Sell in May … Then Go Shopping for Deals

You can find good bargains as stocks sell off

   
Sell in May … Then Go Shopping for Deals

Everybody likes to talk about the old Wall Street adage, “Sell in May and go away,” but in my experience, few people actually do it. This year, however, the idea is getting even more attention than usual. April was volatile, tech stocks have been hit, international tensions are high, the Fed is cutting back on stimulus, and on top of all that, the S&P 500 hasn’t had a 10% correction in nearly three years.

So should you sell this May?

Yes.

Should you go away?

Not a chance.

For me as a value investor, May is my equivalent of Black Friday. If you know where to look, you can get some fantastic deals. (And you don’t have to get in line at 3 a.m. to do it!)

As with most clichés, there is a basis for selling in May. The market historically has its best returns between November and April, with May to October often weaker. This pattern doesn’t hold every year, of course, which is the problem. Last year, for example, the S&P 500 rallied 7% from late June to early August.

Still, selling in May can make a lot of sense, and we’ve already seen investors bailing out of overvalued high-P/E stocks and rotating into more reasonably valued stocks. If you still own stocks that you keep you awake at night, or have run up and gotten smacked, or that just seem to sit there, or whose story has changed from when you bought it, now may be a good time to sell before we are knee-deep in the weakest time of the year.

Then, prepare to go bargain-hunting.

We’ve all seen retail advertisements saying, “Our Lowest Prices of the Year!” That’s how I look at the next several months. Summer is a great time to take advantage of low prices.

As a contemporary value investor, I cull through discarded companies looking for rough gems, tarnished coins, and rare birds. We don’t buy something just because it’s cheap, but because it’s cheap and has value to be unlocked. I dig deep for answers to a slew of questions in my analysis: “Why is a company cheap? How cheap is it? Can management fix any problems?” to name just a few. The key is identifying “temporary” problems and avoiding “terminal” ones.

So you see why “Sell in May and go away” is in fact the beginning of the value investing season for me. We are entering the time of year in which I have historically found some terrific winners, and if you’re looking for a bargain, here are two to put on your shopping list.

Two for Your Shopping List

Genworth Financial (GNW), which I’ve written about before, is one of my favorites in part because I started buying it at less than $6 per share, so it is now a triple. More important, I see more upside as it still trades at a large discount (roughly 40%) to GAAP book value of $29.03 per share. The next near-term catalyst for Genworth will be an initial public offering (IPO) of its Australian mortgage insurance business, which I expect will happen this year.

Another good deal right now is Devon Energy (DVN), an undervalued exploration and production (E&P) company with a $33 billion enterprise value but a $29 billion market cap. Devon is in the process of fixing its problems — it’s “on the operating table” as Warren Buffett might say. The operation looks about complete, and thus begins the recuperative phase when I expect to see better earnings.

Management has completely restructured the balance sheet with a transformational acquisition (Crosstex), and shareholders are about to reap the bounty. But restructuring is only part of the story. Natural gas prices have jumped from around $3.50 last fall to recent highs above $4.80. I expect that trend to continue over time, and Devon, which produces oil and gas, is well-positioned to benefit.

Going forward, the new capital structure leaves room for management to “drop down” assets in Devon’s master limited partnership (MLP), EnLink Midstream, formerly Crosstex. This move would have the effect of lowering their cost of capital, deleveraging the balance sheet, and driving dividend growth. Couple this with rising gas prices, and we can earn an attractive return on our capital. The key metric for shareholders going forward will be dividend growth, and management has already indicated that the dividend for the general partner (ELNC) is expected to grow 20% annually.

My current target in Contemporary Value Investor is $84, which is about 17.5% above current prices. That’s just capital appreciation and that does not include dividend earnings. It’s also my first target, and I would not be at all surprised if we’re able to sell it for even higher than that.

At the time of publication, Henry Lee held GNW and DVN in his Contemporary Value Investor portfolio.

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