Roy Ward, editor of Cabot Benjamin Graham Value Letter, recommends stocks based on his own thorough analysis of their valuation. While he normally considers a range of factors to determine the levels at which a stock would be over- or under-valued, a recent special issue focused exclusively on stocks that are undervalued relative to their book value. As Ward wrote, “Book value per share is simply the shareholder’s equity or retained earnings divided by the number of common shares outstanding. Is book value per share important? By itself, no. But when compared to the company’s stock price, it’s enormously important. If a company’s stock price is less than its book value per share, the company could theoretically be liquidated and, as a stockholder, you would receive more money from the liquidation than if you sold your stock on the stock exchange. Book value is important to investors because quality companies with low price-to-book value (P/BV) ratios have outperformed companies with higher valuations for the past three, five and 10-year periods.” Today’s recommendation is one of the stocks from Ward’s special issue.
“Fred’s, Inc. (FRED) — Max Buy Price is 14.93; Min Sell Price is 21.11. Founded in 1947 in Memphis, Fred’s sells discount merchandise including household goods, pharmacy items, food, pet supplies, clothing and linens from 701 stores in 15 states in the Southeast and Midwest. The stores also offer a large selection of generic drugs, which are in high demand and highly profitable. Average store size is modest, about 14,400 square feet.
“U.S. consumers continue to seek bargains when shopping for food, clothing and household items even though the economy is improving. Major retailers are aggressively cutting prices to compete for each retail dollar. Sellers of luxury goods and high-end merchandise, such as Saks, Tiffany’s and Coach, are producing solid sales, but their stock prices are too high. The stock prices of discount and dollar store companies such as Ross Stores, T J Maxx, Dollar Tree and others that are enjoying strong sales are also too high to buy right now.
“Fred’s is a small discount retailer with sales of less than $2 billion, and its stock price is very reasonable. Same-store sales have been flat during recent months, but I expect much better sales growth during the next several quarters as Fred’s has opened 26 new stores in 2011 and has renovated 413 stores during the past two years. I expect sales to increase 7% and earnings to rise 12% during the next 12 months. The retailer has added pharmacies to half of its stores and is working to add pharmacies to most of its remaining stores. In addition, Fred’s will continue to open many new stores and renovate existing stores.
“FRED shares are undervalued at 1.07 times book value and at 13.5 times forward earnings per share. The Value Line Financial Strength Rating is B++, and the dividend yield of 1.8% is decent. I expect the strong demand for merchandise offered at low prices to continue during the next several years.
“I advise buying FRED at or below 14.93 and selling when the stock price hits 21.11. FRED shares are low risk.”
- J. Royden Ward, Cabot Benjamin Graham Value Letter, May 2012