Should we follow Warren Buffett back into the stock market? Eric Fry thinks so. But the market is still volatile. More short-term losses are on the cards. Eric recommends six beaten-down companies that offer high yields and the potential for a strong recovery.

This from Rude Awakening:

History tells us that epic panics create epic buying opportunities. Inconveniently, history does not tell us in advance how long the panics will last or how low stock prices will ultimately fall. Great buying opportunities always present themselves in hindsight. In other words, to quote Henry Ford, “History is bunk.” Financial history, in particular, is bunk.

Therefore, knowing only that we do not know how low prices will fall, we must exercise a measure of caution and prudence. That said, a cheap stock is a cheap stock, even if it is destined to become cheaper. So let’s get a little crazy. Let’s imagine that we are prepared to risk some of our precious capital. Let’s imagine that we are prepared to stare financial peril straight in the face until it buckles under the strain and runs away whimpering. Let’s imagine that we are courageous enough to buy a stock…What stock would we buy?

In the midst of one of the many recent multi-hundred-point selloffs, your editor dialed up an expert on Canadian investment trusts.  “Hey Danny, how’re you holding up?” Your editor started off.

“I’m still answering my phone,” came the reply. “But I can’t say that I’m enjoying myself.”

“Well, you’ve got plenty of company,” your editor empathized. “This is brutal. So what’s the smart money doing?”

“No idea,” Danny joked. “I haven’t seen any smart money around here for several weeks.”

“Okay, so what are YOU doing?” your editor persisted.

“Well, all of my clients are selling, so I’m thinking that I should probably be buying.”

“Are you?”

“A little,” Danny said, “but the problem is that the stocks I follow looked dirt cheap two weeks ago. And now they’re down another 30% or so. It’s unbelievable.”

“What’s causing this carnage?”

“Panic…Pure panic.”

“Understood,” your editor empathized, “but if you were making your first buys today, what would you buy? In other words, if an alien, loaded down with cash, stepped out of his spacecraft and strolled into your office, what would you tell him to buy?”

“Almost anything,” came the reply. “I’d start with Penn West (NYSE: PWE). That’s a blue chip investment trust that’s down 50% from its mid-summer high. And now it’s yielding more than 20%.” [Editor's Note: Your editor does not own Canadian investment trusts, but at least one member of his extended family owns PWE and ERF.]

“Amazing!” your editor replied. “Is this company susceptible to any credit problems?”

“Not that I know of,” Danny said. “It carries very little leverage. But look, with the benefit of hindsight, you can see how we got here. Oil is collapsing, the Canadian dollar is collapsing and to top it all off, investors are freaking out. You add it all up and you get Canadian investment trusts that yield 25%!…I mean this Canadian dollar is just hard to believe. It is down 4% just TODAY! So that brings its loss against the US dollar to more than 15% since mid-Summer. I think you could easily argue that Canada’s finances are in MUCH better shape than the U.S.’s. But the markets see it differently.”

“Yeah, these are incredible times. What else do you like?”

“I’ll give you a short list,” said Danny. “I like Baytex Energy Trust (NYSE: BTE), Provident Energy Trust (NYSE: PVX) and Enerplus Resources Fund (NYSE: ERF). All three stocks yield about 20%, which seems totally crazy. Even if you believe energy prices are going to remain depressed, these stocks are too cheap.”

“Thanks Danny. Hang in there!”

To be clear, dear investor, Danny’s “short list” of distressed investment trusts are not automatically a buy because they yield more than 20%. But as we never tire of observing here at the Rude Awakening, they are probably less of a sell. (Please remember, that oil and gas investment trusts like Penn West derive their incomes from oil and gas production. So when energy prices are tumbling, as they are currently, these trusts earn less income, which means that their dividend payouts could fall sharply).

A few days after speaking with Danny, your editor checked in with Chris Mayer, editor of Capital & Crisis. [By the way, if you missed the October 14 edition of the Rude Awakening, you almost missed Chris' examination of Atlas Pipeline Partners (NYSE: APL), a deeply depressed stock that pays a very high dividend. Click here to read the story].

Chris is nervous, but excited. “I never expected to see stocks as cheap as they are today,” he said. “I had always assumed that deep value stocks became extinct sometime in the 1940s and that I would never see them during my career. But I was wrong. Deep value stocks are reappearing in parts of the stock market. The ENTIRE stock market is not cheap, of course. But many individual stocks are.”

Chris expanded upon this observation in a recent email alert to his subscribers:

“Recently, The Wall Street Journal reported a fact that shows just how extreme some valuations have become out there. According to the WSJ, nearly one out of every 10 stocks trades below the value of its per share cash holdings, “an even greater proportion than [Benjamin] Graham found in 1932.” [Graham, author of "The Intelligent Investor," is legendary among us value investors as the "Father of Value Investing."]

The year 1932 was horrific for stocks. By July 9 of that year the Dow Jones Industrial Average had collapsed 91% from its 1929 peak. So it’s hard to believe that there are more stocks trading below their cash balances now than in 1932. Amazing!

Or to put it more specifically, of the 9,194 stocks Standard & Poor’s tracks, about 876 trade below their per share cash holdings. In theory, you could drain the cash in these companies’ treasuries to buy the whole company and get everything else for free.

Loews Corp. (NYSE: L) isn’t quite that cheap, but it is VERY cheap. For starters, the stock is 40% cheaper than when I first recommended it to my subscribers. But that’s not all. At the current quote of $26 per share, Loews trades for just under 6 times earnings and has $3.5 billion of net cash — or about 30% of its market cap. If you net out that cash, Loews’ price-to-earnings ratio slips to well under 5. That’s incredibly cheap for such a well-financed company.

Even better, the company’s net asset value comes in around $40 per share. Much of that NAV is in publicly traded companies. So it’s easy to figure the values. And they are good investments on a stand-alone basis. Loews owns stakes in Boardwalk Pipelines and Diamond Offshore, both of which look like bargains. If these shares rise in value, as I expect they will, Loews’ NAV will also rise. In other words, Loews is cheap on its own merits as is, and you get its cheap portfolio, too. Loews is also a buy.

There are a lot of these kinds of opportunities out there now. At least in pockets, we have the kind of true Depression-era valuations that Ben Graham would have recognized. Old Ben Graham is more relevant now than ever because the market we are in increasingly resembles the ugliness of 1930s, when Graham plied his trade. Graham wrote in 1932, and I think it will prove true today: “In all probability, [the stock market] is wrong, as it always has been wrong in its major judgments of the future.”

Source: Soldiers of Fortune