Deep-Value Investing in the "G Ice" Age

Marcin and his partner, Steve Epstein, sat down with Barron's last Monday at Defiance's offices in Conshohocken, Pa., just outside Philadelphia. Defiance won't be found in stocks like General Electric, Coca-Cola or ExxonMobil. What Marcin does like includes Cummins, a maker of diesel engines; Western Digital, a disk-drive producer, and Skechers, a shoe maker that specializes in quality knockoffs. All three have two things in common: low valuations and high growth.

Barron's: How is Defiance different from all the other value managers?

Marcin: We're among the deepest-value managers out there. The average P/E of the longs in our portfolio is nine. These companies are showing average annual earnings growth of 15%. All of them have good balance sheets.

That seems too good to be true.

Marcin: I call it too-good-to-be true investing. When a stock gets too good to be true, it can achieve a fair valuation through an appreciating share price or deteriorating fundamentals. We have a portfolio of companies that is growing strongly now that is compellingly undervalued with significant upside. The valuations are low enough that we have a fair margin for error. We look for companies that are doing well whose stocks are cheap.

Would that rule out a stock like Pfizer, which trades at just eight times earnings?

Marcin: We don't own Pfizer. It's not growing.

Where are you finding companies you like?

Marcin: We have coined a term called G Ice. It stands for global infrastructure, commodity and energy. It captures many different industries, including construction, machinery, energy and even technology.

What excites you about this investment theme?

Marcin: Many people today still don't realize that the growth companies of this decade are global infrastructure, commodity and energy companies and not necessarily firms making deodorant, soda, diapers or drugs. We're not buying yesterday's winners that are now trading for 20 times earnings. Coca-Cola is a great company but it's a 20-P/E stock that has annual earnings growth of 10%. I want to buy the reverse, a 10 P/E stock growing at 20%. For the past 20 years, people thought the only areas of secular growth were consumer products, health care and technology. They treated economically sensitive companies as deep cyclicals and didn't value them properly. These are the growth industries of this decade and if you put market multiples on Terex (TEX), Cummins (CMI) and Western Digital (WDC), you would have much higher prices for the stocks.

Why are these companies trading for such low valuations?

Marcin: There's concern about the U.S. economy and whether the weakness here will spread abroad. We're betting it won't. These companies are satisfying the explosive global demand for energy, commodities and infrastructure. Most every company that we are talking about has 15% annual growth in revenues and profits if the cycle continues, and yet they all trade for around 10 times earnings.