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By Harry Milling | 04-13-2010 11:36 AM

Recipe for Successful Cyclical Investing

Cyclicals investors need a longer-term time horizon, a strong stomach, and a thick skin, says David Wallack of Analyst Pick T. Rowe Price Mid-Cap Value.

Harry Milling: Lastly, you mentioned cyclical companies, and you've done well with cyclical companies, Weyerhaeuser is a good example. It's still one of your top holdings, if not your top holding. What is it about cyclical companies that you like so much? What is maybe the best way to value them? I'm sure that depends on what sector it's in, but is there any sort of common theme when you value a cyclical company? Would you use P/E or would you use something else?

David Wallack: Well I think there are a whole host of valuations techniques that you can use and probably should use when you look at any asset or any stock. We are omnivorous; we will use anything we can to try and understand what an asset might be worth.

In the case of Weyerhaeuser, you have a particularly complex company in the sense that they're in a host of different businesses, each of which is unique. We're attracted often to old companies that have accumulated assets over the years. Here you have a company that's been in business for 100 years. It's the biggest private owner of timber in the United States. It's asset rich.

Over the years, they've acquired and accumulated assets in other businesses. They have one of the biggest lumber operations in the country. They have a fluff pulp business that manufactures pulp that goes into making diapers. They have one of the largest homebuilders in the country buried in Weyerhaeuser that few people know about. There are other assets as well.

So we value each of those separately. We'll value the timber operation based on a DCF-type of analysis, a discounted cash flow analysis. In addition, at some point in time Weyerhaeuser is likely to convert that part of the business into a real estate investment trust, so we've used a REIT type of framework to analyze it.

The lumber operations we value based upon replacement value, private market value, P/E based on future earnings potential of the company.

The fluff pulp business we will use replacement value analysis, and we could also use cash flow or earnings in that perspective.

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