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Profiting from the stocks everybody else hates

Daily Buy-Sell Adviser
0 Comments|August 27, 2008

"Invest at the point of maximum pessimism."

The late Sir John Templeton made a fortune buying stocks nobody else would touch, says this Canadian advisory. Here’s how to do it today. 

These are the times that try men’s—and women’s—souls in the investment world. 

But they’re supposed to be the best of times for value investors. Those looking for attractive stocks at depressed prices have a wealth of choice at the moment. 

So, follow the example of one of the greatest value investors of all time, says one Canadian analyst. Don’t just buy stocks that are down, buy stocks that are hated by most investors. 

Writing in Investor’s Digest of Canada, Mr. Dave Skarica suggests you profit from the advice of the late Sir John Templeton, who died this summer at age 95. Although he has now ceded the stage to Mr. Warren Buffett, Sir John was his equal in the art of investing in undervalued stocks, according to Mr. Skarica. 

Sir John’s philosophy of “buying cheap, beat-up companies and sectors led to his fund being the best performing mutual fund in the world from 1954 to 1992.“ 

Here’s how this analyst believes today’s investors can fatten up their portfolios on some lean and hungry stocks.  

Every stock under $1 

As an example of beaten-up sectors, this analyst goes back to 2001-2002. At that time, he liked uranium and oil. They may seem like obvious choices now, but they were not very popular at the time. 

Uranium stood at less than US$15 a pound and oil traded in the low, low price range of US$16 to $23 a barrel.  

He recommended Cameco Corp. (TSX: T.CCO, Stock Forum), the world’s largest uranium producer and Suncor Energy Inc. (TSX: T.SU, Stock Forum), both of which have gone on to trade at large multiples of their recommended prices.  

In order to make this bargain-basement strategy work, he adds, it is handy to avoid the herd. Sir John Templeton often said “living far away from Wall Street helped his investment philosophy because he could go against the crowd and buy beat-up sectors and stocks without being influenced by the whims and fads of Wall Street,” explains the analyst.  

Sir John first put this approach to work in 1939. The United States was still two years away from going to war, but the investor anticipated a wartime boom. He borrowed $10,000 and told his broker to buy $100 worth of every stock trading for less than $1. There were 104 of them. 34 of them were in bankruptcy.  

You can guess the result. Over the next four years, the young investor quadrupled his money—and only four of the companies went under. A bear market still held sway in the early 1940s, but that did not stop this now-famous investor from striking it rich. 

And it spawned his most famous saying: “Invest at the point of maximum pessimism.” 

The earnings are garbage 

That means you want to find sectors that are not just undervalued, but downright hated. In 1982, says Mr. Skarica, the entire market was hated. In the early 2000s, resource stocks got the same cold shoulder treatment. 

Today, no one is more shunned than those who fly the friendly skies. “We all know that high resource prices are killing the airlines; their earnings are garbage, they are losing money hand over fist,” says the analyst. “We are seeing massive restructuring, added fees, decrease in capacity, etc.” 

So what could be more attractive? 

There are two reasons to like the airlines, adds the analyst, both of them with a Templeton-like negativity. First, they are hated. Second, how much farther can they fall? 

The Philadelphia Airline index (AMEX: XAL, Stock Forum) is as heavily oversold as it has been since the two low points in this decade—the aftermath of the 9/11 attacks and the bottom of the bear market in 2002. In each case, the airline index almost doubled within nine months of hitting its lows. 

From today’s perspective, the pullback in oil prices certainly does not hurt, although it has yet to render fuel prices cheap by any means. 

When it gets down to specifics, adds Mr. Skarica, you should look for two things. 

Leaders and bankrupts 

“Look for airlines that have held up and are positioning themselves to be the new leaders in the industry,” advises the analyst. “And look at near-bankrupt companies which can really leverage themselves into an airline rally.” 

The two stocks that fit the former category, he believes, are WestJet Airlines Ltd. (TSX: T.WJA, Stock Forum) and Southwest Airlines Co. (NYSE: LUV, Stock Forum). Both are adding capacity and flights when others are cutting back.  

“Their stocks have held up better than the rest of the industry,” he adds, “showing relative strength and they should be the new leaders in a bounce for the airlines.” 

WestJet closed Monday at $15.05, about two and a half dollars higher than when this article was written. Southwest closed at $14.83, a little more than a dollar higher than its price at the time of writing. 

In the going-bust category, Mr. Skarica has two candidates, two airlines that are “too big to fail.” 

ACE Aviation Holdings Inc. (TSX: T.ACE.A, Stock Forum), better known as Air Canada, is one. American Airlines, or AMR Corp. (NYSE: AMR, Stock Forum), is the other. Both fell over 60% in the first half of the year. But an oil pullback and a stock market rally in the short to intermediate term could give them a good bounce. 

In fact, Air Canada has come up a little less than a dollar since this article was written, to a close of $10.88. American Airlines has risen by more than $5, to $10.06. So maybe there is a bit of bounce in these big, battered airlines. 

Sure, it may seem crazy to buy the most despised stocks on the exchanges, Mr. Skarica says to his readers in Investor’s Digest of Canada. But Sir John Templeton must have gotten some odd looks from his broker when he ordered all those downtrodden stocks in 1939. 

So if you don’t mind hanging around with the outcasts of the market, you may find yourself with some unexpected but very welcome profits on your hands.

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