Author: Zanshin Capital
Model: Buffettian Value
Disclosures: Long JNJ, TEVA, STRA
Stocks as a whole are not overvalued at the moment. As of 6/3/11, The Wall Street Journal reports the trailing 12 month P/E of the Dow Industrial stocks at a reasonable 13.82.
However, it has been surprisingly hard to find high quality, deeply undervalued securities as buy candidates for my portfolio. Although I am very skeptical of my (or anyone else’s) ability to forecast short term market-wide fluctuations, I can’t help but notice that each time I find myself in a similar situation with a scarcity of attractive value stocks, the market tends to head for a correction. The market had a significant fall at the end of last week (6/1-6/3). Again, the fact that valuations are still reasonable overall should probably act as a shock absorber and provide a floor to any steep fall.
Some sectors do retain some degree of attractiveness as worthy of long term investments, with healthcare probably retaining a leadership position here. Long term demographics are favorable in this sector: the story of baby boomers entering their old age and needing more healthcare and assistance has many mentioned many times before, but this does not make it any less true.
Save for a timid rebound during the last month or two, healthcare stocks generally continue to trade at very attractive multiples. Even some of the large pharmaceutical companies seem to be facing a brighter future as their pipelines are improving. Such companies are blessed with a number of competitive advantages that make them sturdy long term contenders, including powerful economies of scale from R&D and marketing, protected cash flows through patents, captive consumers and non-cyclical products.
The energy sector has rebounded to some extent from the irrational lows of one year ago. The dreams of an imminent alternative energy revolution have proven premature and a slowly rebounding economy coupled with little new supply is causing prices to increase. I believe the entire story did not unfold yet and that there is still significant upside remaining in this sector, particularly among the integrated oil majors, still trading at relatively low valuations, and the oil drillers.
At Zanshin we also aim to capitalize on the for-profit education industry, under threat from a regulatory change by the Department of Education. Scared investors fled the sector en masse and this has resulted in attractive valuations across the board. We picked the best-in-class company and are confident it will have both the staying power to withstand the DoE rules and thrive in an environment where a number of weaker competitors will be likely crippled by the new rules.
I am skeptical of predicting short term macroeconomic developments. That is why I prefer to acquire shares in companies that tend to perform well in most economic conditions, and to use an investment horizon much longer than a typical business cycle. In any event, my mid-term view of the economy is optimistic. Albeit slowly, recovery has been in place for almost two years now, consumers are progressively de-leveraging and companies are flush with cash.
The missing link in the chain is the housing market, which might well begin to recover within the next 12 months. Once that happens, due to the massive size of the real estate sector and its related industries, GDP should receive a significant boost and unemployment should start decreasing in a sustained pace (the housing sector is labor intensive). That will be the beginning of the real recovery and will likely translate favorably in the stock market’s performance.
While we wait, the Zanshin portfolio holds solid franchises with strong recent earnings.
Sources:
“P/Es & Yields on Major Indexes” Wall Street Journal, as of 6/3. http://online.wsj.com/mdc/public/page/2_3021-peyield.html
