For Sale?

After the worst week ever for the Dow, the recent drop-off is now worthy of wikipedia. At cocktail parties and dinner tables the topic du jour is the market and the effect on investors' retirement accounts. We love to put the stock market in the simplest of terms, and in an odd retrospective view. The stock market is merely a place where businesses are bought and sold. Contrary to popular opinion, it is never universally wrong or right to buy or sell. But we should at least think about why we're buying or selling a piece of a business.

Cash flows

According to finance theory (and sometimes reality) the value of any asset is equal to the present value of all future expected cash flows. And with some stocks down 80% +, their very existence is now questioned, even without the toxic balance sheets of banks. Peak to trough the market has fallen over 46%, well into what economists consider bear market territory.

So if you have some cash on the sidelines, here's what to look for in companies and in strategies:

• A super clean balance sheet: since credit is a huge part of the problem, debt is now a sin. We have yet to see the coming wave of corporate debt defaults. The 10%+ spread of non-investment grade debt to US Treasuries is a testament to risk and uncertainty.
  

• Tiny market caps: these are thinly traded and have little or no analyst coverage; their price swings can be the biggest and their pricing the most inefficient.

• A large cash pile: this serves as a further cushion, or margin of safety, against a greater collapse.

• A business: a product or service that is needed or wanted in any economic environment.

• Options: covered calls (if you'd like to lower your effective cost basis but cap your upside, consider this) or married puts (to protect the downside).
  

And?

Faro is finding extreme value in global mining, Brazilian poultry, and Chinese education. Timing the market bottom is a fool's errand. However, I wouldn't bet (long at least) on banks or the American consumer (70% of GDP). Shrinking retirement accounts, falling home prices, and tightened credit must eventually bring even the most spendthrift of consumers to question whether to fork out $40.00 for dinner or drop $200.00 for jeans. Though the recent plunge reflects this, the enhanced awareness may likely lead to a self-fulfilling prophesy: an even bigger drop for companies that sell stuff people only think they need.

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Note: Though readers may note the poor record (along with the market) of previous stock recommendations on this site, Faro is happy to report a flat last two weeks due to a short position in a domestic retailer.

Image: http://www.biojobblog.com/for_sale_sign(1).jpg