Cheap stocks

Joel Bowman, reporting from Dubai in the Persian Gulf...

In a global economic warzone where deflation reigns supreme, it is a rare instance when the investor can find something for nothing. Instead, he is more likely to watch the something he bought on Monday turn into a nothing by Friday.

Just to be clear, your editors have never expected something for nothing. We are not Wall Street bankers. We are not American automakers. All we ask for is a little something for something. These days, even something for anything would be nice.

But the trend is against us. The rate at which somethings around the world are quickly dissolving into nothings is astonishing. So far in 2008, the slowing world economy has erased over $32 trillion dollars in stock market capitalization. That's almost three times America's GDP, and certainly more something-to-nothing action that many men can bare.

But there is an upside.

The mass wealth vaporization of 2008 has left many companies trading for well below what we might call fair value.

"Stocks have fallen so far that 2,267 companies around the globe offered profits to investors for free as of the open of trading today," explained Bloomberg earlier this week. "That's eight times as many as at the end of the last bear market, when the shares rose 115 percent over the next year.

"Companies in the MSCI World Index traded for an average $1.17 per dollar of net assets, the lowest since at least 1995, and 39 percent sold at a discount to shareholder equity as of the open."

Stocks are cheap, in other words. Could they get cheaper? Yes, they could. But when so many stocks are trading at next to nothing, many value investors are starting to feel like it is time to do something. In the column below, our own value expert, Chris Mayer, offers up four beaten down stocks for your learned consideration.

Shooting Stocks in a Barrel, Part II
By Chris Mayer

The panic in this market is incredible. It's leading to some absurd valuations. Particularly among the smaller-cap stocks. These stocks have really been hit hard because they have less liquidity than large cap stocks.

When waves of selling sweep through the stock market, they might rock a large cap stock from stem to stern. But the same waves will capsize a small cap stock. So the conditions in the financial markets are very scary right now for any investor who's holding small-cap resource stocks. But unless we slip into some global depression, these stocks will come back - and come back with a vengeance.

I, for one, can't wait until earnings season, when we'll get fresh numbers and updates on the companies I've been recommending to the subscribers of my investment service, Mayer's Special Situations. I'm betting that the earnings power of many of these companies has not changed all that much in the last 90 days – at least not as much as their tumbling stock prices would have you believe.

So I'd like to highlight some stocks that look like particularly deep values right now.

NGAS Resources (NGAS:nasdaq ). Recent price: $1.47. I like the long-term outlook for natural gas. As T. Boone Pickens, the 80-year-old billionaire investor, says, "Natural gas is the fuel of the future." It is clean-burning, and we have a lot of it in America. The estimates for U.S. shale plays are up around 840 trillion cubic feet of gas - the equivalent of more than 140 billion barrels of oil – or more than half the stated reserves of Saudi Arabia. Energy independence? Seems to me you have to look at natural gas.



NGAS has plenty of acreage. It also owns 636 miles of pipelines. It owns the critical infrastructure to bring its gas to market. The proved reserves alone - some 102 billion cubic feet of gas - ought to fetch $10 per share for a potential purchaser. The pipelines, at only 10 times pretax earnings, come in at about $65 million – or $2.50 per share. So infrastructure assets - which are becoming increasingly expensive to build – easily cover your entire investment in NGAS, since the shares trade for about $1.48 as I write. And I haven't even put any value on the undeveloped acreage. The net asset value (NAV) per share on NGAS is somewhere north of $12 per share.

NGAS has some debt, which we have to watch. It has $95 million in debt, but it is not due until 2010 and 2011. If natural gas prices stay low for a long stretch of time, this debt could cause some problems. The value of the assets in NGAS, though, offers a lot of protection.

OM Group (OMG:nyse ). Recent price: $18.63. This is another one that baffles. OM Group had a great quarter ending June 30, and the shares surged 18% the day it announced earnings and nearly got to $40 in the ensuing rally. We got our shares for $30. Today, they are about $19. Amazing.

OM Group makes all kinds of chemicals, powders and materials, mostly from three metals: cobalt, nickel and copper. You can find the original recommendation in letter No. 25. That thesis is still intact, and I won't rehash the whole thing here. Except I will point out that the company now trades for 3.5 times earnings. Predicting where these earnings will go from here is almost impossible. But I'm comfortable with the cobalt story and the metal's growing use in batteries and aerospace. And at these prices, you can be wrong on earnings and still come out looking good.

Cobalt prices have tumbled to $13 per pound, compared to about $35 one year ago. As a result, earnings estimates are all over the map – ranging from $1.90 a share on the low side to $5.00 on the high side. For perspective, OMG earned $5.00 in 2007, when the cobalt price averaged $29 a pound. So maybe 2009 is a bad year. But the cobalt price will rebound eventually, and when it does, OMG will rebound as well. I should also point out that OMG has no net debt and plenty of excess cash, yet trades for less than half of stated book value.

The market is factoring in a very gloomy outlook for OMG, even though the most recent quarter gave us nothing but positive news (remember that 18% single-day gain). The market seems to have forgotten that and thrown out OM Group's shares with all other commodity names.

Canadian Superior Energy (SNG:amex ). Recent Price: $1.01 I was in Manhattan recently for the Value Investing Congress. The West Coast Asset Management team was there. They made a presentation on a few ideas they like. Someone asked them about Canadian Superior, which was their favorite idea about six months ago. They still like it and said that since their presentation, Canadian "has done nothing but knock the cover off the ball."

I agree. Since we've owned it, Canadian has delivered good news on the exploration front and overall good results. These bits of news have, at times, sent the shares up as much as 20% in a single day. But those gains soon melted under the barrage of broader bad economic news and the market's overwhelming sell-off.

As long as natural gas prices remain in the can, it seems as if market sentiment won't turn much on the natural gas names. The market has just stomped on all of them and pushed share prices to really cheap levels. I think Canadian is a steal and gives you legitimate 10 times potential from its current price of only $1.00 per share. We picked up shares in June, and you can find the full write-up in letter No. 24.

Altius Minerals (ALS:tsx ). Recent price: C$4.10. Altius owns a portfolio of royalties and prospects in Newfoundland and Labrador. This stock has tumbled to the sort of valuation extreme that I have rarely seen during my carreer. In fact, it is so statistically cheap that it is the kind of stock I have only read about in the dusty financial history books on the Great Depression. It's something Ben Graham might've stumbled on in 1934.

The stock sells for less than its net cash!

The stock market currently values Altius at C$127 million. But as recently as June 30, the company had $187 million in cash. And that's not its only asset. Nor is the company losing money. It's actually adding to that cash pile. No surprise that insiders are buying. Plus, the company announced it would buy back 10% of the stock. So at the current price, in theory, you can buy the company for $127 million, drain the company treasury to get your purchase price back and still have $46 million left in cash, plus all the assets for free.

Altius, like all the stocks I have I highlighted here, look really, really cheap, with big upside.

I believe that's really all we can do as investors. We can't say what other people will pay for the stock or when they might pay more than they do today. We can only find these anomalies and wait for the market to correct the gaps, as it does over time.

I know that for the last couple of months, the stock market has been a very treacherous place for investment capital. On the other hand, cheap is cheap. And some of the stocks I've mentioned above are "Depression-style" cheap. I am not trading in and out of the market, trying to pick tops and bottoms. I believe such an effort is futile. Instead, I look for deep values and collect good bets.

Over time, we'll get paid. But in crazy markets like this, we have to realize it might take a little while. We'll have to be patient and build low-cost positions in these stocks. These are the times when you plant the seeds of monster future returns.

All bear market cycles turn eventually - as even this one will.