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December 5, 2008
Dead Money

Wish List company Lakeland Industries Inc. has been making a successful push into international markets, the company has a solid balance sheet, and its stock is trading considerably below book value. What this tells us is that investors are expecting the assets of the business – most notably the company’s inventories – to generate negative returns (or less than book) in the future.  Well managed or not, investors may be right…

The problem facing many companies like Lakeland today is that the global slowdown is rapidly spreading and threatening to turn once profitable businesses into dead money.  This is the case not only because activities previously supported by high commodity prices (i.e. mining) are collapsing along with commodity prices, but also because asset deflation/tighter lending standards are amplifying this ongoing destruction in demand. In the case of Lakeland, some of its business lines geared toward non-cyclical industries may remain profitable during this downturn. However, many others will likely not.

What Can Bring Dead Money Back To Life?

The story goes that once all the ‘bad debts’ in the financial sector are erased a new cyclical upturn will be able to take root. A similar theme is also at play in many other industries.  For example, once enough mining capacity is shuttered the price of many metals may rise, once enough plants are closed the automobile industry may stabilize, and as the supply of houses for sale in the U.S. decreases prices will stop falling so rapidly.

The danger with ‘once enough’ thinking is that with so much asset price deflation in the world demand destruction will not be easily reversed. Moreover, there is the risk that as capacity is contracted in various segments of the economy via layoffs and plant closures, this will prompt wave after wave of more demand destruction. The hope from policy makers is that demand can at least be stabilized using emergency stimulus measures as the excess capacity of financial products, commodities, automobiles, etc. is allowed to contract. Suffice to say, for those awaiting their dead money investments to post positive returns this can be a gut wrenching process.

The Investment Horizon From Hell?

Parking capital in dead money stocks can be profitable.  The idea is to select companies that are not only very competitive but also have a strong balance sheet that enables them to withstand challenging times for longer than their counterparts.  In the case of purely commodity driven businesses, the idea is to wait until commodity prices rebound for your ‘dead’ investment to spring to life. With this said, dead money investing can require a great deal of patience, and if the current global recession becomes something akin to a depression, there is the risk that a long-term investment horizon morphs into something closer to forever.

Lakeland, which is one of the only highly ‘cyclical’ companies in the Wish List, has a strong balance sheet and will likely be left standing when the current downturn bottoms.  Some other dead money considerations are listed below. Please note that this is not a recommendation to buy any of these stocks.



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