One thing more than any other makes searching for value
difficult these days: Loans.
The best way to search for discounted companies is to set up a
screen that looks at net asset value -- assets minus liabilities.
(To see how profitable value stocks can be, scroll down to the
third table on this page: 12 value stocks, 12 winners, average
gain of +88%!)
If the market capitalization of a company is less than the net
asset value (or "shareholder equity"), then an investor may have
found a bargain, as most companies trade at a multiple to rather
than a fraction of book value.
But loans, believe it or not, totally screw that up. Consider: I
ran a screen seeking U.S. companies with a market cap of more than
$1 billion and a price-to-book ratio of less than 0.75. This
returned about 40 companies, half of them financial institutions.
And each one of them was on the list because of loans.
A loan, at least on the balance sheet, is carried at its historical
cost. If you use $1 billion to make $1 billion worth of loans, then
your books are going to show $1 billion worth of assets, less
whatever amount has been paid back.
The trouble with that, especially these days, is that any given
billion dollars' worth of loans likely isn't worth a billion
dollars because of an increase in the default rate.
Some loans, of course, are going to go bad even in the best of
times. That's never a good thing, but it's to be expected and it is
rightly treated as a cost of doing business.
Today, however, default rates are much higher. They are so much
higher, in fact, that they're far more than a mere cost of doing
business -- something to be subtracted from the asset's overall
return -- and have become a factor that means the value of the
asset must be adjusted.
So even though a bank may have $100 billion in assets, the market
is going to adjust the value of those assets based on the actual
value of the loans rather than their historical cost. And, voila,
you get a whole bunch of banks with "cheap" assets showing up on
value screens. But the assets aren't classically cheap: You're not
getting a deal if you buy these banks, you're getting what looks
like a deal because of the disparity between the historical cost
and the actual value of the assets.
So the trick -- or one trick anyway -- is just to throw out the
banks and look at the other companies in the screen. And there are
some interesting choices:
Three wireless companies made the list:
Sprint Nextel Corp. (
United States Cellular Corp. (
Leap Wireless International, Inc. (Nasdaq: LEAP)
Sprint Nextel hasn't made money for the past five quarters and is
poised to deliver a net loss for 2010 as well. Unites States
Cellular actually turns a profit, but it's already trading at well
above what I would consider a fair valuation given its 2010
earnings outlook, which means it offers only downside. And Leap
Wireless, which sells the popular prepaid Cricket cell phone
service, posted a profit in only two years of the millennium's
first decade and likely will lose even more this year.
Value Verdict: These stocks are cheap for a reason -- no one wants
to own them. The companies aren't making any money and have bleak
futures as far as the bottom line is concerned. Investors should
The Coal-Fired Utilities
Two of the companies on the list are electric utilities over which
hangs a cloud of uncertainty because of the cap and trade bill,
which could restrict their operations or render them unprofitable.
One of the companies is
RRI Energy, Inc. (
. It has had such deep-seated profitability problems --
multi-hundred-million-dollar losses in three of the past four years
as well as the first three quarters of 2009 -- that it can't be
The other, however,
Mirant Corp. (
, bears looking into. The company, which sells power to power
companies rather than to individual customers, is profitable. Very
profitable, in fact: Its operating margins are near 30%. Despite
this, Mirant is trading at only five times its trailing 12-month
earnings, a substantial discount to its typical valuation of about
7.5 times earnings.
This is for two reasons: The first is legislative risk. If Congress
imposes strict emissions controls on power producers, Mirant's
margins could be squeezed to almost nothing. Second, the overall
earnings outlook for 2010 is for less than half the profit Mirant
turned in for all of 2009.
Investors willing to look beyond the upcoming year and who foresee
Mirant engineering its environmental footprint so as to comply and
thrive despite emissions regulation likely see a lot of value in
these shares. The United States will always need power and
utilities will always need to purchase juice beyond their
production capacity to handle peak demand. That bodes well for
Mirant going forward.
The High Yielders
Two of the securities that emerged in my value screen are high
yielders that look extremely promising for value investors who like
a rich dividend stream.
The first is
HRPT Properties Trust (
, which owns commercial real estate in urban cores, much of which
is leased to U.S. government agencies or to medical clinics. Its
assets can be purchased for 65 cents on the dollar, a great deal
given its earnings, which amount to a 7.4% yield. This payout --
amounting to some $26.9 million a quarter -- was easily covered by
roughly $59 million in cash from operations in the most recent
The second high-yielding security my screen found is
Brookfield Infrastructure Partners LP (
, which owns electrical and transportation assets around the world.
These assets offer geographic diversity, with no region composing
more than a third of assets. The assets, power lines, railroads and
forests, also generate steady cash flow -- 73% of revenue comes
either from regulated businesses or long-term contracts. The stock
pays a quarterly dividend and yields a respectable 6.2%. These
assets are available to investors for only 72 cents on the dollar.
These two securities may well be the best this screen uncovered.
You could wade through bank balance sheets until rapture and not
find assets of this quality at these low prices. Both of these
undervalued securities present investors the opportunity to capture
a significant income stream in addition to the possibility of
capital appreciation .
Editor, Government-Driven Investing
P.S. If you're serious about high yields, you need to learn
more about Carla Pasternak's "High-Yield Stock of the
Month" for January 2010. This dominant player delivered +50% gains
in 2009 and saw its earnings surge +69% last quarter. It's never
missed a single dividend payment, dividends have rocketed +800% in
the past five years, and the stock still yields nearly 10%. Keep
Disclosure: Andy Obermueller does not own shares of any security
mentioned in this article.
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