By Serkan Unal
The threat of rising inflation is bringing to the forefront defensive value stocks of the Benjamin Graham type. The father of value investing, Graham advised investors to invest with a margin of safety, buying stocks at a comfortable discount to their fair values, at prices that assure minimal downside risk. This margin of safety protects investors from both poor decision-making and market downturns. Empirical evidence shows that value investments have historically outperformed the broader market.
Running a specific value-focused screen on the dividend stocks with market capitalization above $2 billion and dividend yields above 2%, only 5 dividend stocks met the defined value criteria in the current market environment. The applied criteria in selecting the value plays included: price-to-book ratio below 2, trailing and forward price-earnings ratios below 15x, current ratio at or above 1.5, debt-to-equity ratio below 30%, return on equity (ROE) above 15%, historical EPS growth above 5% and positive long-term EPS growth, as well as positive dividend growth. Value investors should evaluate the following five stocks, dominated by resource materials plays.
Freeport-McMoRan Gold & Copper Inc. (NYSE:FCX), a copper and gold play, has a price-to-book of 1.83. Its trailing and forward P/Es are 11.2x and 8.2x, respectively, with the trailing ratio below that of its peers. FCX's balance sheet is marked by nearly 11% of assets in cash and equivalents, long-term debt-to-equity of 21%, and current ratio of 3.2%. Its ROE is 18%. The company's EPS grew, on average, by 7.6% per year over the past five years. EPS growth is forecast at 4.7% per year for the next half-decade. The company's dividend is yielding 3.5% on a payout ratio of 38%. Its dividends grew 18.9% over the past year. In our opinion, in addition to value characteristics, this stock has good growth prospects. While gold prices may weaken in the coming period amid a more constrictive monetary policy, the company should benefit from its rebounding output and stronger demand for copper, with global copper consumption increasing 4% annually in the 2013-2014 period and China's demand rising in the future. Moreover, the company is diversifying into the energy market, announcing acquisitions of two energy companies, Plains Exploration & Production Company (NYSE:PXP) and McMoRan Exploration Co. (NYSE:MMR). While the energy deal will cause share dilution and added debt, FCX could benefit in the long run from the acquisitions' strong fundamentals, margins, and cash flow. Point State Capital is bullish about FCX.
Chevron Corporation (NYSE:CVX), an integrated energy company, is good value based on its price-to-book of 1.6, below the company's five-year metric. CVX's trailing and forward P/Es are 9.3x and 9.1x, respectively. The forward P/E is slightly lower than the industry average of 9.4x. The company has a solid balance sheet with ample liquidity, including $21.3 billion in cash and equivalents, more than its peers Exxon Mobil (NYSE:XOM) and ConocoPhillips (NYSE:COP) combined. Its long-term debt-to-equity is only 8% and its current ratio is 1.64. CVX has an ROE of 19%. The company has achieved EPS growth averaging 11.5% annually over the past five years. Its long-term EPS growth will be flat on average for the next five years. The company is a dividend grower, with dividend increases averaging 7.8% annually over the past five years. The stock currently yields 3.3% and its payout ratio is low at 28%. Chevron has attractive dividend, strong liquidity to mitigate possible downside risks, good future output capacity, and heavy exposure to oil. Stanley Druckenmiller is also a big fan of the company.
Guess, Inc. (NYSE:GES), an apparel retailer, has a price-to-book of about 2, substantially below its respective industry's 4.7. GES is trading on trailing and forward P/Es of 11.2x and 11.6x, respectively, well below its industry averages. The company's balance sheet is characterized by low leverage, with long-term debt to equity of negligible 1% and current ratio of 2.8, better than its industry metrics. The company's ROE is 17.2%. Its annualized growth in EPS and dividends averaged 16.5% and 33.3%, respectively, over the past five years. Guess Inc. is expected to see long-term EPS growth averaging 10.7% per year. The company pays a dividend yield of 3.1% on a payout ratio of 35%. We like the company's capacity to generate strong cash flows, even in the midst of adversity, such as when cotton prices skyrocketed in 2010 and 2011. The cotton prices are down substantially now, the conditions in the European markets are reportedly improving, and sales in Asia are rising. While the company's brand may be out of vogue with Wall Street, it could flourish in emerging markets. One value investor that finds GES attractive is Chuck Royce.
Occidental Petroleum Corporation (NYSE:OXY), another energy company, has a price-to-book of 1.6, below its historical metric. Its trailing and forward P/Es are 11.0x and 11.2x, respectively, below historical averages. Occidental Petroleum's long-term debt to equity is 19%. Its current ratio is 1.5, better than its industry's 1.0. OXY's ROE is 15.3%, almost double that of its industry. The company's annualized EPS and dividend growth averaged 10.8% and 16.7%, respectively, over the past five years. The annualized long-term EPS CAGR is forecasted at 7.0%. OXY pays a dividend yielding 2.7% on a payout ratio of 29%. Occidental Petroleum seems to have strong fundamentals as a basis for its current undervaluation, along with growth prospects including strong exposure to oil and strong long-term output growth. The company's Al Hosn Shah natural gas project in UAE is expected to be the company's major cash flow contributor from 2014. Last quarter, RenTech's Jim Simons boosted his OXY stake by almost 40%.
Sasol Ltd. (NYSE:SSL), a South African high-yield integrated energy and chemicals company, trades on a price-to-book of 1.9, below its historical metrics. The company's trailing and forward P/Es are 9.6x and 12.3x, respectively, below the company's long-term historical averages. Its balance sheet features long-term debt-to-equity of 10% and a current ratio of 2.1%, better than its industry averages. Sasol's ROE is 20.3%. Over the past five years, the company's EPS and dividends grew, on average, by 7.6% and 11.8%, respectively. Analysts forecast the long-term EPS CAGR at 1.6% per year. Sasol pays a high dividend yield of 4.8% on a payout ratio of 46%. The company's main disadvantage is its negative free cash flow due to large capital expenditures. However, Citi is bullish about the stock, as it sees SSL as an "alternative play to cheap shale gas," with "upside at spot prices and conservative earnings outlook versus rivals." Last quarter, billionaire Jim Simons' RenTech and Arrowstreet Capital initiated new positions in the stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Dividendinvestr is a team of analysts. This article was written by Serkan Unal, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.