A look back at US stocks

Benj Gallander and Ben Stadelmann
Friday, January 16, 2009

In our last article, the Canadian stocks mentioned in this column over the past year were reviewed. Here we continue with the American ones.

Two articles were written about the likely effects of the evolving credit crisis on US financial institutions. HSBC was cited as an example of a bank that had been remarkably candid about accelerating loan losses as far back as August 2007. The fact that they were expecting further deterioration last February was a valuable clue about what was in the pipeline — a marked contrast to a host of financial institutions that were either much less transparent or in deep denial.

In July we returned to the subject and concluded that banks were cheaper, but by no means a bargain. Nobody can realistically maintain that there was not plenty of warning of the fall massacre. The failure of IndyMac, Freddie Mac and Fannie Mae on the skids, nasty results from Wachovia, HBOS’s effort to raise capital in Britain, which ended in a fiasco — these were all portents of a full-fledged contagion about to sweep the sector. We still haven’t bought any banking stocks for the Contra portfolio, as we believe that more loan losses will bite as the recession deepens.

In April, Israel’s Magic Software was the topic. Then trading at $1.58 (US), this vendor of ERP software has held up better than most, now at $1.21. The company has negligible debt, cash of over a buck a share and continues to be modestly profitable. No doubt, capital spending on IT upgrades will be under tremendous pressure this year, but we like the position these folks are in.

Also featured that month was our projector manufacturer, InFocus. Then trading at $1.95, this one has felt the full fury of the bear and is trading at present at a lowly 75 cents. Even before the recession hit, the company was in a competitive box, challenged by tech conglomerates with far greater resources in a field where product prices have been relentlessly dropping. The fact that InFocus is debt free and has cash of $1.35 per share is a pretty good indicator that investors have completely given up hope. Not us, though our confidence has waned.

In June the tires were kicked on Plato Learning. This seller of educational software looked to be in turnaround mode after a rough patch, but the large amount of goodwill on the books raised our skepticism. Sure enough, just this week, the company announced a whopping $71.9 million writeoff. It’s fortunate that we decided to stay away from this stock for the portfolio, but we’ll keep an eye on it, as it’s plausible that revenues will be relatively stable in this economic environment.

In August, we took a look at one of our positions in the semiconductor space, Integrated Silicon Solution. This is one ruthlessly competitive business, but we reckoned that it has the makings of a survivor. It’s certainly surviving, but the share price has been slashed from $4.42 then to the current $1.58. This puts it under its cash value of $1.93 per share.

We could see averaging down on this one, but are in no rush to do so, as the destruction of demand in this sector has us cringing. ISSI has revised revenue guidance sharply downwards, and looking at bellwether Intel’s results this week, its obvious that sales in chip land are basically in freefall with no bottom in sight. Definitely not for the faint of heart.

We’d love to report that our contrarian methodology has somehow miraculously sidestepped the market turmoil, but alas, this is not the case. The Contra portfolio had a miserable year, down 36.8 percent, the worst performance in our history. This calculation was not upgraded by the hefty reserves of cash that were put aside during our very successful stretch, as that is not included in our computation. Funny how those perceived stumpy interest rates now look tremendously exciting!

The challenge will be to intelligently deploy this capital while prices are still low yet the worst of the damage to the economy is past, and to select the enterprises that can survive the storm and eventually prosper when favourable conditions return.

Normally, after the portfolio has suffered poundings in the past, it has rebounded with a streak of three spectacular years. Here’s hoping.