Unpopular Large Companies May Offer Above-Average Returns With A Margin Of Safety

Includes: AEG, E, GLW, VALE
by: Andrew Paterson

Following the 133-206% rise in leading securities indices from 2009 depths that may prove historical, the fear that often contributes to the occurrence of such troughs may soon if not already be outweighed by frustration with near-zero bank and money-market returns.

The legendary Benjamin Graham advocated that the conservative investor's portfolio have a balance between bonds and stocks averaging 50-50 but never with more than 75% of the larger element, to " … restrain him from being drawn more and more heavily into common stocks as the market rises to more and more dangerous heights." (Graham, 1973, pg 43). Notwithstanding the 4-year rise in stock prices, low current interest rates motivate the author to favor allocation to stocks near the high end of the range. However, the investor who is transitioning from largely-cash holdings may be prudent to initially target a 50% allocation to stocks, spreading purchases over a few months, then reconsider based on the course of bond interest rates and other events in the interim.

Toward an initial 50% allocation to stocks, how might one now realize satisfactory investment results while maintaining a prudent margin of safety? Many investors may be well served by low-management-cost index funds or ETFs. However, the greatest opportunity for reward, and also for folly, may derive from the choosing of individual stocks for the portfolio. Notwithstanding the rise from March 2009 lows, 'unpopular large companies' that meet financial metrics considered by Graham to offer a margin of safety may confer to the portfolio a chance of a better than average result. The investor with confidence in his or her ability to evaluate such opportunities might consider companies such as these:

Aegon (NYSE:AEG) - headquartered in the Netherlands, AEG is a major provider of life insurance, pension, and asset management products and services in the USA (about 70% of pretax profits), with important new operations in several European and Asian markets. Judged 'too large to fail' and therefore receiving EUR3 billion from the Dutch government in 2009 that has been repaid, AEG sells at only about 40% of tangible book value while paying a 3% dividend that is well covered by earnings. Like many insurers, earnings tend to be constrained by low interest rates -- in the bull case, the shares may therefore hedge the conservative investor somewhat against eventual 'regression to the mean' by interest rates. Indeed, from the 25 July 2012 nadir in 10-year US Treasury rates, AEG rose by 84.5% to 19 Sept 2013, paralleling the 10-year Treasury rate rise of 95% and substantially outstripping the S&P increase of 28.7% (Table 1, below - values from Yahoo Finance).

















In the bear case, the dividend and the safety afforded by being 'too large to fail' may confer some patience until financial assets return to more normal price-to-book value ratios. Some other firms in related industries with similar merits (but not identical - do your due diligence!) include ING Groep NV (NYSE:ING), Genworth (NYSE:GNW) and American National Insurance Co (NASDAQ:ANAT).

Vale (NYSE:VALE) -one of the world's lowest-cost producers of iron and nickel ore, this Brazilian company also mines other metals and fertilizers, and operates a rail system. Recently selling for less than half its 2011 high and 1/3 of its 2008 all-time high, the cost-advantage of this producer is likely to sustain adequate profitability even if fears about oversupply of its key iron markets are realized (and recent evidence suggests that such fears may be somewhat exaggerated). At about 1.2x tangible book value, and with a nearly 5% dividend well covered by earnings, in the bull case, the shares offer the conservative investor a means to participate in growing capital investment associated with worldwide economic recovery. The bear case is that oversupply of iron ore reduces prices and profit margins, however as a low-cost producer Vale probably remains profitable and benefits in the long term from new low-cost production and shuttering of higher-cost competitors. Some other firms in related industries with similar merits include Posco (NYSE:PKX) and Rio Tinto (NYSE:RIO).

ENI (NYSE:E) - this 30% state-owned Italian company participates broadly in the fossil fuel and power industries, with operations in oil exploration & production, gas & power, refining & marketing, petrochemicals, and oilfield services. Now selling near its tangible book value and at only a little more than half of its 2008 high, its gas and electric utility businesses offer some earnings stability that underwrite its nearly 5% dividend. In the bull case, its other businesses will participate in an eventual economic recovery in Europe and hedge the conservative investor against fossil fuel price increases. In the bear case, economic malaise continues and the Italian government hinders ENI's ability to reduce its exposure to unprofitable areas … but it probably still covers the dividend and continues to develop new production. Some other firms in related industries with similar merits include Repsol (OTCQX:REPYY), Total Petroleum (NYSE:TOT), and Chevron (NYSE:CVX).

Corning (NYSE:GLW) - traditionally associated with housewares (sold long ago), GLW serves many industries with high-performance materials. Despite share price declines associated with growing competitiveness in the LCD markets that drove its earnings to new highs in 2011, R&D expenditures comprising about 10% of its global revenues (comparable to pharma companies) continue to generate new revenue streams such as those that have 'reinvented' this company many times in its 162 year history. Selling near tangible book value, with a 2.7% dividend that is well covered by earnings, nearly $2 per share in net cash and an active buy-back program, these shares have fluctuated with product cycles and the 'Internet bubble' (in Corning's case based on demand for optical fiber, that remains an important product line) but on the whole closely paralleled the performance of the S&P 500 over the past 30+ years (Figure 1).

In the bull case, the present dip may prove to be a profitable buying opportunity as new products replace older ones. In the bear case, if R&D does not soon provide a next 'big winner', profits may remain static or even decline for some time but are likely to still cover the dividend and with the shares deriving a margin of safety from their low valuation and the company's stock buy-backs.

In summary, investing in 'unpopular large companies' such as these may by dividends alone yield about half of the 120-year average total return of 8.8% on stocks [estimated from 1871-1992 (Bogle, 1994)], while also offering equity participation in worldwide economic recovery at prices that provide a margin of safety.


Bogle, John (1994). Bogle on Mutual Funds: New Perspectives for the Intelligent Investor. New York: Dell Publishing.

Graham, Benjamin (1973). The Intelligent Investor, 4th revised edition. New York: Harper & Row.

Disclosure: I am long AEG, GLW, VALE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.