These Stocks are Values

If we had to pick just one of Warren Buffett’s folksy chestnuts to sum up the investment strategy that made Berkshire Hathaway such a successful company, this one would get my vote:

“Price is what you pay, value is what you get.”

It’s pretty obvious what this means. Even my dog knows Buffett is a value investor…

Given the outrageous success Berkshire Hathaway investors have enjoyed from Buffett’s eye for value, it’s pretty surprising that more investors don’t “do” value investing.

We like a good story, we like to anticipate future trends, we like stocks with cool gadgets…

But stocks with plenty of cash, low debt, and a book value below 1? Pfffft… boring.

Why should there be nothing sexy about uncovering a solid company that’s just too darn cheap? That’s one of the easiest ways you’ll find to generate reliable profits.

And these days, the S&P 500 is trading at all-time highs and valuations are starting to look a little stretched. So let’s look into the value proposition today…

What is Value?

Investopedia defines value investing:

The strategy of selecting stocks that trade for less than their intrinsic values. Value investors actively seek stocks of companies that they believe the market has undervalued. They believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond with the company’s long-term fundamentals. The result is an opportunity for value investors to profit by buying when the price is deflated.

Typically, value investors select stocks with lower-than-average price-to-book or price-to-earnings ratios and/or high dividend yields. 

That’s a good start. When we look for value investments, the point is to find companies that are worth more than what the current share price says they are worth.

It doesn’t happen as often as you might think. Any of us can point to companies that are overvalued — companies whose share price is based on potential and the hope of future growth.

It’s not so easy to find companies that are truly cheap based on measures like profits, cash, and book value. Because when a company’s stock gets too cheap, investors buy the shares, or big investors like Warren Buffett simply buy the company.

So how do we go about finding companies that can be called “values”?

Only as Good as Your Tools

To uncover the undervalued gems, you have to scour the entire stock market, filtering for the variables you want to see in your potential investment.

You can use a “screen” to do this, and there’s a really detailed one at Finviz.com. Here’s the link.

Next, you need to have a good handle on the variables you want to screen for, like dividend yield, profit margin, book value, etc. Some variables are more helpful than others.

Price measures like share price, market cap, and sales revenue are not helpful at all. As Buffett said, price is simply what you pay. What we want to find is value, or the worth of a company as it relates to its share price.

I’m not a huge fan of using trailing price-to-earnings to find value stocks. That’s because earnings can vary from quarter to quarter for a variety of reasons, and you might miss a good stock because of some earnings volatility that is unrelated to the overall value of the company.

Price-to-book value (P/B) is good one. Book value is what a company is actually worth: it’s cash, buildings, equipment, inventory, etc., plus some intangibles like intellectual property and what’s called goodwill, which is sort of like brand power — as in you can sell Pepsi-Cola for a higher price than Seven-Eleven cola.

Clearly if you’re Pepsi-Cola, you’re worth more than some off-brand. (Hint: Anytime you’re buying value, you want to make sure the company doesn’t overvalue goodwill. You can find goodwill values on a company balance sheet.)

My Screen

I ran a very simple screen to see what would come up.

I used a price-to-book ratio of “under 2” and a price-to-earnings growth (PEG) of “under 3.” Then I did something a little tricksy… I went to the “Technical” section and added a “double bottom.”

If you don’t know, a double bottom is a technical analysis pattern that occurs when a stock price hits a low price, bounces higher, falls back to that price (or close to it), and bounces again. Traders look for double bottoms because they clearly show a price where investors step in and buy.

Why do I care about where investors will buy when I’m looking for value? Because I am assuming that the price of the double bottom represents value to some investors, and that’s why they bought there.

I don’t think I am good enough with market timing to nail a perfect bottom for a stock price. So seeing what other investors do may be helpful.

Let me put it this way: Suppose a company’s P/B ratio hits 1 at that double-bottom price, and then the price bounces 10%. If a week later, I screen for stocks with a P/B of 1, I will not see that stock because it will have a P/B of 1.1, even though it was within my parameters just a week before. I don’t want to miss an opportunity just because I was a little late…

A Narrow Field

Usually, the fewer variables you include in a screen, the more stocks you get. You then have to add variables to narrow the search.

So I was surprised that the screen I just described yielded just seven stocks. I got a steel stock, a construction stock, a copper miner, three oil and gas MLPs, and a refiner.

I find that extremely interesting — not the steel stock (NASDAQ: ZEUS) so much, or the miner (NYSE: TCK)… but three MLPs and a refiner? That’s more than a coincidence. 

We know oil stocks have gotten creamed. And some MLPs have been hit, too, as pipeline volumes may diminish. But this screen suggests there is real value in these stocks. And it also shows that investors have recently indicated that they will buy the stocks at a price not much lower than where they are now.

Throw in the fact that these MLPs pay dividends of 6.9%, 7.6%, and 4.6%, and I think we might be on to something…

So those MLPs are: Enable Midstream Partners (NYSE: ENBL), ONEOK Partners (NYSE: OKS) and Tesoro Logistics (NYSE: TLLP).

Until next time,

Until next time,

Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.