We've made money for our clients in the past in basically one way: find inexpensive companies in strong industries. Inexpensive companies are easy to find, strong industries are not.
Microsoft is plenty cheap at about a 10% free cash flow yield, but the revenue trend is undoubtedly down. Remember when infrastructure spending was going to boost all the machinery stocks? The 22,000 being let go by Caterpillar are wondering the same thing.
When an industry is going well, revenues go up, margins go up and multiples go up in a virtuous cycle. We are now witnessing the opposite.
Has the market discounted the worst? Hard to say. But, if estimates aren't low enough, stocks will follow estimates lower. Take Microsoft again. Consensus estimates for Fiscal 2010 (ending June 2010) are for about $2.00/share. I think those numbers could be 25% lower. Sure, the company will generate boatloads of cash, but (a) what returns will they get with it? and, (b) what is the future trend of their revenues?
Before everyone gets all excited about the market bottoming, let's also entertain the possibility that delevering, lower revenues and lower margins may not be so good for the stock market. One day, the bottom callers will be right,the question is how much will they have left when we get there?
