You know I am always on the lookout to find out if there are any parts of the investment universe that are undervalued.
I do not always have the resources or time to be able to do such analysis and thus rely on a few fund managers and market commentators I have come to respect. I read their commentary and try to combine what they have said or written to form my own picture.
Usually one or two of them have ideas that I investigate further but its usually not all that clear as to what is undervalued.
The recent third quarter commentaries was however so clear as to what is undervalued that it was hard to miss.
Below are extracts of the Q3 reports (emphasis mine):
Jeremy Grantahm – GMO – Just Deserts and Markets Being Silly Again (pdf)
October 2009
Yet Another Plug for U.S. Quality Stocks
Our main argument is quantitative. Quality stocks (high, stable return and low debt) simply look cheap and have gotten painfully cheaper as the Fed beats investors into buying junk and other risky assets, a hair-of-the-dog strategy if ever there was one.
In our seven-year forecast the quality segment has a full seven-percentage-point lead per year over the whole S&P 500, or 9% over the balance ex-quality. This is now at genuine outlier levels.
In addition, there are qualitative arguments. We like owning high-quality blue chips if we are indeed going into a more difficult seven years than any we have faced since the 1970s.
The problems of reducing debt and the potential share dilution that can go with it as it did in Japan for a decade, particularly play to the strength of the largely debt-free high-quality companies.
And for nervous investors there is yet another reason for favoring quality stocks: their more than 50% foreign earnings component, which is higher than the balance of the S&P 500 with its heavy financial component.In the long run, quality stocks have proven to be the one free lunch: you simply have not had to pay for the privilege of owning the great safe companies, as plain logic and established theory would both suggest.
Richard Pzena – Pzena Investment Management – Third Quarter 2009 Commentary
October 2009
Quality continues to be a significant theme in our portfolios, as many companies with strong balance sheets that are leaders in their industries areavailable to us in the cheapest quintile of valuation.
This is particularly prevalent in (but not limited to) the technology sector, where companies have low or no debt, and cash balances that would see them through the most extreme business downturn.
These businesses typically attract premium valuations, but are now some of the cheapest in our investment universe. We have taken advantage of this unusual opportunity
Conclusion
While market pundits are counseling “de-risking” as their advice du jour, equities in general and value spreads in particular remain attractive despite the sharp run up of the last seven months.
History suggests that we are still in the early innings of this value cycle, with the next leg up likely to be driven by earnings increases in the context of a modest economic recovery.
We continue to find high quality companies in sectors experiencing near term stress where we believe research and patience are the ingredients for long term outperformance.
Joel Greenblatt – In a Yahoo Tech Ticker interview – Seeking Value in a momentum market
28 October 2009
Generally speaking, Greenblatt says the value today is predominantly in “higher quality business that didn’t get hurt as badly in the recession” vs. the low-quality names like AIG and Fannie Mae which led the rally off the March lows.
Among the “beaten up stocks” currently ranked highly by Greenblatt’s are construction companies, select retailers and McGraw-Hill.
If large quality companies are cheap I looked at a few possible candidates in the USA as identified by Joel Greenblatt’s ?Magic Formula? and sorted by price to earnings (?PE?) ratio.
Company | Price (17.11.09) | Debt/Equity (%) | Market cap (USD m) | PE Ratio | Dividend Yield (%) | Price to book |
NOBLE CORP | 44.76 | 17.5 | 11,724 | 7.1 | 0.4 | 1.8 |
ELI LILLY & CO | 35.94 | 155.3 | 41,296 | 7.8 | 5.5 | 4.2 |
PFIZER INC | 17.94 | 30.1 | 144,768 | 8.2 | 3.6 | 2.2 |
FOREST LABS INC | 28.98 | 0.0 | 8,745 | 8.3 | 0.0 | 1.9 |
HARRIS CORP | 45.12 | 68.7 | 5,943 | 9.3 | 2.0 | 3.1 |
CARDINAL HEALTH | 31.49 | 41.8 | 11,421 | 9.5 | 2.2 | 2.3 |
DIAMOND OFFSHORE | 103.58 | 15.0 | 14,399 | 10.2 | 0.5 | 4.0 |
LOCKHEED MARTIN | 76.31 | 132.8 | 29,058 | 10.2 | 3.3 | 9.3 |
L-3 COMM HLDGS | 79.34 | 77.8 | 9,221 | 10.3 | 1.8 | 1.4 |
PITNEY BOWES INC | 25.07 | N/A | 5,193 | 10.4 | 5.7 | 67.8 |
NATL OILWELL VAR | 46.13 | 6.9 | 19,295 | 10.4 | 0.9 | 1.4 |
NORTHROP GRUMMAN | 56.03 | 33.1 | 17,580 | 10.5 | 3.1 | 1.4 |
RAYTHEON CO | 50.21 | 25.4 | 19,241 | 10.6 | 2.5 | 2.0 |
GENERAL DYNAMICS | 67.94 | 40.0 | 26,211 | 10.9 | 2.2 | 2.2 |
DISH NETWORK-A | 22.15 | N/A | 9,898 | 11.2 | 0.0 | N/A |
GARMIN LTD | 32.33 | 0.0 | 6,488 | 11.3 | 2.3 | 2.5 |
FLUOR CORP | 45.37 | 5.7 | 8,121 | 11.4 | 1.1 | 2.6 |
AMGEN INC | 56.28 | 49.9 | 56,963 | 12.0 | 0.0 | 2.5 |
AUTOZONE INC | 142.62 | N/A | 7,112 | 12.1 | 0.0 | N/A |
JACOBS ENGIN GRP | 38.88 | 2.5 | 4,818 | 12.1 | 0.0 | 1.8 |
BIOGEN IDEC INC | 46.05 | 19.7 | 13,317 | 12.2 | 0.0 | 2.0 |
BRISTOL-MYER SQB | 24.23 | 55.1 | 47,999 | 12.4 | 5.1 | 3.7 |
JOY GLOBAL INC | 56.85 | 106.6 | 5,817 | 12.8 | 1.2 | 6.6 |
IBM | 128.63 | 251.9 | 168,969 | 13.3 | 1.7 | 9.2 |
APOLLO GROUP-A | 56.39 | 50.9 | 8,731 | 13.4 | 0.0 | 7.5 |
JOHNSON&JOHNSON | 62.17 | 27.9 | 171,533 | 13.7 | 3.2 | 3.4 |
FISERV INC | 48.73 | 158.2 | 7,499 | 13.7 | 0.0 | 2.6 |
LORILLARD INC | 79.38 | 0.0 | 12,752 | 13.8 | 5.0 | 33.5 |
OMNICOM GROUP | 37.26 | 87.2 | 11,597 | 13.9 | 1.6 | 2.9 |
ITT CORP | 53.06 | 70.2 | 9,694 | 14.0 | 1.6 | 2.7 |
VIACOM INC-B | 31.27 | 113.8 | 19,130 | 14.0 | 0.0 | 2.4 |
MCGRAW-HILL COS | 31.85 | 98.9 | 10,030 | 14.0 | 2.8 | 6.0 |
AMERISOURCEBERGE | 24.28 | 43.4 | 7,217 | 14.0 | 1.3 | 2.6 |
CA INC | 22.36 | 44.6 | 11,666 | 14.1 | 0.7 | 2.4 |
AMDOCS LTD | 27.01 | 0.0 | 5,509 | 14.1 | 0.0 | 1.7 |
DELL INC | 15.95 | 47.1 | 31,192 | 14.4 | 0.0 | 6.7 |
CLOROX CO | 60.21 | N/A | 8,418 | 14.4 | 3.3 | N/A |
DR PEPPER SNAPPL | 27.78 | 135.1 | 7,058 | 14.5 | 0.0 | 2.3 |
MCKESSON CORP | 63.74 | 40.5 | 17,081 | 14.8 | 0.8 | 2.5 |
TIME WARNER INC | 32.55 | 94.5 | 38,005 | 14.8 | 2.3 | 1.1 |
UNITED TECH CORP | 69.93 | 72.1 | 65,562 | 15.3 | 2.2 | 3.5 |
LABORATORY CP | 74.19 | 102.0 | 7,879 | 15.3 | 0.0 | 3.9 |
QUEST DIAGNOSTIC | 59.07 | 85.5 | 10,922 | 15.7 | 0.7 | 2.8 |
ROSS STORES INC | 45.59 | 15.1 | 5,703 | 16.6 | 1.0 | 5.3 |
GAP INC/THE | 22.31 | 1.1 | 15,569 | 16.8 | 1.5 | 3.3 |
COACH INC | 34.48 | 2.0 | 10,997 | 17.9 | 0.9 | 6.0 |
AUTOMATIC DATA | 44.01 | 14.5 | 22,209 | 18.3 | 3.1 | 3.9 |
EXPEDIA INC | 24.96 | 66.3 | 7,207 | 20.5 | 0.0 | 2.8 |
MASTERCARD INC-A | 231.00 | 8.8 | 29,973 | 21.2 | 0.3 | 9.3 |
DISCOVERY COMM-A | 31.88 | 68.3 | 8,510 | 34.3 | 0.0 | 1.5 |
Source: List of companies ? Magic Formula Investing (www.magicformulainvesting.com)
Financial information ? Bloomberg (www.bloomberg.com)
A list of cheap large European companies can be found on my article Dogs of the STOXX 2009 – Update Kindly note that the output of the two stock screens above is just to identify possibly undervalued companies. It should just be a starting point for your analysis.
Next week Tuesday Nikki and I am off on holiday to South Africa. I am really looking forward to more sunny days and spending relaxing time with my family.
I have lined up some interesting guest posts for the first two weeks when I have limited internet access.
Your packing his bags analyst.
PS To find value investing ideas where you invest take a look at our stock screener service
PPS It costs less than a cheap lunch for two and if you do not like it you get your money back. Why not sign up right now before it slips your mind?
Disclosure: I have a position in Johnson & Johnson