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Buffett Picks for the Obama Economy

By    |   Wednesday, 26 November 2008 08:48 AM

A common post-election ritual among financial magazines is to develop portfolios based upon the policies of the incoming administration. These lists usually contain speculative stocks based upon the candidate’s campaign promises.

One problem with this approach is that promises made to win an election don’t always drive the subsequent actions of politicians once they get into office.

A well-remembered example was Bill Clinton’s middle-class tax cut, a hallmark of his 1992 campaign. After the election, the president-elect claimed he was shocked to learn the true state of the economy and reluctantly realized that the federal budget could not accommodate his promises.

With this in mind, I will attempt to find winners based upon the expected policies of the Obama administration.

Alternative energy is expected to benefit from federal subsidies. However this means the government rather the markets will be picking individual winners, and investment gains will be dependent upon the impact of lobbyists hired to promote various causes.

Some magazines are attempting to pick winners among health care companies. I think this is an area where caution is needed. After seeing how financial companies are having shareholder value diminished or wiped out by government help, investors should let healthcare policies take shape before rushing into new investments.

One campaign promise that seems likely to withstand the realities of politics is that the government will do all it can to create jobs. While we don’t know the specifics of this action, it is likely that industrial companies will benefit from infrastructure development, and this is the easiest way for government to create jobs.

Additionally, some industrial companies supply consumer goods manufacturers and will benefit from an economic recovery.

For this week’s screen, I started with that idea and added some simple filters to find value stocks like the ones trusted Obama advisor Warren Buffett might look for.

  • Of the 12 economic sectors defined by Standard & Poor’s, I limited the screen to only Basic Materials and Capital Goods which include heavy industrial companies and companies that provide basic inputs into consumer goods.

  • To avoid buying companies with a long history of losses, the P/E ratio must be greater than zero meaning that the company shows a profit over the past 12 months.

  • A positive earnings forecast for the next 12 months was also required.

  • One of Buffett’s favorite indicators of a good company is a high return on equity. This list is limited to companies with a return on equity in the top ten percent of all listed stocks.

    Six companies seem likely to benefit in the Obama economy.

    BHP Billiton (BHP) is an Australian diversified natural resources company. The world’s third largest iron ore producer also mines aluminum, copper, coal, uranium, gold, zinc, lead, silver, and diamonds. Poised to benefit from highway construction, nuclear energy, or a consumer rebound, BHP pays a 5.5 percent dividend at the recent price of 38.25 and has increased that dividend by an average of 37 percent a year for the past five years.

    Compass Minerals (CMP) is a salt and fertilizer producer in North America and the United Kingdom. Fertilizer offers indirect exposure to alternative fuel ethanol, which is made from corn. After beating earnings estimates by more than 50 percent in the most recent quarter, analysts have been racing to increase their estimates. At a recent price of 50.66, the P/E ratio stands at 13 for a company expected to more than double its earnings this year.

    Crown Holdings (CCK) makes cans for food and beverages. Last year, 73 percent of sales were derived from operations outside the United States; making CCK a way to profit from a global recovery led by the United States. CCK enjoys free-cash-flow growth of 25 percent a year and is expected to earn $1.93 in 2009, giving the stock a P/E ratio of 7 at the recent price of 14.50.

    Innophos Holding (IPHS) is a producer of specialty phosphates. These scary sounding chemicals are used in soft drinks, sports drinks, juices, food products, toothpaste, other dental products, petroleum and petrochemical products, and various soaps and detergents. At a recent price near 14, IPHS offers a 5.8 percent dividend yield that is safe, since the payout represents less than 10 percent of the company’s earnings. The P/E ratio is only 2, and earnings are solid.

    Rio Tinto (RTP) is a U.K.-based mining company with operations around the world. The company recently spurned a takeover offer from BHP Billiton which valued RTP at about $200 per share. Declining commodity prices and the demise of that deal have driven RTP shares to about 105 a share. At this level, the stock trades with a P/E ratio of only 3 based upon next year’s projected earnings of more than $30 a share. The dividend is $5.44 a share, amply covered by earnings and paying patient investors a yield of more than 4 percent.

    Solutia (SOA) makes chemical materials, like nylon, that are used in consumer and industrial applications. Its photovoltaic business serves the green energy market for thin-film solar panels. SOA emerged from bankruptcy in February 2008. More than a third of outstanding shares are owned by Harbinger Capital Partners, a hedge fund with more than $12 billion in assets. Harbinger is an activist firm that tries to find value in beaten down stocks, like The New York Times. Through the first half of the year, the fund was up 30 percent. Recent price: 6.09.

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    A common post-election ritual among financial magazines is to develop portfolios based upon the policies of the incoming administration. These lists usually contain speculative stocks based upon the candidate’s campaign promises.One problem with this approach is that...
    Wednesday, 26 November 2008 08:48 AM
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