One of the biggest weaknesses of the
research model is that it tends to focus on stocks that are able to
make the fastest upward move, failing to really look at which
stocks could post strong returns over the long haul. As a result, a
number of solid long-term investment opportunities simply fall
through the cracks.
But it hasn't always been this way.
Back in the days of Benjamin Graham and David Dodd -- both known as
the grandfathers of value investing -- an emphasis was placed on
stocks as assets. These investors focused on what a company was
worth in relation to its assets, the defensibility of its
, and the level of
that could be sustainably produced throughout the years.
Every once in a while, I come across what Icall a "Graham &
Dodd special." These opportunities typically involve large,
well-established businesses that operate in an industry with deep
barriers to entry. They often involve large amounts of capital
spending, creating an impediment to new firms looking to crack the
. And they can count on a steady recurring base of customers that
need to keep coming back to them.
My Graham & Dodd stock for 2012:
Goodyear Tire & Rubber (NYSE:
, which is currently deeply out of favor and remarkably cheap by
almost any measure. Assuming we'll be driving vehicles that have
tires in the next five or 10 years, this is a company with staying
power. Yet you won't find Goodyear on any Wall Street's lists of
top stock ideas. Simply put, it's an unsexy business that isn't
poised to outperform the market in the next few weeks or
The stock chart above paints a pretty clear picture. For a moment,
forget the financial crisis of 2008 that severely punished all
kinds of stocks. That anomalous event is highly unlikely to recur.
Excluding that brutal period, this stock is near a four-year low,
trading for less than half of what it did before the global
began a multi-year slump.
Shares of Goodyear remain in a deep funk, even as the North
American market gets stronger. Nowadays, it's Europe that weighs
heavily. Yet as soon as the continent's economy hits bottom, we may
see a fairly solid snapback in European vehicle sales. That market
has been depressed for five years, and the average vehicle age
creeps ever higher. We're seeing a snapback in the United States
now, and will likely see one in Europe in a year or two.
Meanwhile, note how cheap this stock has become. At a recent $11,
Goodyear trades for 4.5 times projected 2013 profits and sports a
price-to-sales ratio of 0.12. Yet these numbers may not always give
an accurate gauge of what a company should be worth. Instead, let's
look at how this company is valued in relation to historical and
free cash flow
Goodyear carries a
of $2.7 billion and an
of $5.8 billion. Cash flow generation can be erratic, because it's
largely tied to raw materials (rubber) prices and unit volumes. In
2009, EBITDA fell to a decade-low of $580 million, but it rebounded
to a decade-high of $1.67 billion in 2011. During the past eight
years, EBITDA has averaged $1.2 billion. This means the company
trades for less than five times normal EBITDA and less than four
times trailing EBITDA. For a company with such a solid base of
recurring revenue (sales bottomed out at a decade low $16.3 billion
in 2009 and are already back above $22 billion), and a strong
global brand, that's a very low EBITDA multiple.
Using free cash flow (
) as a measure, Goodyear doesn't look as appealing. The company has
only reported positive free cash flow in one of the past three
years, or a cumulative $236 million in the past three years. The
explanation is simple. Goodyear routinely spent $600 million to
$700 million on annual capital spending (2004 through 2009), but
management has decided to step on the gas. Goodyear spiked
by $300 million to $400 million above usual levels in each of the
past two years so it could modernize plants and lower long-term
manufacturing costs. This move should set the stage for much more
robust free cash flow in coming years.
2012: A lost year?
Goodyear's stock stood at $15 in early January but is now down
about $11. This suggests investors have thrown in the towel on
2012, perhaps noting that unit sales of tires are expected to be
down this year. Yet it's important to see the total revenue figure
and not just sales volumes.
Goodyear has pushed through a series of price hikes in all of its
key markets, which will more than offset the sales decline in
. As a result, sales are expected to rise around 3% this year to
$23.5 billion and another 6% in 2013 to nearly $25 billion. That
consensus forecast looks too conservative, because it appears to
imply that 2013 tire sales will be even worse than 2012, blunting
what will likely be high single-digit price increases, if recent
history is any guide.
But even if 2012 is seen as a "lost year" because of weak global
demand, it's worth noting the expected
of $1.85 per share will still be near record levels. And analysts
say the heavy capital spending I noted earlier will lead to firming
margins in 2013, which could propel
earnings per share (
to $2.50. Merrill Lynch says this figure could exceed $3 by 2014,
which isn't bad for an $11 stock. Operating margins could hit a
record 6.0% by 2014, thanks to those internal investments I
Still, investors are unloading this deep-value stock right now. "A
large Q1 beat, confident 2013 affirmation, debt refinancing
and improving pension metrics were met with a 5% stock sell-off
that we, along with many investors, found puzzling," note analysts
at Citigroup, who maintained their $21
Risks to Consider:
Rubber prices are always a wildcard, so any sort of troubles on
that front will impede margins for Goodyear.
Action to Take -->
There's really no reason to
of Goodyear at this moment. Unless, of course, you want to own
companies that have a tremendous long-term track record and sport
very low valuations. What this stock lacks in
it more than makes up for in safety, stability and a path to higher
profits within a few years. And if shares reach that $21 price
target set by Citigroup, you'd have nearly doubled your money if
you bought at current prices.
If you haven't heard about this unique opportunity, then I want to
tell you about it now. StreetAuthority has staked me with
$100,000 of real money
to invest in my absolute best ideas. For a limited time, you'll be
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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