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The Very Best Value Plays for Patient Investors
By: David Sterman
Long before the days of growth stocks, investors used to search
for value in stocks that were trading for less than the net assets
on their balance sheets. It was a tried-and-true formula for
protecting your downside while searching for upside.
The stock market's original gurus - Columbia Business School's Benjamin Graham and David Dodd - laid out a pretty simple premise in their 1934 book Security Analysis : Since we have no crystal ball that tells us where a business is headed, we can only place a value on things we already know. And we know that if a company chose to shut down tomorrow, sell off its assets, pay off its debts, and turn it all into cash, we can get a sense of what value exists. This is a company's tangible book value , which excludes non-cash balance sheet items such as goodwill and amortization. And as those esteemed authors noted, if the stock market's value of a company (known as market capitalization) is less than that tangible book value, then you've got a potential bargain.
In theory, a stock's value should never fall below tangible book value, because investors should bid shares back up right to the point where those two values are equal -- also known as "trading at book." But the market is never that efficient. Sometimes, a stock will fall below its intrinsic worth and trade well below tangible book value. In bull markets, you can always find a few dozen stocks trading below book. And in markets like the current one, you'll find hundreds.
In some instances, investors are right to ignore stated book value. For example, if a company is losing money, cash will decline and so will book value. Alcoa (NYSE: AA ) , which kicks off earnings season every quarter, is a fine example. Tangible book value has fallen from $12.76 per share at the end of 2007 to a recent $7.40. Shares fell down to just $5 at the height of the economic crisis, because investors knew that tangible book value would keep shrinking in the face of open-ended losses.
In other instances, a company will carry assets at their cost, but those assets may no longer be worth as much. For example, oil refiners Valero (NYSE: VLO ) and Western Refining (NYSE: WNR ) spent billions of dollars to build massive facilities to produce gasoline and diesel fuel. But the industry is awash in too much capacity, and neither firm would get all of its money back if they wanted to sell some of those refineries.
In some extreme instances, these stocks not only trade below book value, but below cash levels. Telecom equipment maker Sycamore Networks (Nasdaq: SCMR ) is valued by investors at roughly $500 million. Yet Sycamore has roughly $635 million in short and long-term investments.
Presumably, a rival could come along and pay a 25% premium to the company's current market value and get the whole business for free by sucking out that cash. This is a clear instance where Graham & Dodd would be scratching their heads.
I ran a screen and found hundreds of stocks trading below book. I've greatly condensed that list for you by, among other things, placing a $500 million minimum on market value. I've also eliminated a number of financial services firms due to anomalies associated with the stated values of their assets and liabilities (though we retained some financial names on the list that do represent clearly-valued balance sheet items).
|Company (Ticker)||Market Cap.||Recent Price||Tangible Book Value Per Share||Price as Percentage of Book Value|
(NYSE: TRN )
(NYSE: RDC )
|OM Group (NYSE: OMG )||$743M||$24.08||$27.02||89%|
|Bristow Group (NYSE: BRS )||$1.1B||$31.75||$36.41||87%|
(NYSE: CKH )
|Ameren Corp (NYSE: AEE )||$5.9B||$24.90||$29.04||86%|
|Ingram Micro (NYSE: IM )||$2.6B||$15.60||$18.32||85%|
|CapitalSource (NYSE: CSE )||$1.7B||$5.29||$6.22||85%|
(Nasdaq: CENX )
|Kaiser Alum. Corp.
(Nasdaq: KALU )
|Questar Corp. (NYSE: STR )||$2.8B||$16.22||$19.31||84%|
|Globalstar (Nasdaq: GSAT )||$506M||$1.69||$2.02||84%|
(NYSE: CEG )
|Helix Energy (NYSE: HLX )||$1.1B||$10.41||$12.71||82%|
(Nasdaq: WINN )
|Piper Jaffray (NYSE: PJC )||$640M||$30.82||$38.50||80%|
(NYSE: PNM )
(NYSE: RCL )
(NYSE: LPX )
(NYSE: VLO )
|Dillard's (NYSE: DDS )||$1.5B||$21.45||$31.21||69%|
Ingram Micro (NYSE: IM )
As the table shows, some stocks trade for sharp discounts to book value. And many of these stocks have likely found a floor, even if the rest of the market slumps further. For example, shares of Ingram Micro, the world's largest distributor of office equipment and electronics, have fallen to just 85% of tangible book value on fears that European sales will slump in coming quarters.
But value investors should be ready to pounce. That's because tangible book value has risen from $10.59 in 2004 to a recent $18.32. Almost all of that gain is attributable to a rising cash hoard, which now approaches $1 billion. And that figure is likely to keep rising, as Ingram Micro should remain nicely profitable, even if European sales slump. Ingram Micro has never lost money (excluding a one-time charge in 2009) in its history.
Dillard's (NYSE: DDS )
There are two things you need to know about this long-standing department store chain. Management has a very spotty track record in terms of sales and profit growth, and the company is sitting on a gold mine in terms of real estate . The company's portfolio of stores is likely worth at least the $3 billion that it is being valued on its books. Yet the whole company is valued at less than half of that figure.
Dillard's results are sharply improved this year, as earnings per share should more than double. But the country is still awash in too much retail space. So Dillard's would need to wait before trying to raise cash by selling any stores. But if it comes to that, investors should note that many of Dillard's stores are situated in prime locations. Meanwhile, the whole company is valued at just 69% of tangible book value.
Royal Caribbean (NYSE: RCL )
A cruise ship just isn't worth as much anymore. They cost oodles of money to build, and are currently being packed in with discount-seeking bargain hunters. Many ships are barely generating more profits than the loans taken out to pay for them. Part of the problem stems from a glut of cruise ships that were built while the economy was humming. It takes several years to build a ship, so new ones kept coming, even as the economy slumped.
But over time, demand for cruises should catch up with supply, and the value of the cruise ships built by Royal Caribbean will start to rise back to the value of their construction costs. Shares would need to rise by 21% just to get back up to tangible book value.
Action to Take --> These value situations require patience. Indeed, Graham & Dodd preached " Buy and Hold ." In the meantime, these stocks are likely to fall by less than other stocks that trade far above book value. So you get (eventual) reward without too much risk. Of these companies profiled, Ingram Micro is the most likely to see tangible book value keep rising, while investors in Royal Caribbean and Dillard's will need to wait for the market for their assets (ships and real estate , respectively) to become better appreciated.
-- David Sterman
David Sterman has worked as an investment analyst for nearly two decades. He started his career in equity research at Smith Barney, culminating in a position as Senior Analyst covering European banks. David has also served as Director of Research at Individual Investor and has made numerous media appearances over the years, primarily on CNBC and Bloomberg TV. David has a master's degree in management from Georgia Tech. Read More...
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.StreetAuthority