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Buy What Mr. Market Hates

Posted: Oct 20, 2009 14:54 PM by Sham Gad

Tickers in this Article: GHM, DRYS, KHD, EGLE

The anointed dean of value investing, Ben Graham, used to always focus on those investment areas that were getting the least attention. According to Graham, whatever Mr. Market ignored or hated offered the greatest opportunity for finding tremendous value.

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Inefficient Markets
It doesn't take a genius to understand why Graham felt this way. Stocks most favored by the market attract a lot of attention and as such are usually fully priced if not overpriced.

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Conversely, businesses that aren't doing that well, or operate in boring industries, are often frowned upon and left alone. The absence of buyers can often lead to underpriced stocks in relation to the value received. It only makes sense that just as optimism can lead to premium prices, pessimism can create discount prices. (For related reading, check out The Value Investor's Handbook.)

Due Diligence A Must
Despite the market rally, there are still some businesses and industry that are looking to get through this recession in one piece. Bear in mind, when you look for value in troubled places, most of what you will find should probably be left alone. It's your job to perform due diligence to see whether or not the business stands apart.

The following ideas are names that are struggling but seem to be doing a decent job of weathering the storm. And if they can get through to compete when the economy improves, then investors could be richly rewarded.

Ship-Shape
The dry bulk shipping industry has been hammered hard and continues to face choppy waters. But Eagle Bulk Shipping (Nasdaq:EGLE) looks intriguing. It operates mainly smaller Supramax ships that can ship a wide variety of goods like fertilizer, cement, coal and grains.(For more, check out Stock-Picking Strategies: Value Investing.)

Unlike the larger Capesize ships of DryShips (Nasdaq:DRYS) that carry only coal and iron ore, Eagle's fleet can benefit if several commodities experience a surge in demand instead of being reliant on just one or two products. And because Eagle charters its ships for years, it has revenue visibility for the next few years, increasing the likelihood that it will meet its obligations going forward. At $5.50 a share, the stock is way off its highs of $30 a few years ago.

Solid Balance Sheet
KHD Humboldt (NYSE:KHD) is an engineering company to coal and cement businesses. It helps those industries with more efficient innovative design services. It's a $10 stock with about $11 in net cash per share. The cash is not as strong as it looks - most of the cash on the balance sheet is in the form of contract awards. Still, KHD has a rock solid balance sheet ready to help the company during the next cycle. (For related reading, check out Reading The Balance Sheet.)

Industrial Bargain
Graham Corp (AMEX:GHM) is a designer of heat transfer equipment used in refineries, pharmaceutical plants, food processing plants and just about any other industrial application you can think of. The stock is at $16, with about $4.50 in net cash per share. This was a $50 stock last year before the recession. Clearly, the economy will have to fire on all cylinders for Graham to revisit this price. That won't happen anytime soon, but the strong balance sheet and a gradual recovery makes this an intriguing bet.

The Bottom Line
You can't look at these businesses today and assume future valuations based on 2007 and 2008 numbers. But the share prices have gotten so depressed in many cases that any stable improvement could send the shares higher. The market is not looking at them right now, so it may pay for you to take a look. (For more, see Battered Stocks That Bounce Back.)

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By Sham Gad

Sham Gad is the Managing Partner of Gad Partners Fund's, value inspired investment partnerships modeled after the Buffett Partnerships of the 1950's. Previously, Gad ran the Gad Investment Group and delivered annualized returns of 22% from 2002 to 2005. Gad is also the author of "The Business of Value Investing" which will be out in the fall of 2009. Gad earned his MBA at the University of Georgia in May of 2007. Gad runs a value investing blog. He can also be reached by visiting the Gad Partners Funds site. When not writing or analyzing businesses, Gad enjoys hanging out with his wife Maggie, reading, golf, and yoga

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