A rare balanced view of this month's market from seekingalpha.com

most of the commentators on this site are traders with very short term views. This fellow is the exception:

Anyone else feel like they are in the 10th round of a heavyweight bout - and losing? If you are long stocks, the answer is almost definitely yes. That's how it feels during a correction. As the screaming media won't let us forget today, yesterday we crossed the magical "down 10% from the highs" point that officially means we are in a correction. Funny thing is, by definition, if it is a correction, it must be correct - right?


Personally, I feel like it's an IN-correction, and I know I'm not alone. Sure certain sectors of the market are/were due for a smack-down. The irony is that in corrections like we are currently experiencing, the wrong stuff goes down. The cheap companies get even cheaper, and whatever has been working gets even more expensive. The psychological phenomena at work are known as recency bias and/or extrapolation. People tend to put too much emphasis on recent data points, and tend to extrapolate recent trends into the future. Nobody wants to touch the cheap stuff - it's the old "don't catch a falling knife" syndrome. This all works fine until it doesn't. For now, if you're piling into what's going up, you are doing better short-term, than those of us looking long-term and trying to pick up good companies on the cheap. As David Merkel said:
Absurdity is like infinity. Twice infinity is still infinity. Twice absurd is still absurd. Absurd valuations, whether high or low, can become even more absurd if the expectations of market participants become momentum-based. Momentum investors do not care about valuation; they buy what is going up, and sell what is going down.
The market is big-time scared right now. Look at treasuries. My officemate trades treasuries for a living and he cannot believe the fear and related "flight to quality" he is seeing. The market is buying treasuries no matter how expensive they become, and fleeing the stuff that is really cheap (financials, retail, etc). The 10-year has hit its lowest yield in more than three years, around 3.9%. The 2-yr's discount to Fed-funds is the greatest it's been since 2000.
Other factors are at work too. Many big Wall Street firms end their years this month, and bonuses are on the line. Hence you can bet that they are dumping losers for tax losses and window-dressing as well by buying winners to try and eke out some last minute performance.
We already know that US equity mutual funds have seen large asset outflows as investors tire of taking the pain and either flee to safety (cash, treasuries) or reinvest in overseas funds. Now, we get the news that big pension funds are dumping US equities and moving into international funds too. We are talking about institutions that collectively control more than $500 Billion of assets! For example, Calpers, at $250B, recently decided at a board meeting that they could enhance returns by moving assets into international funds, decreasing US weighting from 40% to 24%, its lowest weighting in more than 20 years. Other big funds are following suit.
Here's some news for you: Pension funds are not the "smart money", even if they are the big money. Just ask Mr. Buffett (how could I write something without quoting him?). In December 2001 in Fortune he wrote the following (I have tried to limit how much I reprint here, so please read the article for more):
In 1971--this was Nifty Fifty time--pension managers, feeling great about the market, put more than 90% of their net cash flow into stocks, a record commitment at the time. And then, in a couple of years, the roof fell in and stocks got way cheaper. So what did the pension fund managers do? They quit buying because stocks got cheaper!
That sort of behavior is especially puzzling when engaged in by pension fund managers, who by all rights should have the longest time horizon of any investors...Yet they behave just like rank amateurs (getting paid, though, as if they had special expertise).
In 1979, when I felt stocks were a screaming buy, I wrote in an article, "Pension fund managers continue to make investment decisions with their eyes firmly fixed on the rear-view mirror. This generals-fighting-the-last -war approach has proved costly in the past and will likely prove equally costly this time around.
I continue to believe that there are many excellent companies out there selling for bargain prices, and I continue to add holdings in retail, financial and other beaten down areas as my subscribers can see. In the near term this has largely been an exercise in masochism. Remember I am trading my own money here as well as my clients'. Yet, amazingly, I am not yet kicking the dog or gazing expectantly at the open (3rd story) window behind my desk. It's not the first time I've been through this, and I have conviction in my investment process and my holdings.
For those fellow Investment Directors whose Vestopia performance records start near the all-time high for the market in October like mine, things may look grim even if we are outperforming the market. Let me say right here that although the daily performance calculation is a necessary evil, never will I do something to try and window-dress my short-term results at the expense of the long-term.
Quoting Legg Mason's thoughtful Investment Strategist, Michael Mauboussin:
We argue that there is an approach that distances the best performers in all probabilistic fields from the average participant...
1. A focus on process vs. outcome
2. A constant search for favorable odds, including a recognition of risk.
3. An understanding of the role of time.
..the ability to stick with these elements in the face of the market's vicissitudes and the crowd's tugs is very difficult - and ultimately all about temperament.
Amen.

Tips and tricks for the value investor

some of these lessons I've learned from the school of hard knocks.

• never buy on a stock tip, even if it's from a guru. Do your own research. Buy with conviction. "I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years." Warren Buffett
• do check to see what the gurus are buying and selling and see if you can understand why they are seeing value where the market does not. I use www.gurufocus.com. Do NOT blindly follow the gurus, however. They are dealing in the billions of dollars and many excellent prospects for the smaller investor are not suitable for them and vice versa.
• generally, ignore analysts' ratings of stocks. They generally upgrade stocks that are going up and downgrade stocks that are dropping--- they are too late to the party. Morningstar's security ratings and assessment of intrinsic value are definitely worth paying attention to, however. www.morningstar.com. (unlike the other links here, this one isn't free for full service)
• generally, stockbrokers know the price of everything and the value of nothing. The are remunerated when you buy and sell a lot so they are motivated to involve you in short term, speculative investments based on momentum. This exposes you to the whims of a madman (Benjamin Graham's "Mr. Market"), something that is not nearly as important over the long term.
• do not buy on valuation alone. Most stocks that have a low P/E and P/B ratio do so for good reasons-- usually low growth (check out the PEG ratio too). Always compare valuation to the competitors and see if you can figure out why the market has punished the stock. If the reason is irrational or short term, it MIGHT be a buying opportunity.
• If you're considering buying shares of a company always read a transcript of the last quarter's conference call and the last year end Q4 call (available at www.seekingalpha.com). If you don't have time to read the whole thing (who does?) ignore the opening comments (mostly hype) and just read the CFO's report and the Q & A section at the end. The CFO is not a salesman like the CEO and COO, so he/she gives the straight stuff. If it's US based company, execs can go to jail for longer than Canada puts our murderers away if they present something misleading so don't be put off if they seem cautious--- wouldn't you be? They shouldn't be evasive without stating a good reason for being so. After reading the transcripts you should be able to understand two things: how the company earns it's $ and how it plans to increase those earnings in the future.
• When you look at financial reports always compare the statement of cash flows to the earnings. If earnings are increasing and cash flows are not, get nervous. There are legit reasons for this phenomenon; however, they should be easy to find. If you can't figure it out, ask the investor relations dude. If you still don't understand (in plain english), sell!
• ignore technical analysts/chart readers. Pseudoscience substituting for momentum investing. I don't know any rich chartists.
• if everyone is talking about a stock or you read about it in the newspaper, you're too late to the party. Far greater minds have probed it's every nook and cranny and the market has evaluated it long ago.
• if you want to invest in a sector and you don't have the time or energy to research it yourself, buy an ETF with the lowest management expense ratio you can find. I prefer fundamentally indexed ETFs (as opposed to those indexed by market cap, as the majority are). An objective easy-to-read summary of ETFs is here.
• Don't over-diversify, despite what you read in the financial mags. "Wide diversification is only required when investors do not understand what they are doing. " Warren Buffett
• If you feel a sickening feel in your stomach when you buy value stocks (particularly after they fall even further...) and everyone else you know is selling when you are buying, then you are finally getting the idea... :-)
• if the market is volatile--- buy your stake in 25% portions-- hopefully on the way to the bottom. If the market is moving "sideways" save brokerage fees by buying all at once
• dividends DO matter. really high yields may be unsustainable--- check the "payout ratio". if it's > 50% of the retained earnings, be wary. if a company has otherwise good balance sheets and has been increasing dividends regularly (even from a modest amount) I find this more reassuring than a large dividend yield in a shaky company
• do not buy a company with the latest technological breakthrough, no matter how impressive. Focus on companies that know how to sell product and make money from it by controlling their costs, managing their debts and beefing up their margins. (look at Dell-- not the best innovator and definite not the first big PC manufacturer... but if you bought $10,000 worth of shares in the late 80's, you'd be a millionaire now).
• try to choose companies with products that don't become obsolete for a long time i.e. Cemex. Cement doesn't change much year to year, lol. Inventory management is a perpetual nightmare, particularly with tech products and vehicles. Companies that manage their inventories well maintain and increase their margins which pretty much always translates into the bottom line.
  

Of blind squirrels and flying pigs...

Link to article here

if you don't have time to read the whole article, the points are summarized here:

• Economists cannot predict the turning points in the economy. Of the forty-eight predictions made by economists, forty-six missed the turning points.
• Economists’ forecasting skill is about as good as guessing. For example, even the economists who directly or indirectly run the economy—the Federal Reserve, the Council of Economic Advisors and the Congressional Budget—had forecasting records that were worse than pure chance.
• There are no economic forecasters who consistently lead the pack in forecasting accuracy.
• There are no economic ideologies whose adherents produce consistently superior economic forecasts.
• Increased sophistication provides no improvement in economic forecasting accuracy.
• Consensus forecasts offer little improvement.
• Forecasts may be affected by psychological bias. Some economists are perpetually optimistic and others perpetually pessimistic.(1)
  

Since the underlying basis of most stock market forecasts is an economic forecast, the evidence suggests that stock market strategists who predict bull and bear markets will have no greater success than do the economists.

Benjamin Graham--- Warren's prof. From The Stingy Investor.com

stocks selected by Graham's Simple Way gained an average of 26.6% over the last year which bests a 20.8% advance for the S&P500 as represented by the SPY exchange-traded fund. (In both cases dividends are included but not reinvested.) That's an outperformance of 5.8 percentage points for the Simple Way. Since 2005 Graham's method did even better with a 54.0% gain that outpaced the SPY fund by 19.8 percentage points. Not bad for a technique that has been around for more than 40 years.

Graham's Simple Way is based on two main criteria.

First, stocks must have an earnings yield that is at least twice as large as the average yield on long-term AAA corporate bonds. Furthermore, Graham thought investors should not buy stocks with earnings yields of less than 10%.

Earnings yield is the reciprocal of the more common price-to-earnings ratio. Instead of dividing price by earnings, as you do for P/E ratios, earnings yield is found by dividing earnings by price and the result shown as a percentage. So, if a stock earned $1 per share last year and is trading at $20 per share then its earnings yield would be 5% (i.e. $1 / $20 * 100%).

The average yield on AAA 20-year U.S. corporate bonds was 6.01% on June 1, 2007. So, according to the Simplest Way a stock is cheap if it has an earnings yield of more than 12.02% (or a positive P/E ratio of less than 8.32).

Graham's second requirement focused on safety by demanding that companies have little debt. He stuck to stocks with leverage ratios (the ratio of total assets to shareholder's equity) of two or less. Although low-debt firms are relatively safe, it is important to remember that there is no such thing as a totally safe stock.

When it came to selling, Graham suggested waiting for either a 50% profit or no later than the end of the second calendar year after purchase. I differ from Graham in that I'm willing to let my winners run three years minimum. However, Graham's admonition to trim one's losers is good to keep in mind. Nonetheless, to make performance calculations less onerous, I assume that stocks are held between articles (which appear about once a year) and are then replaced by new stocks.

This year Graham's criteria narrowed the large universe of stocks down to 179. But I decided to focus on U.S. stocks with market capitalizations of more than $500 million (down from a billion dollars last year), which are shown in Table 1. Even after including a few smaller stocks, the list is down to 11 stocks this year from 22 last year.

When looking at the list, you should keep in mind that some stocks will inevitably fair poorly. For instance, the biggest dog from last year was Louisiana-Pacific Corp (LPX) which lost 16.9%. Indeed, 7 of the 22 stocks from last year lost money. While losses were more than made up for by big gains elsewhere, owning a portfolio of value stocks can be stressful for some investors.

Feeling Moody? MCO-- a classic value play

This is a core Buffet holding and is a highly hated company these days---> scapegoated for the subprime housing disaster. Spurious lawsuits are being launched v.s. Moody's by institutional investors along these lines of thinking.

I love it when this happens. This kind of emotional overlay provides an opportunity to inexpensively buy a company that deserves to be very expensive:

1. is over 100 years old and mid-large cap.
2. has one of the highest long term profit margins, ROIC and ROA in any publically listed company in US history suggesting consistently superb management.
3. is one company of a duopoly (S & P is the other). This provides a WIDE economic moat due to the high barrier to entry. Recent attempts to legislate a change to this situation have failed.
4. has a global footprint.
5. is buying back its own stock aggressively.
6. has no operating debt and lots of cash in the bank

This article by Yarnell "Thinking like a Business Owner" says it better than I can:

Moody’s: a case study

To find a great franchise that is currently out of favor, one need look no farther than to the center of the storm raging in the credit markets. Founded in 1900, Moody’s (MCO) has a dominant and durable franchise as a member of the credit rating oligopoly that reigns supreme in the growing global fixed-income market. The credit rating business has high barriers to entry by virtue of both its required government designation and the well entrenched positions of its participants established over many decades. Moody’s essentially collects a royalty on the growth of the capital markets. This powerful and well managed franchise demonstrates superior economic characteristics in terms of high return on equity, high profit margins and low capital requirements resulting in reasonably predictable owner earnings. Moody’s generates substantial free cash flow which its management is sensibly using to repurchase its shares.

It is easy to extol the virtues of Moody’s, but one must consider any potential risks as well. Facing the prospect of legal challenges and legislative changes in the wake of the credit crisis, the business is viewed by some as vulnerable to a fundamental change. However, given that all the participants in the industry face the same challenges, there is no readily available alternative, and over any meaningful period of time the bond market that fuels the global economy will undoubtedly grow (even if it experiences a temporary setback), Moody’s franchise will remain relatively unscathed.

Given Moody’s reasonably predictable profits, it is possible to place a reasonable estimate on its intrinsic value. Last year Moody’s generated about $700 million in owner earnings and in 2004 it generated about $500 million in owner earnings. Owner earnings have grown about 25% compounded annually over about the last 10 years. The next ten years will not see that level of growth. A more conservative estimate of Moody’s value involves going back to the 2004 estimate of owner earnings as a base, using 10% for the rate of growth in those earnings and choosing a 9% discount rate, one arrives at a discounted present value of about $15 billion. If one uses a growth rate of 15%, then one arrives at discounted present value of over $18 billion. The current market value of the company is just under $12 billion. Therefore, one can purchase one of the strongest business franchises in the world for a price reasonably below a conservative estimate of its intrinsic value. Even if the fundamentals of the company weaken in response to the current credit crisis, the margin of safety in the purchase will mitigate against permanent loss of capital. This makes Moody’s a company worth owning at a price worth paying. It is not surprising that Moody’s is currently out of fashion.

If the price of the company weakens, whether in response to the credit situation, general market conditions or any other reason, it may present an opportunity to own more of a great company. The business-like investor can build wealth over time by accumulating great companies at increasingly attractive prices.

The author owns shares of the company mentioned in this article.

I plan to bid for some MCO shares over the next few days. I think that a margin of safety exists making this a good long term bet. I'll hold it for 3 years before losing my patience with this investment.

l

more on the US greenback

Derek Decloet's G&M article

Some general comments and Cemex CX--- a bull's perspective from Motley Fool's CAPS

The US and Global markets remain in free fall mode. Rather than panic, the savvy investor needs to focus his/her search for buying opportunities that may not come along again. These kind of market conditions tend to weed out competition with weaker balance sheets and poor management strategies. When the market eventually cycles back (however long that takes), the strong, well managed company emerges with a greater market share and is positioned to take advantage of the rebound in growth and investor confidence.

I've been a fan of CX for some time. It's hardly an "unknown" company but I do believe it has been unfairly discounted by the housing debacle. Investors have taken an indiscriminate flight away from any stock that has the word "housing" associated with it.

I started buying CX at $31 and have bought stocks in small quantities all the way down to $25. As I free up some more cash, I intend to add to my position gradually. I hope it drops to the low 20's!

An extensive and well-thought out analysis below from ACMPartnersip (sic), a CAPS member on the Motley Fool:

At today's prices CX offers incredible value, with a forward earnings yield of roughly 13%. CX's global reach, best in class management team, strong free cash flow generation, high quality assets, and low cost structure should represent just a few of the reasons why shares' today represent considerable opportunity. Current concerns relating to the U.S. housing slowdown (for some reason U.S. investors use CX as a vehicle to play U.S. housing even though U.S.Housing probably represents less than 10% of 2006 EBITDA), as well as the fact that it is domiciled in Mexico (CX appears to be excessively discounted do to this) have unfairly punished the stock over the last few months. Cemex has a long-running record of using the steady and substantial cash flows from its mexican operations to support the cheap debt necessary to opportunistically aquire competitors around the globe. With Mexican population centers largely landlocked, CX has captured 50% of the market. And becasue self construction is so prevalent, the brand has developed a substantial brand and distribution advantage, which allows for prolific margins on bagged cement. This outsized profitability, coupled with the increasingly oligopolistic nature of the industry should lead CX shareholders to market smashing returns for years to come. My estimate of intrinsic value, sits conservatively 40% above today's prices with additional upside likely as uncertainty over various issues (such as the recent Rinker aquisition) begins to disappear over the next few quarters.

Company Overview, History, Industry and Management Analysis:

CX's world class management team, highly profitable domestic market, and it's ability to generate strong amounts of free cash, has allowed the company to build itself from a small domestic player into a global powerhouse (currently the third largest player in the global cement industry). CX's assets would be nearly impossible to replicate for a variety of reasons, and its outsized profits are protected from significant competitive threats due to poweful barriers to entry fundamental to the industry itself. Reason's include...

Transport costs act as a significant barrier to entry in the cement industy, especially for incumbents in geographically protected markets. Cement is a low value to weight product, therefore competition and demand drivers are mainly local, generally restricted to 100-150 miles. It is hard to import/export cement because of transportation cost, humidity, and the need of port infrastructure and grinding facilities. As a consequence, global trading accounts for only 7% of consumption worldwide.

The majors...Cemex, La Farge, and Holcim control most of the global trading, which is important in the U.S where imports represented 24% of consumption in 2006. Waterborne transportation remains the cheapest way to transport cement, but with tight ship supply and escalating fuel costs, this source has become considerably less profitable in recent years...and due to CX's proximity to the U.S., this trend has and will continue to improve their competitive position vs. their primary rivals who suffer a distinct disadvantage in serving the world's most lucrative market.

In the cement industry, the cost structure at both the cement plant as well as the distribution level is vitally important, and CX is a leader in both thanks to its flexible energy strategy and advanced logistical capabilities. Their flexible energy strategy and logistic capabilities determine their baseline economics (ex. If production costs are lower in another region, and assuming transport costs don't chew up the difference, the disparity can be profitably arbitraged).

An example of Cemex's savvy management as well as one of its unique competitive advantages can be seen in its use of petroleum coke. Energy accounts for close to half of cement production costs. CX reduces its oil and gas exposure (i.e. its risk) by substituting petroleum coke, a lower cost and less volatile source of fuel. Therefore CX, on top of its geographic proximity to the United States, has yet another strategic advantage concerning the global cement trade...it not only has to spend less on fuel (simply because it doesn't have to travel nearly as far as its competitors), it's fuel is actually cheaper and more efficient than its rivals.

Another barrier to trade involves government intervention, often in the form of quotas or tariffs. In fact, currently CX is a prime beneficiary of the unwinding of one such situation. The U.S. and Mexican governments negotiated a reduction and eventual elimination of long-standing limits on Mexican cement imports. Because U.S. demand has long outstripped domestic supply, Asian and other plants have filled the gap (another reason why trade is disproportionately important in the U.S.). If CX is successful in supplanting a portion of this business from its Asian competition with mexican cement, the additional volume and attendant operating leverage could yield quite a significant windfall not included in my fair value estimation.

Essentially, in developed countries, it has been very difficult to expand supply due to the difficulty in getting the environmental license and permits for new quarries and plants. Holcim, for example, gave up on a plant expansion in the U.S. after many years of unfruitful efforts. In developing countries, most cement is consumed by the informal economy through the sale of bags (vs. bulk). Clients are generally very small and distribution and brand become strong barriers to entry (commonsensically, margins are typically higher in developed countries). In summary, the combination of high transportation costs, licensing/permit restrictions, pulverized distribution and oligopilistic behavior present strong barriers to competition in the cement business.

Additional Pertinent Points:

Cemex is diversified across geographies and up and down the value chain, selling cement, aggregates, and concrete

Rapid infrastructure investments in developing countries have soaked up industry supply and created a favorable supply/demand environment

Repeat-buyer programs, online ordering, and a flexible, one time concrete delivery network (all aimed at increasing reocurring revenue as well as "stickyness") are just a few examples of Cemex's unrivaled service, for which customers are often willing to pay a premium

International expansion has been the hallmark of Cemex's strategy for decades: By employing centralized thinking (the Cemex way!), and leveraging operational practices across all markets, CX has been able to quickly implement "best practices" within newly aquired companies. Historically, this has lead to an immediate improvement in the newly aquired company's operations, leading to increased profitability, and substantial cost savings over time as they benifit from CX's scale and expertise.

CX management has an outstanding record of intelligently allocating capital, and is not hesitant to make big up-front investments that may hurt near term results, but will add value over the long term. Management also has a stellar record of talent development (providing a deep bench). Additionally, similar to many legendary companies such as WMT, management places a large premium on information flow: an intranet connects all offices and plants for real time data sharing

CX benefits from significant tax advantages as well. Loopholes in the mexican tax system (which have in some respects been eliminated recently) for multinational corporations have benefited CX to a meaningful degree over its history. An example of this is that many of their international companies have R&D expenses paid to its Switzerland subsidiary, where R&D is not taxed. The overall effect can be seen in their accounting tax rate of 17% in 2007 of which only 11% are related to cash taxes.

Although such tax advantages may seem like a win-win situation, it actually presents a few problems for the company... primarily being that as things currently stand it makes no sense for management to pay dividends or buy back stock, since this would be taxed at a full tax rate. This underlying truth goes along way in explaining why CX, a cash flow machine, needs to use its cash in aquisitions to avoid worsening its capital structure and tax planning. The good thing is, and in contrast to most companies over time, management has created significant value in each of their major aquisitions. There ability to integrate and implement their best practices quickly and effectively across newly aquired organizations has typically resulted in results (ROIC) of 200-300bps above its cost of capital. Pretty impressive....

Catalysts:

The first likely catalyst is Increasing pricing power due to the strong reduction in imports and the oligopolistic nature of the sector. The recent and sizable price increase in U.S.cement should start to land on Wall Streets radar within the next few quarters...

Cost cutting and stable/improving pricing has mitigated much of the downward earnings pressure from recent volume declines within the U.S. market. Even with today's incredibly poor demand environment, it is worth noting that CX's U.S. operating margin was still a very respectable 17%. While I expect further declines within the U.S. market in the short term, this should be offset by higher prices for cement and aggregates coupled with yet to be realized synergies from the Rinker aquisition (in this unique case, CX management's past track record of success gives me confidence in their ability to deliver exactly what they say they will)...propping up U.S. earnings. Cemex's global diversification is also critical at this juncture, as Cemex has recently (as of last quarter) increased operating profits in all of its other markets outside of the U.S. and U.K.

Another likely catalyst...current negotiations with CRH regarding the divestiture of certain assets in the U.S.