Our “2012″ Dirt-cheap value investor’s portfolio

Some of these names we’ve written about before on the market diary, so they are all curent holdings, but the primary reason we continue to hold them is their dirt-cheap valuation. These value stocks often require patience and an eventual catalyst to break them out of their current state. This is a value investor’s portfolio and is intended mainly for “buy-and-holders” that are looking for limited downside risk should we see a difficult market. We remain long most of the names:

Applied Materials (AMAT) - getting a pop today and late in the year, along with other semi’s, this semi cap equipment maker is thought to be near the trough of its order cycle, and its valuation certainly supports that notion. Trading at 15(x) depressed forward earnings, which are expected to fall 42% in fiscal 2012 given current estimates, orders fell 42% y/y in the November quarter. AMAT is trading at 1(x) enterprise value to 4-quarter trailing sales, and 5(x) EV to cash-flow and free-cash-flow. What caught my eye was the 13% free-cash-flow yield for AMAT, as the equipment manufacturer nears the bottom of the cycle. (Long AMAT)

Dell Computer (DELL) - we havent owned in a while, but Dell is getting pretty interesting on a valuation perspective. Dell was decimated as corporate job growth slowed the last 10 years, and enterprise spending on PC’s dried up. The return of Michael Dell did little for the business. The valuation is dirt cheap today, based on these metrics: trading at 0.44(x) price to 4-quarter trailing sales, and 7(x) expected 2012 earnings, but earnings arent expected to grow much at all over the next few years thanks to iPads, and continued muted job growth. Dell has $7.50 in cash on the balance sheet (and thus, trading under $15 per share is trading at less than 2(x) balance sheet cash, and on an enterprise value basis, is trading at 0.33 EV to 4-quarter trailing sales, and 4(x) cash flow. What the catalyst is, is unknown. Dell sports a “free-cash-flow yield” of 17% - not too shabby.

Alcoa - trading at a 15% discount to tangible book value of $10.30 per share and less than 10(x) 2011 expected earnings. The thing is estimates continue to sink on AA, so this is the proverbial salmon swimming up stream. at 8(x) cash-flow it isnt as cheap as other stocks, but the US wont likely enter a recession, and the global aerospace cycle remains intact. AA usually is one of the first companies to report each quarter. It faces easier comp’s against 2011 next year, which is a plus. China is a wildcard, and not a plus if it continues to slow. Our tangible book value calculations assume all balance sheet liabilities are stated/valued accurately, including pension benefit obligations. Alcoa sports a free-cash-flow yield of 9% as of the Sept ’11 earnings report. (Long AA)

Ford Motor (F) - trading at 5(x) cash-flow and 10(x) automotive cash-flow, Ford’s cash-flow and balance sheet have improved as the earnings estimates have deteriorated. We need to see better US automotive and European margins. They declared their first dividend in years recently of $0.05 per share, (which i erroneously thought would be a catalyst for the stock) and the stock didnt respond much. SAAR estimates of 13 - 13.5 ml are still lower than peak estimates so car sales arent the problem and the company continues to gain share. Commodity costs are an issue, but teh key metric to watch is North American pre-tax US auto margins - we need to see this number return to 10% versus its current 6% level. Ford’s combined free-cash-flow yield is 19% (Ford Automotive and Credit combined). (Long F)

Best Buy (BBY) - probably our most controversial pick, BBY at 2(x) cash-flow is too compelling to ignore. Most of the analyst sentiment is negative. The October 4 2011 low was $21.79. The October ’08 low was $16.42. So much is stacked against BBY right now given the pricing of TV’s and consumer electronics, against the fixed costs of a bricks-and-mortars retailer. But here is something you dont hear: with fiscal 2012 almost done, consensus eps is expected to fall 1% (which isnt too bad given the headlines), but 2013 consensus eps est’s have actually risne from 5%, 6%, 7% and now to 10% the last 4 quarters. Revenue growth is still expected at low single digits. Best Buy’s free-cash-flow yield is a whopping 29%. (long BBY)

Here are the valuation metrics for BBY based on enterprise value at 11/11 quarter end data: (i kid you not)

EV to 4-qtr trailing sales = 0.14(x)

EV to 4-qtr cash-flow = 2(x)

EV to 4-qtr free-cash-flow = 3(x)

We just bought a slug of BBY for one account. However this is definitely a holding with a short leash. Below the October ’11 low would be a worry.

That is our “dirt-cheap” value investors portfolio for next year. We’ll see how it does. We are long most of these names currently. We didnt wrote about any financials since they are universally cheap. Goldman Sachs at 75% of tangible book ? The same can be said for all the major banks. I’m just not sure whether the big banks become utilities and how this plays out. We’ll have to see how banks trade with improved real estate news. That will be a key tell. (Long GS, JPM)

Have a wonderful holiday.