Buying Stocks For Pennies On The Dollar

By Aaron Levitt | April 26, 2010 AAA

With the S&P 500 - SPDR S&P 500 ETF(NYSE: SPY) - reaching new highs and analyst's calling bubbles in various asset classes like Chinese real estate - Claymore/AlphaShares China Real Estate ETF (NYSE: TAO) - stocks are no longer as cheap as they were when the financial crisis began. Investors are facing the quandary of where to place their money.

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Interest rates, although rising, are still paying next to nothing, and Greece's and Spain's debt problems still plague the markets headlines - risk control is still on many investors' minds. Many portfolios have shifted gears and there has been a return to quality as of late. Dividend stocks and their underlying funds such as iShares Dow Jones Select Dividend Index (NYSE: DVY) have been some of the best performing assets so far in 2010. However, there are some ways for investors to buy quality blue-chip assets at close-out prices.

High Quality Stocks at Flea-Market Prices
Generally misunderstood by investors, closed-end funds may be the ticket to adding quality blue chips to a portfolio. As a cross between ETFs and mutual funds, closed-end funds trade on the stock market with a fixed number of shares. The funds are actively managed and unlike a mutual fund, allow managers to be fully invested. However, due to supply and demand, many times the unit's trade for discounts to their net asset values (NAV), allowing investors to pick up stocks for pennies on the dollar.

By exploiting that discount, investors can find some great holdings for the long term. For example, if a closed-end fund is trading at a 10% discount to its net asset value , you effectively get a dollar's worth of assets for 90 cents. Looking for blue chips, investors can place their bets with many of the grandfather funds that have been trading since the 1920s. These funds are battle tested, having long histories of investing in good times and bad, and represent good core long-term holdings.

Adding Old Granddad to a Portfolio
The Adams Express Corporation (NYSE: ADX) was founded in 1840 originally as a courier service specializing in the transport of stock securities and other related documents. However, by the end of the 1920s Adams became more of a holding company for various investments and, finally, converted into a closed-end fund in 1929. Currently, the fund trades at an attractive 15% discount to holdings. These include portfolio stalwarts PepsiCo (NYSE: PEP) and Unilever (NYSE: UL). The fund also has a large position in Petroleum & Resources (NYSE: PEO), itself a closed-end fund trading at a 12% discount. Adams currently pays around a 2% dividend.

With a turnover ratio of 25%, meaning it typically holds stocks for four years, General American Investors (NYSE: GAM) is positioned for the long term. Focusing on growth companies, such as Costco Wholesale (NASDAQ: COST), General American trades at 12% discount to its NAV and has outperformed the S&P 500 over the past one-, five-, 10- and 20-year periods.

Bottom Line
The broad stock market has experienced massive gains over the past several months and many assets are no longer as "cheap" as they once were. Even dividend-paying blue chips have risen by quite a bit. Investors willing to take a look at some old closed-end funds can pick up some great stocks for pennies on the dollar. The previously mentioned funds, as well as Central Securities (NYSE: CET) with its 18% discount, make great long-term core holdings and should see their discounts evaporate as the market continues to grow. (For more, see Uncovering Closed-End Funds.)

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