The Business Behind the Name Is What Counts

“Sure, I’ll buy it at that price. That company’s going to be here in 10 years, and it’ll still be here in 100 years.”

I was watching Fox Business News one Friday morning when I heard that statement. I waited to hear the name of the company, but it didn’t come up again. The broadcast moved on to another topic – oil – and my attention was diverted.

Was it GM? Or was it Macy’s? Exxon? Sears? All those companies had just experienced a slump.

As you know, the market is in the doldrums. A lot of companies’ price-to-earnings ratios (P/E) are looking attractive. The Dow’s forward P/E is only 12.8. The S&P 500’s is only 14.7.

There are some upscale names going for downscale prices. It’s a good time to be looking for bargains. But be careful. Yes, the market drags down good companies along with the bad. But the cheapest buys may also be basement bargains for a reason.

Of the four companies I listed above, all have proud traditions and famous names. But I stuck in a clinker on purpose. Did you notice?

Sears is only a shadow of its former self. It was, for decades, the mega-store of its day, marketing thousands of products through the famous Sears catalog. As big as a phonebook, it clued America in to the latest gadgets, fashions, tools, appliances, toys, and everything in between. And America trusted the “solid as Sears” brand and flocked to its stores.

Seems like ancient history, doesn’t it? Sears lost its way… but it didn’t happen overnight. It took years of lurching from one business model to another. During that period, many investors bought Sears for its cheap price and famous name. But the name couldn’t revive the price.

And now both are diminished and will probably remain so.

The retail business changed, and Sears couldn’t figure out how to change with it. But it wasn’t inevitable. With smarter management, Sears could have done much better.

Some sectors are just meant to whither away, however. I loved reading newspapers when I was growing up in Salem, Massachusetts. My favorite journalist? It was William F. Buckley Jr. He was always spouting off. I had a dictionary beside me when I turned to the editorial pages to find his column. It was great. I picked up at least three or four new vocabulary words every time I read him. (When I was a university student in London, a highlight was watching Mr. Buckley debate Mr. Tony Benn, the highly respected leftist intellectual and renowned orator.)

So a few years ago, when I did an online search using some of my favorite value ratios and The New York Times, Washington Post, and USA TODAY popped up, I was more than intrigued. I was kicking myself with delight. With P/Es under 10, how could I not invest in those companies?

Of course, I checked them out – but (in hindsight) with a little less rigor than usual. I ended up going with USA Today. It wasn’t one of my best decisions. The newspaper industry had changed. I knew that, of course. But I had underestimated how much. It was no longer the “easy money” business I had grown up with. In his 2007 Letter to Shareholders, Warren Buffett described it best:

“… the newspaper business was as easy a way to make huge returns as existed in America. As one not-too-bright publisher famously said, ‘I owe my fortune to two great American institutions: monopoly and nepotism.’ No paper in a one-paper city, however bad the product or however inept the management, could avoid gushing profits.”

The Internet – with an almost infinite choice of media outlets fighting for a finite set of eyeballs – took all of that away. I’m afraid the newspaper business as we knew it is gone forever. And bad management had nothing to do with it.

Newspapers were an investment trap. And right now, there are several other traps you should avoid.

• Banks

Do you think the sovereign wealth funds (set up by countries with lots of hard cash on their hands to invest in higher-return assets than government bonds) regret their investments into America’s biggest banks? The banks think so. With their most recent write-downs, they’re giving those funds some of their money back. The government thinks so too. It wants to spend a trillion dollars or more to buy the toxic mortgage debt these banks still hold.

Slicing and dicing mortgages into so-called high-quality derivative instruments and then selling them throughout the world didn’t work out so well, did it? And right now, there’s nothing to replace this market that brought in trillions of dollars to the banks.

• Oil majors

Do the big oil companies have a plan? Doesn’t look like it. Exxon is spending more money buying back shares than in exploration and production. Oil scheduled for delivery eight years from now is trading at less than current prices. Falling future production plus falling future prices adds up to falling profits. Big oil’s business model is broken.

• Any sector that depends on cheap oil

Airlines? Of course. But their headaches extend way beyond expensive jet fuel. Putting thousands of airplanes out to pasture isn’t a good sign. Petrochemical companies? Trucking? Yep. They’re all in trouble. And even if you buy them at cheap prices, their problems aren’t going to go away.

But the auto sector’s not broken. Even GM isn’t broken. Auto companies have to give drivers what they want. And what they want is smaller, gas-sipping cars. If anything, the auto industry can turn expensive gas into an opportunity. When the worst of the recession is over, people will be dying to replace their old gas-guzzlers.

As a matter of fact, when consumers start doing that, it’ll be one of the first signs that the recession is over. Auto companies are going to blast out of the recession and lead the market to higher ground. But only if they give drivers what they want. If they don’t, it won’t be because of a broken business model. It’ll be because of that other -avoidable – disease. Bad management.

The sovereign wealth funds should be investing in the downtrodden auto sector, not banks. The auto companies are your real bargains. Not only in the U.S. but also in Japan, Korea, and India.

[Ed. Note: You can make money just by making smart decisions about where and how to invest. Find a company with good fundamentals, and you’ll be sleeping soundly for years.]