(COF) The Cheap “Ones” – Finding Value Stocks

Firms for which the market’s expectations of the future are low tend to be very cheap statistically. There is a very large body of research that suggests that over time you do much better buying cheap firms than expensive ones, even if the expensive ones seem to have the hot products and the buzz around them.

However, you can also get stuck in a “value trap” — a stock that is cheap for a reason and simply sits at low multiples for long periods of time without much improvement in the underlying metrics (the multiple of what).

The key is to try to find cheap stocks where the underlying fundamentals are improving. Then not only do you enjoy the underlying growth, but you also tend to get a multiple expansion. More often than not, it is the multiple expansion that provides the biggest part of the return.

One of the best indications of improving underlying fundamentals is a positive earnings surprise, coupled with rising earnings estimates. Those are the factors that drive the Zacks Rank. Only the best 5% of all firms earn the Zacks #1 Rank.

The most common measure of value is the P/E ratio. It is not perfect, especially for firms with volatile earnings streams (such as cyclical stocks). If one were to base all value on the P/E ratio, then any company that runs a loss in a given year would be “properly” valued at zero. Clearly that is not the case. Still if I were forced to pick only one measure of value, it is probably the one I would go with.

I looked for all the firms with market capitalizations over $1 billion that have Zacks #1 Ranks (Strong Buy) that also have single digit P/Es based on current expectations for both this year and next. I then applied less stringent requirements based on other key valuation criteria.

The firms might not be super cheap based on non-earnings criteria, but they sure are not exorbitantly expensive. They have to pay at least a nominal dividend, be selling for less than 9x cash flow, 1.5x sales and 2.0x book value.

A total of nine firms made the cut. It is a surprisingly well diversified group, with seven of the 16 Zacks economic sectors represented. More than half of the firms are based outside the U.S.

Here are some of the highlights of the four with the lowest P/Es based on this year’s earnings. Prices are based on the close 6/20, while the “Price to’s” are based on the 6/17 close:

Lafarge (LAFGY, $15.19) is one of the largest producers of cement and gypsum wallboard in the world. While construction has been very weak here in the U.S., other parts of the world continue to build. Eventually building will pick up here as well. This is a cheap stock based on all five major valuation criteria.

A P/E of 3 for this year would seem to indicate that the market is expecting those earnings to fall precipitously. However, the P/E based on 2012 earnings is even lower, as the consensus is expecting earnings that are 12.5% higher in 2012 than in 2012. Just as a word of warning, the balance sheet on this one is more than a bit suspect, as the company has a very high debt level.

Capital One Financial (COF, $49.60). What’s in your wallet? Well there could be a lot more if you invest in COF. Consumers have gradually been getting their debt under control, and credit card delinquencies have started to trend down, although they still remain at very high levels.

Earnings are expected to decline next year relative to this one, but even based on 2012 earnings, the P/E is just 8.3x. The key reason for the decline is the cut in debit card fees that banks can charge. That will be a one time — but permanent — decline, not a continuous erosion in earnings power.

This is also a very cheap sock based on book value, but as with all the big banks, as long as they are allowed to mark their assets to models rather than to market, there will be a question to the true value of the assets of the firm.

Volkswagen (VLKAY, $34.75) might not have a huge market share here in the U.S., but it is the third largest auto company in the world. It sells not only under the VW brand but also under Audi and a few super-high-end luxury brands such as Bentley and Lamborghini. I would note that most of the auto industry looks cheap, but few have the sort of estimate momentum that VW has.

ASM International (ASMI, $35.79) is a Dutch semi-equipment company, making the machines that make the basic building blocks, semiconductors, of the modern economy. It sells for less than seven times next year’s earnings and just over one times sales despite boasting net margins of over 10%. It also boasts a strong balance sheet, with cash net of long-term debt at 22% of its total value.

As always, a screen should be only the first step in your investment investigation. These stocks though have the very appealing combination of being extremely cheap on a statistical basis, and are starting to get some estimate momentum behind them. Historically that has often proved to be the path to some very large gains.

Company Ticker P/E Using Curr FY Est P/E Using Next FY Est Div Yield Price/Book Price/Cash Flow Price/Sales %Ch Curr Fiscal Yr Est – 4 Wks %Ch Next Fiscal Ye Est – 4 wks
Lafarge Sa-Adr (LFRGY) 2.97 2.64 2.93% 0.73 6.66 0.78 0.00% 0.00%
Capital One Fin (COF) 7.07 8.34 0.41% 0.81 6.14 1.3 4.21% 1.68%
Volkswagen-Adr (VLKAY) 7.22 6.3 1.41% 0.71 3.7 0.27 0.00% 0.00%
Asm Intl Nv (ASMI) 7.62 6.66 1.31% 1.98 8.87 1.02 4.13% 4.18%
Domtar Corp (UFS) 8.53 9.52 1.52% 1.15 4.42 0.65 -0.92% -0.65%
Slm Corp (SLM) 9.15 8.53 2.51% 1.81 4.49 1.26 0.81% 0.84%
Avx Corp (AVX) 9.47 9.29 1.51% 1.21 8.32 1.5 4.42% 5.03%
Fresh Del Monte (FDP) 9.91 9.29 0.77% 0.9 8.2 0.43 0.00% 0.00%
Telecom De Sp (VIV) 9.97 9.79 7.05% 1.53 3.89 0.95 2.74% 0.71%

ASM INTL NV (ASMI): Free Stock Analysis Report

CAPITAL ONE FIN (COF): Free Stock Analysis Report

LAFARGE SA-ADR (LFRGY): Free Stock Analysis Report

Zacks Investment Research

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