6 “Deep Value” Ideas to Consider

Published June 06, 2012

| TradeKing




Alan Brochstein Explains an Indicator of Value
 
Stock analysts or financial journalists often suggest that a stock is “undervalued”. More often than not, they are talking about the price relative to earnings (PE ratio) being low. Value investors will consider the level of earnings or potential earnings, but they also typically look at other metrics of valuation as well. One of the more popular measures of value is to compare the price to the “book value”, which is the difference between the assets and liabilities of the company divided by the number of shares outstanding.

This ratio, which is also known as “P/B”, can be very helpful as an additional or even substitute measure for PE, like, for instance, when a company is losing money, which makes the PE ratio meaningless. The thinking is that if the value of the stock is less than the carrying value of its assets less its liabilities, it must be a good deal. In theory, the assets can be sold and the liabilities paid off, leaving the shareholder with more than the value of the stock.

Unfortunately, like most tools, P/B suffers from some potential challenges. For instance, sometimes the assets aren’t worth as much as believed and need to be “written down”. Perhaps the inventory can’t be sold. Maybe the receivables can’t all be collected. Possibly, the factory isn’t worth as much as expected to another user. These are just some of the potential pitfalls to relying upon the book value.

Some assets aren’t as concrete as others – these include goodwill and intangibles, which can result from acquisitions. If the company is liquidated, these assets are unlikely to be worth as much as when the company is in operation.

Despite the shortcomings, I think that the P/B measure can be useful for identifying potential opportunities, but I prefer to consider price to tangible book value (P/TB), which excludes the goodwill and intangibles. When the P/TB is less than 1, it can signify “deep value”, a term often attributed to the teachings of Ben Graham, who popularized the notion of buying stocks below book value.

I often look at companies trading below tangible book value, but I take steps to improve the odds of success when I consider recommending the stocks. First, I like to see that the company has been profitable. Second, I avoid stocks with substantial debt, as the stock holder can ultimately lose control of the company to the holders of the debt. With these constraints in mind, I decided to screen for some potential “deep value” opportunities. Here are the parameters I employed:

·       Member of Russell 3000 (2928 companies)
·       P/TB < 1 (374 companies)
·       EPS > 0 (264 companies)
·       Debt to Capital < 10% ( 71 companies)
·       Market Cap > $500mm ( 20 companies)

Most of the stocks that qualified were Financials, many of which have substantial leverage that isn’t technically debt. While a few of these appear to be worth considering, I restricted the final list to those stocks outside of that sector. Here are the six that made the cut:
 


The companies that made the list, which is sorted from low to high on the price to tangible-book-value metric, aren’t recommendations. As always, you should do your own investigation before purchasing any stock.

The source of the data in the table is Baseline. I highlighted several different characteristics. Note that five of the six companies have more cash than debt, which is positive. Also, three of the stocks trade below 10PE on a trailing basis, and all but one trade at below 10X projected 2013 earnings. Two of the companies have grown sales and earnings over the past year, while the other four have experienced modest declines in sales. All of the companies are expected to grow earnings in 2013, and four of the companies have grown earnings over the past five years.

I own AVX (AVX) and Tech Data (TECD) in my Top 20 Model Portfolio, so I am most familiar with them and believe that they do indeed offer tremendous value. AVX manufactures ceramic capacitors used in a variety of applications, while TECD is a distributor of IT hardware and software focused on Europe and the Americas. AVX is majority owned by Kyocera (KYO).

Benchmark (BHE) is a contract manufacturer, while Triquint Semiconductor (TQNT) makes semiconductors used in communications. Fresh Del Monte (FDP) markets fresh fruit and vegetables to Europe, Africa and the Middle East, while Murphy Oil is a producer of oil and gas, and it also refines and markets petroleum products.

This screen is designed to identify some potential investment opportunities that may also offer some downside protection in the event the market remains challenging. Keep in mind that screening is only an initial part of a more complete process, which includes a more thorough investigation of the company’s prospects. As I have shared, using P/TB can be helpful, but it isn’t a fail-proof tool. I wouldn’t be surprised to learn that candle making companies traded below book value when electric light bulbs took off!


Regards,
Alan Brochstein
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator

Disclosure:  Long AVX and TECD in models at Invest By Model

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