Below Book Value? Sign Me Up
Tuesday February 10, 8:14 am ET
ByTim Melvin, RealMoney.com Contributor
Unless you have been living on the nonplanet Pluto, you know Dr. Doom has been predicting further stock market declines ahead. Nouriel Roubini has been dead on so far about the economic and market meltdowns, and for that reason alone his viewpoint is worth considering. He thinks the market will continue to fall and the recession is going to be still deeper and longer than many others think.
It is no secret that I agree with a lot of what Roubini has to say. I think there is at least 20% more downside in this market before reality even begins to set in. Piling into the stock market based on some half-baked stimulus or bank plan out of Washington strikes me as dangerous and foolish. There are a lot of cheap stocks around, and I spend most of my time looking for them. But I prefer to use the tiptoe approach to getting into the market.
One of my search methods is running screens based on various criteria. One of my favorites is S&P 500 stocks trading below book value. Last year my good friend Henry Carstens of Vertical Solutions backtested this approach for me and found that this grouping of stocks substantially outperformed the market. I ran that screen yesterday and found that the list now approaches 20% of the S&P 500. That's about as long a list as it has been in some time. A lot of the names are banks, and I'm just not ready to approach banks yet. I think that eventually some banks such as BB&T Corporation and KeyCorp will be make strong purchase candidates, but we need to see how this new plan works (or more to the point, doesn't work) before investing in that sector. There are some stocks, however, that are attractive and worth considering, especially at lower prices.
Leucadia has been referred to as the mini Berkshire Hathaway . Ian Cummings and Saul Steinberg do preside over a collection of operating businesses and public equities, but it's more eclectic than Warren's collection. They are not afraid to buy distressed assets and wait for, or even preside over, a turnaround. The two have managed Leucadia since 1978 and book value has grown at better than 21% over that time.
Buying the stock below tangible book value seems like a pretty safe bet to me in spite of the hits they took in 2008. The pair made investments in mining, auto credit and securities brokerage firms that were pounded in the market selloff. In spite of this, right now you can buy these assets at two-thirds of tangible book value. The company has investments across a wide swatch of the economic landscape, including timber, plastics, clean energy, gaming and real estate. I think it is safe to speculate that Steinberg and Cummings did not suddenly lose their investment acumen and that this stock will resume its growth track in years ahead.
As Maryland Terrapins fan, I find the name tough to see on my sheets, but Duke Energy is now trading at less than tangible book. In recent years Duke has cut back its position in riskier elements of the power industry and now less than 25% of its operations are in unregulated businesses. The 2006 acquisition of Cinergy doubled its service area. The company pays a healthy dividend in excess of 5%, and management has committed to maintaining the payout. If the stock were to fall in line with an anticipated market decline, it would be too cheap even for a Terp fan to ignore
King Pharmaceuticals is a company I wrote about last year. The stock has not really done a lot since then, but plenty has changed at the company. It completed the acquisition of Alpharma in the final week of 2008. The $1.6 billion deal strengthened the company's presence in the pain management market. This should pay long-term benefits by partially offsets generics competition for some its main drugs. If we get to that 6 handle I predict on the S&P 500, King could well fall to levels to cheap to ignore.
Cincinnati Financial has been on my "S&P 500 stocks below book" list for a long time. Although book value has fallen, so has the price. Like many insurers, the company has struggled with poor investment markets and a weak insurance pricing environment. The company is conservative in its underwriting policies and has been able to stay in the black.
Cincinnati Financial has more than $1 billion of cash and equivalents and pays a healthy dividend that is expected to be continued. Management recently said it expects the combination of the dividend plus book value growth to average between 12% and 15% over the next five years. Buying below tangible book should give a slightly higher total return than that over the time period.
These stocks appear to be to have a sufficient long-term margin of safety such that they can be purchased. I would not go nuts, but I'm willing to begin establishing positions in these high-quality names. If Dr. Doom and I are correct, you will have future opportunities to buy more shares at lower prices before the year is over.
