With the tumbling of former high-flying tech and meme stocks, market analysts are increasingly saying that “value investing is back.” As a life-long value investor, I look at this in a few other ways, as well, like, “investing in profitable companies is back,” “thinking about valuation is back” and “buying stocks just because they are going up fast is now out of fashion.”
What makes a good value stock? First, the underlying company’s revenues are backed by products or services that are highly likely to have enduring relevance, both in the near-term and long-term. Their primary product or service fills a basic need rather than a faddish or trendy impulse, and is highly competitive in its current form. Stable revenues provide a solid foundation.
The value of an investment is driven by the underlying company’s profits and cash flows. The best way to ensure profits (and wide margins) is through minimal competition. But, even if competition is keen it should be responsible and with limits. High barriers to entry provide an effective constraint on the arrival of new competition.
Warren Buffett was once asked which he would prefer – dishonest management or incompetent management. His reply was that he would rather have dishonest management, because there is only so much damage it could produce and eventually it would be found out, whereas an incompetent management could destroy a company. The best answer, of course, is “neither.” Value investors want to find a company with capable, honest and shareholder-friendly management.
Financial sustainability is critical, as well. This means the company can sustain its healthy profit margins and free cash flow, and is backed by a balance sheet that carries a responsible amount of debt.
And, of course, the shares should have an attractively low valuation. It probably doesn’t make sense to pay 30x earnings or 20x EV/EBITDA for a prosaic company’s stock. Valuation is another term for “expectations.” Buying a low-expectations stock provides a layer of safety for periods when the fundamentals or macro environment become unfavorable. Multiples below 10x will usually provide considerable downside protection.
One company that meets all of these criteria, listed below, is almost certainly the world’s most reliable and boring company. Perhaps fittingly, it also is one of Berkshire Hathaway’s largest holdings.
Verizon Stock: Perfectly Boring
Verizon Communications (VZ) – Verizon is the nation’s largest wireless telecom service provider. Its base of 150 million subscribers provides it with 50% more market share than the number two provider. This position, along with its strong offerings in closely related markets like broadband and cloud, help it meet the essential and enduring need for communications. Following the merger of T-Mobile and Sprint, leaving only three major providers (currently hobbled AT&T being the third), the threat of extremely aggressive and margin-eroding competition is easing. Verizon’s revenues and profits continue to steadily grind higher, while its cash flow remains robust and looks poised to increase as temporarily elevated capital spending falls back to normal levels. The balance sheet is investment grade, even as the company plans to trim its debt load over the next few years.
Management, led by Hans Vestberg and supported by a highly capable team, provides the skill and quality that help Verizon maintain its edge. Their allocation of capital to dividends and share buybacks provides an important discipline on the company’s spending as well as a stream of cash to investors.
Verizon stock trades at a modest 9.7x estimated 2022 earnings and 8.1x estimated EBITDA. Its regularly increased dividend offers an appealing 4.8% yield, providing what some investors view as a safe and higher-yielding alternative to cash.
The shares offer investors a few other attractive side benefits – the company isn’t much influenced by rising commodity prices or rising interest rates.
While our stock recommendations in the Cabot Undervalued Stocks Advisor and the Cabot Turnaround Letter carry more return potential along with higher risk, we know a good value stock when we see one. Verizon stock may be the most boring in the market, but it also appears to be the most reliable. That has a lot of appeal in a stock market that seems to have neither.