Follow the Long-Term Winners' Picks

• ByTim Melvin, RealMoney.com Contributor
• On 10:59 am EDT, Tuesday May 19, 2009

As I wrote on Friday, I spent most of last week in Naples, Fla. Although my purpose for traveling to southwest Florida was to attend some business meetings, I added a few days to the trip to explore the area that was ground zero for the credit and real estate crisis.

On my last night there, I had dinner with some friends who are involved in the markets. During the course of dinner, I was asked what investors should be watching for as an indication of what was going to happen in the markets.

My answer was that the first two things you must watch are real estate and unemployment. These are the absolute keys to a real recovery in the market and the economy. Until we stop losing jobs and until real estate prices stop going down, there will be pressure on our financial system.

My second point was that the current bear market is creating one of the greatest opportunities for building permanent real wealth, and that it is important to continually look for bargain-basement opportunities. In addition to your own screening and research, it is important to pay attention to what those successful long-term investors are doing with their money.

Fortunately, securities regulations make this very easy to do. Most managers are required to publicly release their holdings at the end of each quarter. By tracking the portfolio changes, you effectively establish a research department composed of the best minds in the market. You should always do additional investigation of your own, but using these investors as sources for ideas has worked very well for me over the years.

Two of my favorite managers recently filed their forms with the regulators. Both are in the deep-value, distressed and activist corners of the market. These are the sectors investors should be focusing on, as I believe they will the most profitable by a wide margin over the next decade.

The first was the filing of Third Point LLC, the distressed and activist fund managed by Daniel Loeb. Since the fund was founded in 1996, it is reported to have earned 16% or so annually without the use of much leverage, if any. In his recent letter to shareholders, Loeb said he was less pessimistic about where the economy would be at the end of the quarter. The firm is covering its financial shorts and jettisoning what Loeb referred to as doomsday positions such as gold. He said the fund is also finding long positions that offer what he called attractive opportunities.

Third Point established a new position in the home health and hospice company Amedisys in the quarter. As baby boomers age, this is going to be high-growth industry for years to come, in my opinion. The company has exceeded analyst expectations four quarters in a row and is expected to have earnings growth of almost 20% annually for the next five years. Earnings for the first quarter were up more than 50% year over year. In spite of this, the stock trades at a price-to-earnings ratio of just 8.8. The company has a solid balance sheet and is in a good position to make sensible strategic acquisitions.

Third Point also opened a position in Life Partners Holdings, one of the more interesting companies in the marketplace today. The company is in the life insurance settlement business. Simply put, it buys life insurance contracts at a discount from policyholders who are in need of immediate cash. Life Partners then resells these contracts to retail and institutional investors. The company acts as an agent and receives a fee for its services.

Life Partners is growing rapidly, with earnings growth in 2008 of 46% on a 43% revenue increase. In spite of this growth, the shares trade at just 7.9 times earnings. I will also note that 30% of the shares of the somewhat controversial company are sold short, so there is the possibility of a short-squeeze rally in the stock.

It does appear that Third Point is making something of a bet on an aging population. It also opened positions in three major drug companies. In the last quarter it bought Wyeth, Schering-Plough and Pfizer.

Some of these purchases may be arbitrage-related, but the fund remained long all three at quarter's end. It also ventured further into the financial services area on the long side. Loeb added to his activist position in Phoenix Companies and established a position in the money management firm Legg Mason.

Anytime I find something of a non-market nature that I believe is noteworthy, I like to pass it along. First, the restaurant where we dined last week is a discovery worth noting. Longtime restaurant executive Don Smith and his wife Angela opened Angelina's in Bonita Springs last year, in defiance of the economy. If you are anywhere in the area, this is one of the best new upper-end establishments I have found in years, and it is well worth visiting.

The second discovery is the Peter Bowen series of Gabriel Dupree novels. They are a great way to escape the real world for a while. Find them and read them if you enjoy good mysteries with solid writing and great characters.

Tomorrow I will look at the activities of one of the few investors who publicly predicted the financial crisis. David Einhorn of Greenlight Partners made some interesting moves in the quarter, and I will discuss them on Wednesday.

Buzz up!