Ten Undervalued Stocks with Encouraging Profitability

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(Written by Rebecca Lipman. List compiled by Eben Esterhuizen, CFA. ROE data sourced from Google Finance, all other data sourced from Finviz.)

Are you the type of investor who likes to take a closer look at company profits? Do you value the opinions of stock market legends? If so, you’ll probably enjoy the following list.

We start by considering the wisdom of Benjamin Graham, a former mentor of Warren Buffett and the so-called “Godfather” of value investing. He is also the creator of the Graham Number from which we can help identify the maximum price a stock is worth. (More details below)

For this list we started with a universe of stocks with market caps above $300 million and screened for companies that appear significantly undervalued to the Graham number.

Next we considered that companies can earn profits in different ways – some more preferred than others. So we looked at the profitability trends of the potentially undervalued names using the DuPont analysis of return on equity (ROE) profitability.

ROE can be broken up into three components such that increases in ROE can be attributed to those components.

ROE
= (Net Profit/Equity)
= (Net profit/Sales)*(Sales/Assets)*(Assets/Equity)
= (Net Profit margin)*(Asset turnover)*(Leverage ratio)

We took only the names showing the most encouraging profitability trends. (More details below)

For a more in-depth look at the Graham equation and DuPont breakdown, take a look at the following information before starting your analysis on the list below:

The Graham Number is the maximum price that a value investor should pay for a given stock. A stock whose share price is below the Graham Number is considered to be undervalued or of good value.

It is a calculation for the fair-value price of a stock based on its earnings per share (EPS) and book value per share (the value of the company’s assets divided by the number of shares).

The Graham Number = Square Root of (22.5) x (TTM EPS) x (MRQ Book Value per Share).

We use the Graham Number to screen for potentially undervalued stocks

Note: The market does not price stocks based on the Graham Number, so share prices could increase significantly above the Graham Number, or fall far below it. This is also just one of many ways to value a stock.

Return on Equity (ROE) is a widely-used profitability measure. The problem with this is that profitability can come from many sources – some better than others.

In the 1920s, the DuPont Corporation developed a useful equation that breaks down ROE into three components.

ROE = Net Profit Margin x Asset Efficiency x Financial Leverage

Net profit margin reflects cost structure, asset efficiency reflects productivity, and financial leverage is use of debt. Increases in any of the three can contribute to increased ROE.

In general, an encouraging DuPont breakdown implies one or more of the following:

Increasing Net Profit Margin, i.e. higher Net Income/ Revenues
Increasing Asset Efficiency, i.e. higher Sales/Assets
Decreasing Financial Leverage ratio, i.e. lower Assets/Equity

In other words, it is preferable for ROE to rise because of higher net profit margins or asset efficiency. Increasing financial leverage, which would increase ROE, is not always a positive development for a company.

Now that you’re prepared, let’s take a look at the list below. Use it as a starting-off point in your own analysis.

Analyze These Ideas (Tools Will Open In A New Window)

1. Access a thorough description of all companies mentioned
2. Compare analyst ratings for all stocks mentioned below
3. Visualize annual returns for all stocks mentioned

1. Frequency Electronics Inc. (FEIM): Engages in the design, development, and manufacture of high-technology frequency, timing, and synchronization products for satellite and terrestrial voice, video, and data telecommunications. MRQ net profit margin at 8.41% vs. 4.21% y/y. MRQ sales/assets at 0.173 vs. 0.15 y/y. MRQ assets/equity at 1.256 vs. 1.28 y/y. Diluted TTM earnings per share at 0.82, and a MRQ book value per share value at 8.83, implies a Graham Number fair value = sqrt(22.5*0.82*8.83) = $12.76. Based on the stock's price at $9.15, this implies a potential upside of 39.49% from current levels.

2. Beasley Broadcast Group Inc. (BBGI): Engages in acquiring, developing, and operating radio stations in the United States. MRQ net profit margin at 11.02% vs. 8.18% y/y. MRQ sales/assets at 0.1 vs. 0.099 y/y. MRQ assets/equity at 3.777 vs. 4.499 y/y. Diluted TTM earnings per share at 0.43, and a MRQ book value per share value at 2.96, implies a Graham Number fair value = sqrt(22.5*0.43*2.96) = $5.35. Based on the stock's price at $3.84, this implies a potential upside of 39.36% from current levels.

3. Greatbatch, Inc. (GB): Provides technology solutions for medical and industrial applications. MRQ net profit margin at 5.84% vs. 5.53% y/y. MRQ sales/assets at 0.179 vs. 0.171 y/y. MRQ assets/equity at 1.767 vs. 2.098 y/y. Diluted TTM earnings per share at 1.7, and a MRQ book value per share value at 19.85, implies a Graham Number fair value = sqrt(22.5*1.7*19.85) = $27.55. Based on the stock's price at $20.1, this implies a potential upside of 37.09% from current levels.

4. ICF International Inc. (ICFI): Provides management, technology, and policy consulting and implementation services to government, commercial, and international clients. MRQ net profit margin at 4.2% vs. 3.61% y/y. MRQ sales/assets at 0.369 vs. 0.351 y/y. MRQ assets/equity at 1.553 vs. 1.701 y/y. Diluted TTM earnings per share at 1.57, and a MRQ book value per share value at 18.86, implies a Graham Number fair value = sqrt(22.5*1.57*18.86) = $25.81. Based on the stock's price at $19.3, this implies a potential upside of 33.74% from current levels.

5. HB Fuller Co. (FUL): H.B. Fuller Company formulates, manufactures, and markets adhesives, sealants, paints, and other specialty chemical products worldwide. MRQ net profit margin at 5.99% vs. 5.61% y/y. MRQ sales/assets at 0.302 vs. 0.287 y/y. MRQ assets/equity at 1.724 vs. 1.975 y/y. Diluted TTM earnings per share at 1.7, and a MRQ book value per share value at 15.23, implies a Graham Number fair value = sqrt(22.5*1.7*15.23) = $24.14. Based on the stock's price at $18.3, this implies a potential upside of 31.89% from current levels.

6. Curtiss-Wright Corp. (CW): Designs, manufactures, and overhauls precision components and systems. MRQ net profit margin at 6.18% vs. 5.6% y/y. MRQ sales/assets at 0.217 vs. 0.207 y/y. MRQ assets/equity at 1.907 vs. 2.09 y/y. Diluted TTM earnings per share at 2.59, and a MRQ book value per share value at 26.76, implies a Graham Number fair value = sqrt(22.5*2.59*26.76) = $39.49. Based on the stock's price at $29.96, this implies a potential upside of 31.81% from current levels.

7. IXYS Corp. (IXYS): Engages in the development, manufacture, and marketing of power semiconductors, advanced mixed signal integrated circuits (ICs), application specific integrated circuits (ASICs), and systems and radio frequency semiconductors. MRQ net profit margin at 9.81% vs. 7.69% y/y. MRQ sales/assets at 0.301 vs. 0.298 y/y. MRQ assets/equity at 1.399 vs. 1.547 y/y. Diluted TTM earnings per share at 1.23, and a MRQ book value per share value at 7.66, implies a Graham Number fair value = sqrt(22.5*1.23*7.66) = $14.56. Based on the stock's price at $11.08, this implies a potential upside of 31.41% from current levels.

8. CACI International Inc. (CACI): Provides information technology (IT) and professional services to the U. MRQ net profit margin at 4.77% vs. 3.52% y/y. MRQ sales/assets at 0.415 vs. 0.378 y/y. MRQ assets/equity at 1.775 vs. 1.917 y/y. Diluted TTM earnings per share at 4.61, and a MRQ book value per share value at 43.28, implies a Graham Number fair value = sqrt(22.5*4.61*43.28) = $67.0. Based on the stock's price at $51., this implies a potential upside of 31.38% from current levels.

9. Solutia Inc. (SOA): Engages in the manufacture and marketing of performance materials and specialty chemicals used in a range of consumer and industrial applications. MRQ net profit margin at 12.52% vs. 8.17% y/y. MRQ sales/assets at 0.149 vs. 0.147 y/y. MRQ assets/equity at 3.82 vs. 6.81 y/y. Diluted TTM earnings per share at 1.88, and a MRQ book value per share value at 7.82, implies a Graham Number fair value = sqrt(22.5*1.88*7.82) = $18.19. Based on the stock's price at $13.94, this implies a potential upside of 30.47% from current levels.

10. Rofin-Sinar Technologies Inc. (RSTI): Designs, develops, engineers, makes, and markets industrial lasers and supplies used for material-processing applications worldwide. MRQ net profit margin at 9.84% vs. 8.77% y/y. MRQ sales/assets at 0.236 vs. 0.215 y/y. MRQ assets/equity at 1.374 vs. 1.378 y/y. Diluted TTM earnings per share at 1.89, and a MRQ book value per share value at 16.8, implies a Graham Number fair value = sqrt(22.5*1.89*16.8) = $26.73. Based on the stock's price at $20.5, this implies a potential upside of 30.38% from current levels. 



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks


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