Article from Financial Post about Benjamin Graham's principles

If you are interested in a higher risk commodity play, Sherritt may be interesting to you. Too much uncertainty for me. I think that the reward:risk ratio is favourable at any rate.

Graham's metrics still apply

Stock selection narrows field to Sherritt Int.

Richard Morrison, Financial Post
Published: Friday, April 04, 2008

Bloomberg News, Kagan Mcleod, National Post
Each Friday, Richard Morrison, an editor at Financial Post and a longtime active trader, takes you through a variety of screening tools to help the individual investor find great stocks.

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Benjamin Graham, the father of modern security analysis, was a professor at Columbia University, taught Warren Buffett and wrote the most famous -- and arguably the best -- book on investing, The Intelligent Investor, first published in 1949. In a chapter on stock selection for defensive investors, he said they should look for large, dividend-paying companies with little debt and a consistent record of profitability, whose shares trade at low multiples to earnings and book value.

We applied Graham's criteria to the Canadian market, using the FP Corporate Analyzer program to identify companies Graham would likely find attractive. We found nothing. To-day's markets are much loftier than they were in Graham's day, so those seeking established companies with undervalued share prices have to loosen his requirements a bit to find any U.S.-listed bargains. Rules have to be bent even further to find a Canadian candidate.

Large-cap stocks Graham said defensive investors should avoid small companies -- something that's easier to do in the United States than in Canada. For example, there are about 1,100 companies with a market capitalization of more than $1-billion on the New York Stock Exchange, but only about 250 common stocks and income trusts larger than $1-billion on the Toronto Stock Exchange (30 of which are interlisted on the NYSE). We placed the minimum market capitalization at the $500-million mark, giving us a universe of 323 stocks.

Current ratio Graham's candidate companies had to be able to easily handle their debt payments. To that end, the current ratio--current assets to current liabilities -- had to be at least two. Long-term debt should not exceed net current assets, or working capital. We plugged that criteria into the FP Corporate Analyzer and our field of candidates dropped to 92.

Earnings growth Graham insisted his candidate companies have some earnings in each of the past 10 years and have increased their earnings by at least one-third over the same period. The requirement was too strict and turned up nothing, so we modified the search to ask for those companies whose earnings had increased by at least 1% in each of the past five years. The result was only 19 names.

Graham's further requirement that candidates have uninterrupted dividend payments for at least the past 20 years also would have left us with nothing, so we asked only that our candidate paid a dividend.

Finally, we applied two more Graham criteria to our list: a price-to-earnings ratio of no more than 15, which knocked our candidates down to seven, and a price-to-book ratio of no more than 1.5. The result? One company, Sherritt International Corp. (S/TSX).

Sherritt, best known for its activities in Cuba, has interests in nickel, cobalt, coal, and oil and gas production, is the closest we got to a company that meets Graham's criteria.

Norman Rothery, founder of the Stingy Investor Web site (stingyinvestor.com) and the Rothery Report, a newsletter that focuses on value stocks, said he would have been shocked had any Canadian company met Graham's original qualifications. "You have to make approximations to Graham's original rules to get anything at all."

Sherritt has turned up on several of his screens, Rothery said, noting the company appears in an "all-star" list of best potential investments he compiled in MoneySense magazine. Sherritt scored an A for value and a B for growth.

Despite its deep value characteristics, stock screens won't turn up such things as political risk, which must be factored into Sherritt. Sherritt has a 50% interest with the Cuban government in the Moa nickel-cobalt open pit mine in Moa Bay in eastern Cuba. Originally owned by Freeport-McMorRan Copper & Gold Inc.,Moa was confiscated by the Cuban regime in the late 1950s. Moa's sulphides are shipped to the Fort Saskatchewan nickel-cobalt refinery north of Edmonton, providing most of its nickel feed.

Sherritt is a 40% owner and operator of the US$3.3-billion Ambatovy nickel laterite project in Madagascar, where production is expected in 2010. It also has oil and gas interests in Cuba, Spain and Pakistan.

Last month, Sherritt announced a plan to acquire the 59% of the Royal Utilities Income Fund it didn't already own. The fund controls Prairie Mines & Royalty Ltd., whose eight mines in Alberta and Saskatchewan supply coal to nearby generating plants. The company also announced plans raise $400-million in capital through a bought deal.

Eight analysts follow Sherritt -- six say buy, two say hold -- but most were lukewarm to the Royal deal, and many lowered their 12-month target prices, but even the most pessimistic expect the stock to reach $17 in 12 months. One, Ray Goldie of Salman Partners, has a $27.20 target.

Company specifics aside, Graham's criteria is still worthwhile, Rothery said.

"I've been running similar defensive-type screens for the Canadian MoneySaver magazine for several years, and it's worked very well."

Great Ideas from Businessweek: buy the deep value investors

Have a read of the article below. Not only can you be a deep value investor, but you can also buy shares of holding companies (usually also involved in insurance, much like WB's Berkshire) that specialize in buying discounted gems and holding them for the long term. Since they have considerably more resources and experience than most of us do, they often have an edge. Look for the following:

• a long term track record of double digit ROIC and at least 10% insider ownership in the small to mid caps
• low to no debt and leverage that is on the low end for the industry
• trading at or near book value (current bargain)

BAM is well covered in my other posts and a core holding of mine.

I am doing further research in to PICO (where I see there is big time insider buying, short term misery and long term good prospects being water suppliers in the US Southwest) and Y where there is no debt, respected conservative management, attractive fundamentals and a Morningstar endorsement that says, "For the long-term investor, we endorse buying this stock any time it settles into 5-star territory". Y is solidly 5 star-- trading at $349 and FMV at $518.

How to Feast with the Vultures

by Anne Tergesen

A credit crisis. A volatile stock market. A projected wave of corporate bankruptcies. To most people it sounds like hell. But for investors who specialize in distressed assets it's just the opposite. "Bear markets are often when these guys plant the seeds for their next big winners," says Chris Mayer, editor of Capital & Crisis, a newsletter that focuses on contrarian investments.

Such scavengers scour the market for stocks, bonds, or whole companies to buy on the cheap, paying less than they think the company's assets are worth. A subspecies, known as vulture investors, aims even lower. These investors pick at carcasses of companies in or approaching bankruptcy, often amassing sizable stakes in order to wield influence in a restructuring or liquidation.

While some of these high-risk investments fail, others can be "monster home runs," says Mayer. His favorite "deep value" players—chiefs of little-known companies such as Leucadia National (LUK) and Brookfield Asset Management (BAM)—boast average annual returns of 15% or more over the past 10 years.

The most obvious way to get into the action is to buy a value-oriented mutual fund (tables). A more rewarding approach may be to invest in companies such as Leucadia. Like Berkshire Hathaway, these are publicly traded holding companies run by managers with histories of sniffing out value. Yes, the risks are more concentrated. But returns, on average, exceed those of the typical value fund over the past decade. Patience is crucial, since returns can fluctuate unpredictably, rising in years when managers sell profitable investments and stagnating when they hold a lot of cash.

Because of the stock market sell-off, share prices of many of these players are cheap vs. historic norms. And after largely sitting on the sidelines during the bull market, many of the companies are flush with cash. They are positioned to take advantage of lower stock prices as well as a projected spike in the default rate for U.S. speculative grade bonds. BusinessWeek's guide to leading publicly traded value players is a good place to start your research.

LEUCADIA NATIONAL

New York-based Leucadia owns everything from a biopharmaceutical company to wineries to a 38% stake in Light & Power Holdings of Barbados. Once weighted toward insurance, the company's portfolio now tilts toward natural resources, including Australian iron ore producer Fortescue Metals Group and Goober Drilling, a Stillwater (Okla.) oil-and-gas concern.

Chairman Ian Cumming and President Joseph Steinberg practice "the epitome of distressed investing," says Steven Rogé, whose Rogé Partners (ROGEX) and Rogé Select Opportunities (RSOFX) funds are shareholders. After Hurricane Katrina nearly destroyed the Hard Rock Hotel & Casino Biloxi, Miss., in 2005, for example, Leucadia bought about half of parent Premier Entertainment Biloxi. In 2001, with Berkshire Hathaway (BRK), it purchased half of bankrupt financial-services company Finova Group. More recently it bought some 25% of subprime auto lender AmeriCredit.

Cumming and Steinberg are often compared to Warren Buffett—and not just for their strict value approach to investing. Like the Oracle of Omaha, the two write engaging letters to investors. "Shareholders who gamble are encouraged to come visit the [Hard Rock Hotel & Casino Biloxi] and leave some money behind!" the most recent one reads. "As always, the odds favor the house, but in this case you own the house." Also like Buffett, Cumming and Steinberg tend to be shareholder-friendly. In 2006 each earned a relatively modest $678,362, in addition to stock-based compensation linked to Leucadia's performance. Between the two, they own some 25% of outstanding shares.

Leucadia trades at 46, and Morningstar analyst Ryan Lentell is in the process of revising his fair-value estimate of 39 upward. "If you're going to buy and hold for a long time, you'll do well," he says. Since 1979 the stock price has appreciated a compounded 25% a year, on average.

WHITE MOUNTAINS INSURANCE

White Mountains Insurance Group (WMT) in Hanover, N.H., buys troubled insurers and then engineers turnarounds. The insurance properties throw off cash White Mountains can use to finance acquisitions. But when markets get frothy, management hoards cash rather than risk overpaying. "Intellectually, we really don't care much about leaving our capital lying fallow for years," the company says on its Web site. "Better to...wait for the occasional high-return opportunity. Frankly, sometimes shareholders would be better off if we just all went to play golf."

With insurance experts, including Buffett, predicting an industrywide profit decline this year, White Mountains's stock is down 6% since Jan. 1. It trades at 476, a hair above its per-share book value (assets minus liabilities), a measure often used to value financial-services firms. Consistent with Buffett's outlook on insurance, Berkshire Hathaway recently sold its 16% stake in the company. CEO Raymond Barrette cited the growing rivalry between the firms. Other value investors see an upside: Shareholders include Mutual Beacon Fund. Morningstar analyst Jim Ryan estimates fair value at 625.

ALLEGHANY

Like many in the deep-value camp, Alleghany (Y) shuns publicity. It doesn't hold quarterly conference calls. Wall Street coverage of the New York company is virtually nonexistent, in part because with lots of cash and little debt, it doesn't often hire investment bankers. Alleghany, which focuses on insurance, also has seen its shares beaten down. That has attracted bargain hunters at fund companies Franklin Mutual Advisers and Royce & Associates. At 342 a share, the stock, up an average 20% a year over five years, trades at a hefty discount to its 518 fair value, Ryan figures.

Alleghany, founded as a railroad holding company in 1929, also owns a portfolio of stocks and bonds. A big winner: Burlington Northern Santa Fe Railway (BNI), on which it has earned over 500% since 1994. Recently, Alleghany bet successfully on energy stocks, which comprise 32% of its equity portfolio.

PICO HOLDINGS

Small-cap PICO started out as a medical-liability insurer in 1981. Now about 70% of assets are in the rights to underground aquifers and other water resources in Southwestern states. "It's one of the better water-asset plays," says Jesse Herrick, who follows alternative-energy technologies for San Francisco institutional broker Merriman Curhan Ford (MERR). PICO also has a portfolio of big-stakes investments that enable it to play a role in management. They include 23% of Jungfraubahn Holding, a railway in the Swiss Alps.

In the 14 years that current management has been at the helm, the stock has delivered compounded average annual gains of 18%—more than twice that of the Standard & Poor's 500-stock index. But housing woes have raised concerns about water demand, sending the La Jolla (Calif.) company's shares down 7% this year, to 31, just above its book value of 27. Herrick puts fair value at 62 to 67.

BROOKFIELD ASSET MANAGEMENT

Over the past five years, Toronto's Brookfield has transformed itself from a wide-ranging conglomerate into a company largely focused on real estate, power, and infrastructure properties. Those include prime London office buildings, millions of acres of timber, and hydropower generating plants around the world. The rationale? Such assets generate steady returns and last a long time without requiring large ongoing investments.

Managing partner J. Bruce Flatt recently invited institutional investors such as pension funds to invest alongside Brookfield. In return for managing the money, Brookfield pockets a small annual fee. The stock, up an average 36% a year since Flatt took over in 2002, has pulled back, partly on concerns about real estate. At 27, it trades below Morningstar's 34 fair-value estimate. Among the shareholders betting on Flatt: vulture Martin Whitman of Third Avenue Value Funds.

Tergesen is an associate editor for BusinessWeek in New York .

Good Credit Bad Credit

Update on Cemex CX

Venezuela's Mr. Chavez is carrying on with his thuggish ways by making good on his threat to nationalize the cement industry in that country. He blames companies like Cemex for the housing shortage--- an inevitable result of his unsustainable type of "socialism".

Cemex's assets in Venezuela represents 4.4% of the companies total. Even if Chavez offers little or no compensation, it is unlikely to make a material impact on Cemex's future cash flow.

If the market over reacts, it may be a buying opportunity. Analysts are more worried about the impact of the USA construction slow down on CX's bottom line. Global infrastructure needs are likely to compensate for this downside and more, IMHO.

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Hoping for more recession.... Why?

Seven Reasons to Welcome a Recession

Jeffrey Strain

04/03/08 - 10:34 AM EDT

Recessions breed fear.

It's only natural. A slowdown in production at companies can result in layoffs and restructuring. People fret about their jobs and worry that it will be much more difficult to find new employment if they are let go. These are understandable concerns.

But for contrarians and bargain hunters, recessions provide a world of opportunities.

Here are seven ways that a recession can actually benefit your personal finances:

Affordable Homes

Those who bought homes looking to flip them for a quick profit and those who took out huge loans that they couldn't afford to pay will look at a recession with fear, but a recession should have little meaning for those who bought a home with the purpose of living in it for a long time.

Recessions are usually short-lived, and the housing market should recover long before most people are planning to sell their house.

For those who had been unable to afford a house because of soaring prices in the past few years, a recession is a golden opportunity. It brings housing prices down to more affordable levels. That means that many people who wanted to buy a house will be able to purchase one.

Recessions are also a good time to look for investment properties or vacation homes if either had been in consideration.

A recession gives anyone looking for quality housing a lot more bang for their buck than when the economy is flying high. Being able to purchase a quality house at an affordable price can greatly increase a person's net worth in the long run.

Low Mortgage Rates

In the attempt to ward off a recession, the Federal Reserve has made interest rates extremely low, resulting in more affordable loans for those who are in the market to purchase a house.

While these rates may not be available throughout the entire recession if inflation continues to rise, the rates will be around as long as the Fed can use them to ease the recession. Taking advantage of these low rates along with lower housing prices can truly make housing a deal.

Great Consumer Deals

As the economy sours and people buy less and less, stores need to provide better deals and discounts to attract consumers to their doors. This can mean steep discounts through sales and promotions, as well as financing that allows consumers to pay no interest over long periods of time.

These deals are not limited to the retail stores. It also means that there are great deals in the second-hand markets, since there are more people trying to sell and fewer people looking to buy. If you are an investor in collectibles and know them well, you can often buy collectibles at steep discounts during a recession that can be turned into a healthy profit when the economy recovers. For those who have saved money waiting for good deals, a recession is a great time to find those deals.

Inexpensive Stocks

While everyone is taking their money out of the market, hard economic times can be a great time to pick up stocks on the cheap when you look at them as long-term investments. Consumer stocks for large, stable companies such as Proctor & GamblePG that provide necessities such as soap and toilet paper will do well no matter what the economic conditions.

Recessions can be a great time to pick up undervalued stocks if you know what you're doing. That can greatly improve your net worth when the stock market recovers.

Great Travel Deals

During times of recession, most people don't think about traveling. For this exact reason, traveling can be a great deal when the economy is shaky. Lack of demand results in excess inventory, which forces hotels and other related travel industries to lower their prices. It also means a greater inventory to choose from and the ability to bargain for upgrades and other perks. That dream vacation that you have always wanted to take can be a lot more affordable during a recession, when travel related industries are begging for your business.

Streamline Your Finances

When things look like they are going to get a bit tougher, people begin to look at their personal finances a bit more closely and start to trim some of the fat. They look at ways that their money can be better spent and how they can get more for each dollar that they do spend. They pad their emergency fund a bit more and don't spend quite as freely as they do during times of rapid growth. This trimming of the fat is a good exercise that can help you see the important financial goals that you want to achieve and, by doing so, help you reach them more quickly.

Lower Credit-Card Rates

If you have a good credit rating, you are in a position to get extra perks from your credit-card company. Credit-card companies see higher delinquency payment rates during a recession, and it becomes even more important for them to keep their best customers. That gives you extra leverage to ask favors from them, such as having your interest rates lowered and annual fees waived.

While most people will look at a recession with fear and uneasiness, it's important to also realize that it's an opportunity to get some great deals and improve your personal finances. Taking advantage will allow you to reap greater benefits from all those dollars you have saved.

How to buy the "Livin' Large" index with an Exchange Traded Fund

Did you know that there are more resident millionaires in Seattle than in our entire country (Canada)?

The middle class has and will feel the bite of economic downturns but those with discretionary income are unlikely to curb their lifestyles.

Read about Claymore's relatively new ETF that buys a basket of stocks that cater to those group for an affordable price (MER = 0.7).

It trades on the NYSE--> ticker ROB.

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Further analysis of SGP Schering-Plough

Read it here at seekingalpha.com