A time-honored method of detecting cheap stocks is to look for ones that sell below book value.
A time-honored method of detecting cheap stocks is to look for ones that sell below book value.
Book value is a company's net worth, or assets minus liabilities. Divide total book value by the number of shares outstanding, and you get the company's book value per share, often called simply “book.” About 6 percent of U.S. stocks now trade below book.
Some of these companies are going nowhere. They are cheap for good reason, illustrating the old joke, “Things are always darkest just before they go completely black.”
Others are inexpensive because they are working through problems that probably are temporary. I have selected five that I think have good potential to rebound from whatever is troubling them, and to notch good capital gains over the next year or two.
One is BlackRock Inc., the world's largest asset manager. Public since 1999, the New York-based company acquired State Street Research in 2005, absorbed Merrill Lynch Investment Management in 2006, and merged with Barclays Global Investors in 2009. It now manages more than $3 trillion. Last year it pulled in more than $8 billion in revenue.
BlackRock trades right at book value, and for 17 times earnings. In the past five years -- a difficult period for financial companies -- earnings have grown at almost a 20 percent annual clip.
BlackRock's Performance
In the five years through March, it has provided investors with a cumulative total return (including reinvested dividends) of 57 percent. Contrast that with about 6 percent for Goldman Sachs Group Inc., and a loss of 65 percent for Bank of America Corp.
Some people insist on looking only at tangible book value per share, which excludes items such as the value of patents, brand names, and goodwill, or the bookkeeping entry that represents the premium one company paid to buy another. They wouldn't like BlackRock. Its tangible book value is negative, as it has lots of goodwill on its books from acquisitions.
My other four picks are much smaller than BlackRock.
OM Group Inc. is a producer of cobalt and metals-based powders and specialty chemicals that I sold during the recession and bear market of 2007-2009 because its revenue and earnings were dropping precipitously. Now, I see signs that operations are recovering. The Cleveland-based company has turned a profit six quarters in a row. Though earnings are far from the record levels of early 2008, the latest quarter was the best performance in more than two years.
One ‘Buy'
The stock is obscure. Only four analysts from lesser-known brokerage houses cover it, according to data compiled by Bloomberg; only one rates it a “buy.”
This is the sort of situation that often gets my greed glands going: a little-followed stock, disdained by those few who know about it, selling cheaply, with improving earnings.
Speedway Motorsports Inc., based in Concord, North Carolina, owns and operates eight auto-racing tracks in eight states -- California, Georgia, Kentucky, Nevada, New Hampshire, North Carolina, Tennessee and Texas.
I recommended this stock in January 2010 and it has returned about a negative 10 percent since then. But I think it is likely to rev up as the economy revives, particularly in the South, where auto racing is most popular.
E.W. Scripps Co. is a recommendation I make with my heart in my throat. My ventures into newspaper stocks in recent years -- notably with New York Times Co. and Gannett Co. -- have been unprofitable. Rising paper costs and Internet competition have punished the industry.
Newspaper Man
What's more, I know I am not objective. I spent 27 years as a journalist for various papers and magazines (including Forbes and the Wall Street Journal) before becoming a money manager in 1997. I'm still fond of the nation's rags.
All that said, Scripps strikes me as a likely gainer in the next year or two. The Cincinnati-based company owns 14 newspapers (including the Commercial Appeal in Memphis, Tennessee) and 10 television stations (among them, WPTV in West Palm Beach, Florida, which the company says is the state's highest-rated broadcaster).
The pulse of newspapers and TV stations is advertising, and I believe ad spending is likely to increase in 2011 and 2012 as the economy gains steam. Internet-based advertising is gaining market share, but it isn't the whole ball game, nor will it become so.
Insurance Buy
Most stocks selling for less than book are insurance stocks. That's partly because book value for insurers is boosted by the reserves of cash and securities they hold to pay future claims.
One insurance stock that looks good to me is Horace Mann Educators Corp., a seller of property and casualty policies, annuities and life insurance. The Springfield, Illinois-based company has shown an annual profit since 1992 and earnings have risen in six of the past eight years.
Horace Mann's expense ratio (expenses divided by premiums) is too high -- 41 percent last year. If the company doesn't cut costs, I think someone else will acquire it and do it for them. In any case, at 0.8 times book value, 0.7 times revenue, and under 10 times earnings, Horace Mann looks like a bargain to me.
Disclosure note: I have no long or short positions, personally or for clients, in the stocks discussed in this week's column.
(John Dorfman, chairman of Thunderstorm Capital in Boston, is a columnist for Bloomberg News. The opinions expressed are his own. His firm or clients may own or trade securities discussed in this column.)
