Value Added


Stocks for the New Normal

Steven Goldberg

A top value manager finds global leaders unusually cheap despite a scary economic backdrop. Check out his fund and his picks.



Investors seem to be of two minds. Some are chasing gold, which trades near $1,200 an ounce -- off its high, but still dear. Gold is a great hedge against inflation, especially inflation caused by loss of faith in paper currency. An equally large crowd is bidding up the prices of U.S. Treasury bonds, which are the best shelter if the nation falls into deflation and interest rates and the general price level decline.

Chris Davis, co-manager of Selected American Shares fund (symbol SLASX), is no Pollyanna. He subscribes to the “new normal” thesis, shorthand for a world so debt-laden that economic growth will be anemic and stock returns will be much lower than their historic average of more than 9% for several more years.

No fund manager can afford to ignore the macro picture today, he argues. “People are right to worry; we face huge structural headwinds,” he says. “I’m not sure whether we’ll get inflation or deflation, but I’m certain we’ll have flation” -- that is, one or the other.

What should you own when uncertainty of which malady will afflict us -- and how seriously it could hit -- is so high? Davis’s answer: stocks, because the alternatives stink. If we get high inflation, Treasury bonds will get clobbered, and if we encounter serious deflation, the price of gold will likely plummet.

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Stocks are hardly a perfect solution. If either inflation or deflation gets out of hand, share prices will plunge because the economy will run into all sorts of complications. But if we can avoid extremes of flation, stocks -- or at least the right stocks -- should perform well.

Stocks are cheap. Standard & Poor’s 500-stock index trades at about 13 times projected earnings for the coming 12 months, compared with a long-term average of 15.5. Based on price alone, the S&P 500 trades where it did in 1998. Treasuries haven’t been this expensive (meaning they yield so little) since the 1950s. Even real estate is far above its 1998 price, as are commodities. “A lot of deflation has already happened in equities,” Davis says.

Selected American Shares, a member of the Kiplinger 25, looks like a better bet than an index fund to me. The fund has returned an annualized 1.5% over the past ten years through July 26 -- puny, but better than the annualized 0.8% loss of the S&P. Expenses of the S class shares are just 0.94%; the D class shares are cheaper at 0.61% annually, but they require a minimum initial investment of $10,000.

Davis, 45, clearly loves what he’s doing. He, co-manager Kenneth Feinberg and their team of 12 analysts seem focused on learning from mistakes (most notably American International Group, which imploded in 2008) and producing better returns. Almost 30% of the fund is still in financials, but that’s less than Davis used to own -- and among the big investment banks, his only holding is a small position in JPMorgan Chase (JPM). The fund has also built a 4% emerging-markets stake, which is new.

What Davis is buying now

Davis looks for global leaders trading at attractive prices relative to earnings and other indicators. He wants healthy and sustainable dividends. And he prefers companies with mountains of cash in case things go wrong. The following stocks are so familiar you’ve probably gotten tired of reading about them. But they fit this very sound strategy.

American Express (AXP) is a longtime and archetypal holding. It’s more profitable than its credit-card rivals because it does much less partnering with banks and service companies. American Express, at $45.43 as of the July 26 market close, trades at 14 times anticipated earnings for 2010. The yield is less than 2%. On the negative side, credit-card companies could lose business to cash purchases in the U.S. as a result of the new financial-reform law.

Davis owns a slug of Warren Buffett’s Berkshire Hathaway (BRK.B). He lauds the company for giving “enormously strong disclosure.” Of course, the big question is what happens after Buffett, who turns 80 next month, isn’t around or as active. Davis concedes the conglomerate then will “be worth less. But unlike many legendary CEOs, Buffett is honor-bound to make his successor’s job as easy as possible,” the fund manager says.

Coca-Cola (KO) is another Davis favorite. With a distribution network in more than 200 countries, growth in emerging markets is powering Coke’s sales. The stock, at $54.94, trades at a price-earnings ratio of 16 on estimated earnings for 2010 and yields 3.2%.

Johnson & Johnson (JNJ) is a health-care colossus, huge in pharmaceuticals, medical devices and consumer health-care products. It has been hurt by safety problems with product manufacturing and faces lots of expiring drug patents. But, at $57.74, J&J trades at a P/E of 12 on estimated earnings for 2010 and yields 3.7%.

The world’s largest consumer-products manufacturer, Procter & Gamble (PG), was stung by sales declines in some products during the recession. But with brands such as Charmin, Gillette and Tide, business is bouncing back. The stock, at $62.52, trades at 16 times anticipated earnings for the fiscal year ending next June and yields 3.1%.

There are no sure things in investing, but high-quality stocks, such as the ones Davis favors, look like winners to me in most economic environments. And when the market does fall, I think these will dip far less.

Steven T. Goldberg (bio) is an investment adviser.



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