s bad “out there”…and so does the stock market. That’s why the S&P 500 has tumbled nearly 80 points since the beginning of the year…and that’s why the stock market might continue floundering for months. But are financial conditions so bad that there is not one single stock to buy?

In the stock market carnage of 2000, for example, you could’ve picked up any number of oil and gas companies on the cheap. You could’ve bought REITs (real estate investment trusts), homebuilders and gold. These are just some examples. You didn’t even have to be particularly smart about which ones you bought. You just had to have the guts to put the money down and the patience to hang on.

Sometimes it’s best not to try to predict where the market is going to go. My favorite investor of all-time is Marty Whitman, who runs the Third Avenue Fund. I looked back and read what Whitman wrote to his shareholders back in 2000. In April 2000, near the peak of the bubble, Whitman told his shareholders that the overall market wasn’t important. He criticized Tiger Robertson, a successful fund manager, for closing his fund. Tiger wrote to his shareholders: “There is no point in subjecting our investors to risk in a market, which I frankly do not understand.”

Whitman responded: “If understanding a market means, as it obviously means for Robertson, understanding fluctuations in securities prices, then I can safely state that I’ve been in the investment business for almost 50 years and I still don’t understand markets — never did, never will. Understanding the market belongs to the realm of abnormal psychology.”

Instead, Whitman advises focusing on understanding companies and specific investment opportunities. The rest would take care of itself over time. And even though the overall market appeared to be in nosebleed territory, Whitman wrote that many common stocks were “dirt cheap.”

So where are those pockets of opportunity today? While the market trades at 18 times earnings, you can pick up Loews Corp. (LTR: NYSE) today for only 11 times earnings — less than 10 times the estimate for 2008. This is a company loaded with cash. It trades at a discount to NAV. Plus, you get the Tisch family, which has a great track record of creating wealth for shareholders. Over the last 25 years, the average annual return on Loews stock is 17%, versus only 11% for the S&P 500. So you tell me, does this stock really deserve to trade at only 60% of the market multiple?

Down in South America, the shares of Argentinean property developer, IRSA (IRS: NYSE), also seem very cheap. This owner/operator of commercial real estate sells for about 17 times earnings and 1.2 times book value. IRSA is also in good financial shape, with little debt and ample cash. But the real sex appeal of the stock is the fact that its real estate portfolio is worth much more than the current share price. Additionally, rental rates continue to increase as older leases expire.

Therefore IRSA has many things I like: Tangible assets that sweat (or that throw off cash and increase in value over time), a strong financial condition and a cheap share price. What we have here is an asset story…with a high-growth kicker.

Another real estate-focused company, Cohen & Steers (CNS: NYSE), also looks like a great value at it current quote of $25.92 a share. The stock price has been nearly cut in half since hitting $41 a share last October. The good news is that the company’s real estate hasn’t gone away. It sits right where it did last October and earns the same rental income. The only thing that has changed is the share price.

Cohen & Steers is primarily a money manager of funds that invest in real estate. The company’s tumbling share price reflects the widespread anxiety that the credit crunch will cause a global economic slowdown, which could reduce the company’s cash flow. But I doubt Cohen & Steers will suffer a serious decline in earnings, if any at all. Besides, the company’s debt-free balance sheet provides a great deal of protection against bad times. Additionally, the two principals own 60% of the stock. If it gets too cheap, they could buy back the other 40% and go private.

Chris Mayer
February 15, 2008

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