Value Investor Finds Bargains Abound

July 6, 2010 · Leave a Comment

By Naureen S. Malik (WSJ)

Art connoisseur Scott Black is annoyed. Demand from investors in emerging markets has been inflating prices for the Impressionist paintings he likes to acquire. Fortunately for his clients, the value investor and money manager sees plenty of bargains in the stock market.

Whether it is the art market or the stock market, Mr. Black, founder and chief investment officer of Delphi Management, sails through boom-and-bust cycles by adhering to investment principles made famous by Benjamin Graham and Warren Buffett. The key is to pick stocks with earnings growth, strong cash flow and low price/earnings multiples.

“Right now, the market is fundamentally cheap,” Mr. Black said. “The problem is the fear factor is overwhelming the fundamentals. … I’m not a harbinger of doom [but] I’m not Pollyanna, either.”

Case in point: The Standard & Poor’s 500 is trading at about 13 to 14 times earnings even though companies’ earnings are up 30% year over year.

“That’s terrific—we are not getting a V-shaped [recovery] in [gross domestic product], but we are getting a V-shaped recovery in earnings,” Mr. Black said. Plus, he said, while emerging-market growth may slow a bit, China and India are still growing at a rapid rate.

He said he doesn’t see the U.S. economy heading into a double-dip recession and expects the stock market to be up over the next six months. But given huge macroeconomic headwinds namely in the form of a burgeoning U.S. deficit, the jobless recovery and Greek debt crisis, stock picking is critical, Mr. Black said.

His Boston-based firm has about $900 million of assets under management for separate accounts. According to Mr. Black, as of June 30, the small-cap accounts are down 1.6% this year, in line with the Russell 2500 Value Index, while the large-cap accounts declined 2.5% versus the 7.6% drop posted by the Standard & Poor’s 500-stock index.

Among Mr. Black’s top picks are tech stocks as well as companies that are tied to the economic recovery, such as Cleveland-based mining company Cliffs Natural Resources, that will benefit from growing steel demand.

Shares of Micron Technology, a global manufacturer of semiconductor devices, continue to face pressure even though the company “shot out the lights” with its earnings and revenue numbers, Mr. Black said. The company also has a strong balance sheet and solid earnings growth, Mr. Black said.

Two stocks that he feels are promising right now, based on earnings growth and attractive valuation, are MKS Instruments, a semiconductor-equipment company based in Massachusetts, and Teva Pharmaceutical Industries, the Israel-based generic-drug maker.

Roughly 70% of MKS’s business is tied to semiconductors, but Mr. Black finds the company’s growing medical-applications and solar businesses as attractive growth opportunities. Revenue, which is expected to double in 2010 compared to last year, will likely climb 10% in 2011, Mr. Black said. MKS has $5.50 per share of net cash and the stock is trading at a 5.4 times earnings. “It’s ridiculous … it’s selling just under 1.3 times book value. You have the wind to your back [and] a bullet-proof balance sheet” with MKS, he said.

The bulk of Teva’s business is in the U.S., with 70% of the company’s sales from generic drugs, and it will be a direct beneficiary of the health-care overhaul as health-care providers look to cut costs, Mr. Black said. Brand-name drugs including Copaxone for multiple sclerosis and Azilect for Parkinson’s disease, are expected to show double-digit percentage sales growth, he noted.

Meanwhile, Mr. Black is holding on to his stake in Hornbeck Offshore Services, a provider of offshore supply and support vessels to the oil and gas drilling industry. The company faces uncertainty over offshore drilling after the Gulf of Mexico oil spill, and investors have been wary.

“What we’ve got right now is a crisis of confidence,” Mr. Black said. “This is a pure ‘Benjamin Graham’ stock,” with little debt and a modern fleet.

Mr. Black maintains a disciplined approach to paintings as well, buying only museum-quality pieces by masters such as Pablo Picasso, Edouard Manet and Paul Cezanne. With 49 paintings in his collection, he is limiting himself to one acquisition a year now.

Mr. Black also takes a value approach to buying paintings, but he collects them because he loves them, not to flip them. He has never sold a painting.

Categories: News
Tagged: Value Investing, Scott Black, delphi management

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