Financial Wisdom

The essence of a Fallen Angel (as opposed to other “value” investing opportunities) is the inherent quality of the underlying franchise. Without a high quality business underlying the stock, the shares are just fallen without being angels. We have defined quality in previous chapters to encompass several different factors. These include quantitiative metrics like balance sheet strength, and consistency of return on equity as well as qualitative strengths like competitive advanantage and management strength. The history of financial markets is riddled with examples of high quality businesses that have temporarily become “fallen angels” only to rise again. Several well known examples include Coca Cola in the early 1980s, Wells Fargo in 1990, and Apple in 2002. Investors buying at very depressed levels were able to earn above average rates of return on their investment for years to come.

Of course, business quality, isn’t just the purview of brand name blue-chip businesses. Smaller emerging growth companies that meet the quality criteria can be an even better place to look for fallen angels. Since large publicly traded companies are widely followed by analysts, owned by institutional investors, and have enormous share float, it generally takes an extreme event like a market panic or industry specific calamity to depress shares to fallen angel prices. Smaller businesses tend to have less analyst coverage, are less widely owned and have issued less stock. As a result, shares in these businesses tend to experience more price volatitliy which in essence provides for a more fertile hunting ground for the fallen angel bargain hunter.

Conscientious bargain hunters would do well to recognized the enormous opportunity provided by the market’s recent sell-off. We have put together a list of 10 fallen angels for the next 5 years. The list includes five larger blue chip companies along with five smaller businesses (market cap < $3 Billion) that meet our criteria for quality and value. The first five a large-cap behemoths. The next issue will feature five small fry that appear to be under-priced.

5 Blue-Chip Fallen Angels
1. General Dynamics (GD)
Down 54% from its 2008 high, General Dynamics offers a compelling long-term value opportunity in a quality defense contractor. The company has a history of consistently generating high rates of return on shareholder equity and is conservativly financed.

2. Google (GOOG)
Down 52% from it’s 2007 high, Google sports a pristine balance sheet, with zero debt. The company generates profit margins in the mid 20% range while returns on shareholder equity have averaged about 18% over the last several years.

3. Jacobs Engineering (JEC)
Down 58% from its 2008 high, Jacobs construction and engineering businesses are a likely beneficiary of the coming domestic infrastructure buildout. With little debt on the balance sheet and a history of generating strong returns on shareholder equity the company is well positioned to benefit as the business cycle shifts from the contraction to expansion phase.

4. Johnson & Johnson (JNJ)
Down 27% from it’s 2008 high, Johnson & Johnson offers investors a reasonably conservative way to play an eventual healthcare turnaround. The company has a long demonstrated ability of growing book value, consistently providing returns on shareholder equity greater than 25% annually.

5. Visa (V)
Down 38% from its 2008 high, Visa suffers from an image problem. Primarily that they are a credit card issuer, exposed to the kinds of financial risks facing other card issuers during a severe economic downturn. In reality, Visa is a payment processing firm with significantly less exposure to the economic contraction. The company generates net profit margins north of 20%, has very little long-term debt and holds a leading industry position.

This entry was posted on Tuesday, May 19th, 2009 at 2:42 pm and is filed under Fallen Angels Report. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.