Here's a stock market tip and it is guaranteed not be part of a Ponzi scheme. Savvy investors, such as the legendary Benjamin Graham, consider a company's book value when deciding which stocks to buy.
What is book value? It is the value of tangible assets, like plant, equipment, inventory and real estate, plus cash and accounts receivables, but not intangible assets such as goodwill. From this is deducted liabilities. Think of book value as the assets remaining if a company goes out of business and is liquidated.
In turbulent markets like we have today, book value provides investors with some degree of reassurance because it does not include assets of dubious value, like subprime mortgages or goodwill. Sure, such tangible assets as real estate and even inventory can lose value, but in general, the value of such assets is not quite as volatile, prone to being manipulated, nor fraught with the potential for unpleasant surprises, as other types of assets.
Right now, with stock prices down sharply, some stocks are looking like good deals based on their price-to-book-value ratio. This ratio says how much you pay for book value. A PBV ratio of 0.95:1 means you are paying only 95 cents for every dollar of book value. Of course, a company typically has additional assets which can have value, such as goodwill and patents. Buying a stock for less than its underlying book value means you've got a nice safety cushion if the company gets into trouble. And if the company does not get into trouble, there is a good chance you got yourself a real bargain.
James P. O'Shaughnessy, one of the gurus I follow, recently noted that three years ago, only nine of the 500 firms in the S&P 500 were trading at prices below their book values; today, 153 of them are. Coming off a period in which many companies' profits were propped up by high leverage, I take this to be a bullish sign because I view book value as often more reliable, more "real", than some profits that have been boosted by lots of debt.
For this reason, I just screened for stocks whose PBV is less than one; stocks where you pay less than a dollar for every dollar of book value. Then I took these stocks and screened them through the Guru Strategies I follow to see which get the approval of at least one of these strategies. Here are four companies whose stock prices are below their book value and that get a passing grade from a Guru Strategy.
One such company is McRae Industries (MRINA). Let me give you a warning about this company: it has a very small cap of about $32 million, so don't go chasing the stock. As I write this, it is trading at about $13; if it sharply shoots up in price, wait for it to fall back. McRae makes military boots (which it has sold to the Israeli Army, as well as the military of the US and other countries), children's shoes and western boots. It also has a subsidiary that is a computer integrator focusing on mobile computing, especially bar code readers. Its PBV is 0.74:1.
The Guru Strategy I base on the writings of Kenneth Fisher likes this stock. It likes that the company has no debt, has a price-to-sales ratio of 0.4:1 (a ratio of 0.75:1 or less is a great value), and an inflation-adjusted EPS growth rate of 25.26%, well above the strategy's 15% minimum. It also has a good amount of free cash per share and a solid three-year average net profit margin.
The next stock is Telecom Italia (TI), Italy's largest telecom company, while also being a major player in the Brazilian telecom market. Its PBV is 0.79:1. The James P. O'Shaughnessy Guru Strategy likes this company's large size (its market cap is about $27 billion), cash flow per share that is greater than the market's mean cash flow per share, large number of shares outstanding, and its dividend. The dividend yield of Telecom Italia is 8.74%. The O'Shaughnessy strategy looks for the 50 companies which pass the previous criteria and have the highest dividend yield, and Telecom Italia is one of them.
Physicians Formula Holdings (FACE) has a PBV of 0.62:1. Another small cap ($47 million), this company has been making premium cosmetics for over 70 years. The strategy based on Peter Lynch's investment ideas considers this company a "fast grower" because its annual growth rate of 32% exceeds the 20% minimum need for this designation. The company's P/E/G ratio (price-to-earnings relative to growth) is 0.17:1. A P/E/G of 1.0 or less is acceptable, and south of 0.5:1 is considered great, so Physicians Formula's P/E/G is very, very strong. Also, the company's debt equals only 17% of equity, which is fairly conservative.
The final stock is Triumph Group (TGI), which manufactures and services aircraft components it sells to airlines and airplane manufacturers. My Benjamin Graham-based strategy likes this company because its PBV is 0.89:1 and its P/E is 12.0. The product of these two, says the strategy, must not exceed 22; for Triumph Group, it is a low 10.68. Also in the company's favor: its size (annual sales of $1.2 billion), very conservative current ratio of 3.3:1 (2:1 is the minimum), long-term debt which is less than net current assets, and its moderate P/E ratio of 12:1.
These four companies are financially solid and have the support of the Guru Strategies. And, of course, they have low PBV ratios. When the market turns around (and it will, eventually), today's prices for these companies should look like great bargains.
Published by Globes [online], Israel business news - www.globes.co.il - on January 29, 2009