By J. Royden Ward, Chief Analyst, Cabot Benjamin Graham Value Investor
In my work, I apply six yardsticks, or price multiples, to help me find which companies are undervalued. I do not, however, use all six for each company, I use just one or two. The price multiples are: P/BV, P/CF, P/D, P/E, P/S and PEG ratios.
The P/BV (price to book value) ratio is calculated by dividing the current stock price by the latest reported book value (or net asset value) per share. I consider the current stock price for a company to be undervalued if the P/BV ratio is less than 1.00. The ratio is best used when evaluating companies in the Energy, Materials and Financials sectors. My favorite company with a low P/BV ratio operates an Oil & Gas Drilling business in the Energy sector. The company’s P/BV ratio is 0.87, well below my 1.00 cutoff, and sales and earnings growth prospects are excellent for the next several years.
The P/CF (price to cash flow) ratio is calculated by dividing the current stock price by the latest four quarters of reported cash flow (or change in cash position) per share. I consider the current stock price for a company to be undervalued if the P/CF ratio is less than 8.00. The ratio is best used when evaluating companies in the Consumer Discretionary and Industrials sectors. My favorite company with a low P/CF ratio is an automobile manufacturer in the Consumer Discretionary sector. The company’s P/CF ratio is 3.40, less than half my 8.00 cutoff. Sales and earnings growth prospects look bright for the next several years.
The P/D (price to dividends) ratio is calculated by dividing the current stock price by the latest annualized quarterly dividend (quarterly dividend time four) per share. The inverse of the price multiple is Div/Price, which is the dividend yield for a company. I consider the current stock price for a company to be undervalued if the P/D ratio is less than 50.00. The ratio is best used when evaluating companies in the Health Care, Financials and Utilities sectors. My favorite company with a low P/D ratio (high yield) operates an Asset Management business in the Financials sector. The company’s P/D ratio is 12.59, way below my 50.00 cutoff (and with a 7.99% yield). Sales and earnings growth prospects are clearly improving for the next several years.
The P/E (price to earnings) ratio is calculated by dividing the current stock price by the latest four quarters of reported earnings (or profits) per share. I consider the current stock price for a company to be undervalued if the P/E ratio is less than 12.00. The P/E ratio is sometimes the least reliable price multiple, because companies adjust earnings per share using different criteria and standards. The ratio is best used when evaluating companies in the Energy, Materials and Financials sectors. My favorite company with a low P/E ratio operates an Asset Management business in the Financials sector. The company’s P/E ratio is 7.19, well below my 12.00 cutoff, and sales and earnings growth prospects are excellent for the next several years.
The P/S (price to sales) ratio is calculated by dividing the current stock price by the latest four quarters of reported sales (or revenues) per share. I consider the current stock price for a company to be undervalued if the P/S ratio is less than 1.00. The ratio is best used when evaluating companies in the Consumer Discretionary and Consumer Staples sectors. My favorite company with a low P/S ratio is an automobile parts maker in the Consumer Discretionary sector. The company’s P/S ratio is 0.38, less than half my 1.00 cutoff. Sales and earnings growth prospects look very bright for the next several years.
The PEG (P/E to projected EPS growth) ratio is calculated by dividing the current stock price by the latest four quarters of reported EPS (earnings) per share, and then dividing the result by projected EPS growth for the next three to five years. I consider the current stock price for a company to be undervalued if the PEG ratio is less than 1.00. The ratio is best used when evaluating growth companies in any of the sectors. My favorite company with a low PEG ratio is a biotechnology company in the Health Care sector. The company’s PEG ratio is 0.66, well below my 1.00 cutoff. Sales and earnings growth prospects are excellent for the next several years.
For value investors, I recommend finding companies using at least one low price multiple. Keep in mind that an extra, extra low price multiple might indicate that there are problems in the company’s future. If the multiple seems to be too good to be true, investigate! After determining the sector to which the company belongs, test if the recommended price multiple is low. Finally, analyze the company’s current growth pattern and find sales and earnings growth forecasts for the next several years.
If two companies are valued alike with the same price to sales, price to earnings, and price to book value ratios, but one company is set to grow at a 15% clip during the next five years or more, and the other company is probably not going to grow at all, you definitely will want to invest in the company with good growth prospects and pass on the company, although undervalued, with little or no growth potential.
Recent Companies Found Using P/BV, P/CF, P/D, P/E, P/S, & PEG Ratios
As examples, here are six stocks that I found using these price multiples on 4/29/14.
Ensco plc (ESV: Current Price 50.83) Industry: Energy – Oil & Gas Drilling; Medium Risk; P/BV = 0.87
Ensco is a leading offshore oil and natural gas driller with shallow water and ultra-deepwater rigs located in many parts of the world. ESV’s focus on deep water drilling is finding strong demand, and its 2011 purchase of Pride International is producing better than expected results.
As a result of high lease rates to customers and high utilization of its rigs, sales and earnings will likely show strong growth during the remainder of 2014, Pride continues to kick in extra profits, too. Meanwhile, many other oil drillers are experiencing slow demand and little profit growth during the first half of 2014. Demand for most drillers will pick up in the second half, though.
I believe these factors place Ensco above its competitors regarding stock price appreciation potential in 2014. I expect sales to increase 13% and EPS to rise 15% to 7.32 during the next 12 months ending 3/31/15. ESV report excellent first quarter sales and earnings results and raised the dividend recently. ESV shares sell at 8.0 times latest 12-month EPS with a dividend yield of 5.9%. ESV’s current price to book value ratio (P/BV) provides further evidence that Ensco is clearly undervalued.
I expect ESV’s stock price to reach my Min Sell Price of 82.87 within one year. Buy ESV at the current price.
Nissan Motor ADR (NSANY: Current Price 17.16) Industry: Consumer Discretionary – Automobile Manufacturers; Medium Risk; P/CF = 3.40
Founded in 1933 and based in Tokyo, Nissan designs, produces and sells passenger cars and commercial vehicles in 190 countries. In March 1999, Nissan and Renault signed an alliance agreement and began setting up joint projects covering most of both companies’ activities. Nissan owns a 15% stake in Renault, and Renault holds 44% of Nissan’s shares.
Nissan’s sales and earnings performance has been lackluster during the past several years, but management’s six-year business plan, announced in 2011, looks promising. Nissan plans to deliver an all-new vehicle every six weeks. The company’s global portfolio will have 66 vehicles and will cover 92% of all markets and segments. Nissan’s focus on sustainable transportation mobility will continue, including zero-emission vehicles and low-emission technologies.
Sales declined 5% to $97 billion and EPS dipped 2% during the 12 months ended 3/31/14. Latest quarterly results indicate that Nissan’s sales will advance 6% and EPS will jump 17% during the next 12 months. Results will likely continue to improve in future years as the company rolls out new vehicles and expands into new markets. Sales in China are improving and European sales are showing positive signs of rebounding, too.
Nissan shares sell at 10.1 times latest EPS and provide a decent 3.5% dividend yield. NSANY’s stock price sells at 15% less than its book value, and current price to current cash flow (P/CF) is only 3.42. Shares will likely reach my Min Sell Price of 26.76 within one to two years. Buy NSANY at the current price.
AllianceBernstein Holding LP (AB: Current Price 25.17) Industry: Financials – Investment Management; Medium Risk; P/Div = 12.59 (7.99% Yield)
AllianceBernstein is a master limited partnership (MLP) and is a leading global investment management firm. The MLP offers high-quality research and diversified investment services to institutional investors and private clients in major global markets.
The company is one of the largest U.S. investment advisors with assets under management totaling $445 billion at January 31. AllianceBernstein significantly increased its size with the October 2000 acquisition of Sanford Bernstein, a leading U.S.-based, value-oriented investment manager, for $3.5 billion in cash and stock.
France-based AXA owns 64% of AllianceBernstein L.P. One-third of AB’s assets under management belongs to clients domiciled outside the U.S. AB’s Institutional Services actively manage stock and bond accounts for institutions, mutual funds including Alliance Mutual Funds for institutions and private clients, and investments for well-heeled clients. The company’s Retail Services unit offers investment management to other individual investors.
AB has begun a major turnaround. The company produced weak sales and earnings from 2008 through mid-2012, caused by poor investment advice to its debt and equity institutional clients. During the past 18 months, though, the company’s investment advice to clients has been among the best in the industry. AB’s new success has attracted many new clients seeking market-beating returns in the debt and equity markets.
Sales advanced 8% and EPS rebounded 37% during the 12 months ended 3/31/14. Lower costs and higher performance fees helped earnings to surge. The company’s turn-around should strengthen during the next 12 months. My forecast includes a revenue increase of 8% and an EPS advance of 17% to 2.21.
At 13.3 times latest 12-month EPS, and with a very attractive dividend yield of 7.99%, AB shares are undervalued. I expect AB shares to reach my Min Sell Price of 33.52 within one year. Buy AB at the current price.
Fortress Investment Group (FIG: Current Price 6.84) Industry: Financials – Asset Management; Medium Risk; P/E = 7.19
Fortress is a leading global alternative asset manager with $62 billion in assets under management as of December 31, 2013. Alternative investments include various types of options which are often used to reduce risk. Fortress is headquartered in New York City and has affiliates with offices in major cities around the world.
Fortress raises, invests and manages private equity funds and hedge funds. Fortress intends to grow its existing businesses, especially its equity and fixed-income operations. FIG will also continue to create innovative products to meet the increasing demand by sophisticated investors for superior risk-adjusted investment returns.
Revenues climbed 22% and EPS soared 51% during the 12 months ended 3/31/14. FIG’s revenues received a big boost from stock market returns and from new mutual funds. Revenues will likely rise another 9% and EPS will advance 25% to 1.15 during the next 12 months. Fortress’ stellar investment returns will attract additional capital during the next several quarters.
At just 7.19 times current EPS and with a low PEG ratio of 0.40, FIG shares are clearly undervalued. The dividend yield add appeal at 4.7%. I have lowered my high risk rating to medium risk, because sales, earnings, and FIG’s share price are less volatile. I expect FIG’s stock price to increase to my Min Sell Price of 13.14 within one to two years. Buy FIG at the current price.
Lear Corp. (LEA: Current Price 82.49) Industry: Consumer Discretionary – Auto Parts; Medium Risk; P/S = 0.38
Lear is a leading global supplier of automotive seating systems, electrical distribution systems, and electronics. The seating division manufactures, assembles, and supplies vehicle seating systems for automobiles and light trucks, which are fully assembled and ready for installation. The electrical and electronic division manufactures, assembles, and supplies electrical and electronic systems and components for vehicles. Founded in 1917, Lear Corp. is headquartered in Southfield, Michigan.
Lear’s purchase of Guilford Mills in May 2012 is producing better than expected sales and earnings results. The maker of vehicle seat fabrics has provided Lear with unique seating systems which are gaining market share.
Sales increased 12% and EPS advanced 16% during the last 12 months ended 3/31/14. Results were bolstered by stronger than expected first quarter sales and earnings. I expect sales to rise 9% and EPS to climb 23% to 7.70 during the next 12 months. Earnings could climb faster if management’s operating efficiency program increases profit margins.
At 13.2 times current EPS and with a dividend yield of 1.0%, LEA shares are undervalued. The company’s current price to sales ratio (P/S) is 0.38, which is quite attractive. I expect LEA to reach my Min Sell Price of 121.20 within one year. Buy LEA at the current price.
Valeant Pharmaceutical International (VRX: Current Price 133.51) Industry: HealthCare – Drugs; High Risk; PEG = 0.66
Valeant is based in Mississauga, near Toronto, and is an international specialty pharmaceutical company, which discovers, develops, manufactures and markets a broad range of pharmaceutical products.
Valeant has developed drugs in almost all areas of medicine with a slightly higher emphasis on neurology and dermatology products. VRX’s drugs include prescription and generic brands. VRX markets about 900 pharmaceutical products globally.
The 2010 merger with Biovail tripled Valeant’s sales, and the marriage has produced better than expected results. The merged company produces a variety of products and has enhanced global marketing capabilities.
Management is aggressively acquiring small companies with potential to quickly add earnings. Valeant has acquired 50 companies during the past four years. During the past 12 months, VRX has purchased 12 companies, highlighted by the acquisitions of Medicis Pharmaceutical (MRX) for $2.6 billion and Bausch & Lomb for $8.7 billion.
The purchases have already added significant earnings for Valeant. Valeant also acquired Solta Medical on January 23, 2014, which is expected to boost earnings and add new opportunities in the specialty medical devices arena. I continue to increase my estimates of sales and earnings to account for Valeant’s purchases.
Lastly, Valeant very recently made a bid to purchase specialty pharmaceutical company Allergan. If the merger is concluded pursuant to this offer, Allergan stockholders will hold 43% of the shares of the combined company. Activist Bill Ackman and his investment firm Pershing Square owns more than 5% of Valeant’s stock and is highly in favor of VRX’s proposal to buy Allergan. Valeant believes cost savings of $2.7 billion, or $4.50 per share, are possible within the first year.
I forecast sales, excluding the possible Allergan merger, will increase 22% and earnings per share will climb 30% during the 12 months ending 3/31/15. The price to earnings ratio of 19.6 is reasonable, even though the company pays no dividend. The balance sheet is solid, although debt is somewhat high.
VRX is high risk because of the stock’s high volatility and the company’s short history since its merger with Biovail. Valeant’s P/E to projected EPS growth ratio (PEG) is 0.66. VRX’s stock price will likely rise to my 180.94 Min Sell Price within one year. Buy VRX at the current price.
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