In a rising stock
market
, it pays to focus on a company's
income statement
. Each move up in the share price usually correlates to the
company's bottom-line performance. But when the market is in
sell-off mode, you should shift your focus to the
balance sheet
. That's where you can measure a company's real worth and get a
handle on how much risk the stock can hold.
Although a company's
market value
can fall below the level of tangible
book value
on its balance sheet, it is likely to fall much less than most,
even if the broader market plunges to fresh lows. That's no small
concern at a time when the European and Chinese economies are now
weakening. Fresh reports point to a global economic slowdown, and
you should be focusing on defensive "below book" stocks right now.
These carry solid upside like growth stocks, but defensive stocks
that trade below tangible book value will allow you to sleep better
at night.
After reviewing the 1,500 stocks that comprise the S&P 400
(which tracks
mid-cap
stocks), S&P 500 (large-caps) and S&P 600 (small caps)
indices, I've found that roughly 7% of them trade below tangible
book value right now. These are the stocks should be catching your
eye right now. And I'll share my thoughts on three of them in
a moment.
But first a quick note... A lot of these "below book" stocks are
in the financial services sector, including big banks such as
Morgan Stanley (NYSE:
MS
)
, at 51% of tangible book,
Bank of America (NYSE:
BAC
)
at 51%, and
Citigroup (NYSE:
C
)
, at 53% of tangible book. If you're a follower of my
$100,000 Real-Money Portfolio
, then you know I've been pounding the table on these stocks for
some time now. These banks are under huge pressure right now on
fears that the Greek economic crisis will de-stabilize global
financial markets. If and when this crisis is diffused, these banks
may post a huge rally.
Here are three other "below book" plays that are in my sights
right now...
1. Arkansas Best (Nasdaq:
ABFS
)
This trucking firm delivered a sub-par first quarter, and
shares
have been pummeled, falling more than 50% from the
52-week high
. First-quarter sales of $440 million missed forecasts by about $10
million. And for a company that has relatively high labor costs,
sales
leverage
is crucial. Analysts at Citigroup "believe Arkansas will see weaker
margins than peers until the cost structure disadvantage from its
union contract is resolved."
But the sell-off has gone too far. The company's market value of
$330 million is far below the $449 million on the balance sheet.
Said another way, nearly half of the company's market value is
supported by the trucker's $183 million net cash position. Of
course investors are concerned that a slow
economy
could cause that balance sheet to weaken. Yet Arkansas Best has
generated negative
free cash flow
only once in the past eight years, when it shed $59 million in
2009. Notably, the trucking industry has become much leaner since
2009, and it's highly unlikely that free cash flow will turn
negative this time around -- assuming a mild U.S.
recession
.
Meanwhile, shares are so cheap that Citigroup, which has a
"Neutral" rating on the stock, still suggests shares are worth $18
-- 40% above current levels. That target price is just three times
Citigroup's projected 2012
EBITDA
forecast. It also happens to coincide with tangible book value.
2. Century Aluminum (Nasdaq:
CENX
)
Though
Alcoa (NYSE:
AA
)
remains my favorite aluminum producer due to its industry-leading
cost structure, it's very hard to deny the appeal of this
second-tier producer, which would benefit from the same pricing
dynamics from which I expect Alcoa to eventually benefit.
Spot
aluminum prices at a recent $0.90 per pound are leading to
significant industry output cuts, which should benefit pricing down
the road. But the industry is in pain right now, as evidenced by
the fact that Century Aluminum's market value has fallen more than
50% in the past year to a recent $625 million, even though it
carries more than $1 billion in tangible book value on its balance
sheet.
Even in a tough pricing and demand environment, Century
Aluminum's free cash flow should still be around $0.90 a share this
year, according to Goldman Sachs analysts. They anticipate a modest
rebound for aluminum in the next few years, which should help free
cash flow to hit $1.30 per share by 2014. In that context, the
recent $7 stock price looks like a screaming bargain.
3. Valero (NYSE:
VLO
)
Turning crude oil into gasoline, diesel and other distillate fuels
has historically been a lousy business. International competition
made it very hard for U.S. refineries to generate targeted returns
on capital investments. But the tide is starting to turn. European
refineries are less capable of converting heavy crude oil, and
American counterparts, which are equipped to work with this
lower-cost source of crude oil, are starting to benefit.
As a result, the investment community is starting to warm up to
these oil refining stocks. And some see deep value in Valero, the
nation's largest oil refinery, which also operates a network of
retail gas stations. The key for this stock is to own it when its
return on capital
is higher than its
cost of capital
. That hasn't been the case in recent years, but net returns are
now positive and expected to keep expanding.
Refineries generated positive net returns from 2003 through
2007, and a similar cycle is playing out now. Back then, the sector
traded for about 4.5 times the EBITDA run rate, based on
enterprise value
. By that metric, Valero should be worth around $28 a share. That's
around 25% upside from the recent stock price. This kind of upside
can also be found when looking at the balance sheet. Valero carries
a market value of $12.2 billion but holds $15.7 billion in tangible
book value.
Risks to Consider:
These stocks are all economically sensitive. Anything deeper
than a mild economic recession in the United States could hurt
shares.
Action to Take -->
Though these stocks may lack some of the upside sizzle of
high-growth stocks, they have solid
asset
support and are likely to fare better than most if the market
weakens further. As I said earlier, you should keep an eye on these
types of stocks and pounce on them when you think the time is
right. The three stocks above are a good place to start.
[
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of AA, C in one or more if its "real money" portfolios.