Shaping a Portfolio for 2010 (IV)–Individual Stocks (ii)-Where Economic Energy ISN’T

Any discount broker will provide some stock screening capabilities.  I think Fidelity’s are particularly good, although I don’t profess to be an expert on the subject.  This is probably the first stop for value investors.  I can’t offer much insight on how to proceed, but typical screens are for price to cash flow, price to book and price to earnings.  Simple screens are probably more effective than complex ones.

For a died-in-the-wool value investor, this may be enough.  But I’ve always thought that before buying a stock, you make up two lists.  One is what could go right, the second is what could go wrong.  A good stock is one that has the largest number of entries on the former list and the smallest number of entries on the latter.

That brings me to the subject of this post–What’s likely not to work in the upcoming bull market?  Remember that just as in a down market, everything goes down, in an up market (just about) everything goes up.  So what follows is about areas I think have the potential to underperform, that is, go up less than the market.  Also, especially in the US market, hidden gems in conceptually bad areas have a really good chance to work as stocks.  So my thoughts here shouldn’t be enough to dissuade you from buying a stock you have researched and really believe ink, just because it’s in a “bad” sector.

Areas I’m Going to Avoid

1. Banks that have received government bailout money.  These stocks have been strong performers as fears abate that they will be forced into bankruptcy.  I have no idea when this period of outperformance will end.  But I worry that these banks are being forced to concentrate their lending in their home markets, meaning that competition will be fierce and therefore margins low.  This will be very good for borrowers, but not for bank profits.  Standard Chartered, a bank that specializes in emerging market, has already reported that it is seeing traditional competitors withdrawing from the developing world.

The other side of this coin is, of course, the opportunities opening up in markets the big US and European banks are leaving.

There’s a second, although of itself pretty lame, reason to avoid this group.  Typically, in the transition from a down market to an up market, the leadership group changes.  This happened, for example, to the mega-cap “Nifty Fifty” in 1973-74, the oil stocks in 1981-82 and the internet stocks in 2001-2002.

2. Healthcare, especially providers of equipment and services.  For a long time the “conceptual” case for this group of stocks  has been that the aging of the Baby Boom will provide ever increasing demand for medical care.  There may be rays of hope in this arena, and drug companies are probably ok.  But I think the move toward more comprehensive medical insurance will bring with it calls for better use of medical dollars.

Also, I think that, although we don’t talk much about it, Americans don’t like the idea that corporations make a lot of money from citizens’ illnesses.  I think we respect people who are caregivers and have no qualms about their earning a good living.  But corporations?  –no.

Others may be able to navigate successfully through this heavily regulated industry.  But I can’t see myself as anything but the “dumb money” here.

3.  Consumer staples.  Again, there are doubtless great companies in this sector, like Procter and Gamble.  And there are niche areas like chewing gum or, in a better economy, chocolate.  Typical behavior in this relatively mature area has been that consumers trade down to cheaper (and less profitable) brands or to private label during bad times and trade back up when the economy gets better.  My worry is that the Baby Boom doesn’t trade back up and private label makes permanent deep inroads into the staples’ most profitable products.

I’m adding this on Apri l 15th.   I hadn’t mentioned companies in secular decline, which I think even value investors would regard as to be avoided –like newspapers, local tv stations, airlines, music companies, traditional book publishing…

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