Many SA readers, myself included, follow Chuck Carnevale, and use his FAST Graphs to help put valuations on stocks before purchasing them. FAST Graphs provides a visual on the margin of safety that value investors seek by overlaying price and fair value trend lines. You can thus see at a glance how long a stock has been priced (black line in FAST Graphs) below fair value (orange line).
Some readers of Mr. Carnevale's articles, myself included, have wondered how long a good stock can remain undervalued. I bought shares in Aflac (NYSE:AFL) several years ago because it looked like such a great value. But AFL languished deep in green territory long enough that I became impatient with its price and with some of management's statements during the latest earnings conference call.
Teva (NYSE:TEVA) is another one that has languished a long time.
But my loss of interest in these two companies doesn't prove anything about them or this method of valuing them.
I thereby performed a more systematic search for an answer to the question posed in the title of this article by reviewing some of the stocks featured in two consecutive articles published by Mr. Carnevale in January 2012: "43 Dividend Champions On Sale: A Rare Opportunity" and "42 Dividend Contenders For Above Average Total Return." Using a post-recession dip in stock price to 20% or more below fair value (column 2) as a criteria for inclusion in the analysis, I found and record in the table below the following: in column 3 is the time to recovery of the stock to within 5% of FV; in column 4 is the "rebound" price return, i.e. price returned upon reaching 5% of FV or the present, which ever occurred 1st; in the far right column is current total (including dividends) 3-year return. The stocks are listed in the order presented in the original two articles.
Fair Value [date]
total 3-yr return
|Aflac||60% (8/31/11)||3+ yrs...||59%||69%|
|Stanley Black & Decker||40% (9/30/11)||0.4 yrs||87%||67%|
|Stepan||55% (2/26/10)||3.0 yrs||49%||37%|
|Archer Daniels||45% (5/28/10)||3.0 yrs||49%||98%|
|Dover||25% (9/30/11)||0.3 yrs||84%||89%|
|Illinois Tool Works||25% (9/30/11)||0.3 yrs||83%||108%|
|HB Fuller||30% (7/31/12)||0.8 yrs||45%||134%|
|Target||22% (6/30/11)||1.1 yrs||58%||27%|
|Walgreen||25% (5/31/12)||0.8 yrs||59%||77%|
|Community Trust B||32% (9/30/11)||2.0 yrs||35%||90%|
|Franklin Resources||26% (9/30/11)||1.7 yrs||54%||62%|
|Medtronic||35% (8/31/10)||3.2 yrs||61%||110%|
|Exxon||36% (12/31/11)||3+ yrs...||34%||42%|
|Helmerich &Payne||41% (9/30/12)||1.3 yrs||123%||87%|
|from "42 Dividend..."|
|24% (1/31/13)||1 yrs||2%||32%|
|54% (9/30/11)||2.5 yrs||100%||98%|
|25% (12/31/10)||3.7+ yrs||0%||37%|
|45% (12/31/11)||1.5 yrs||13%||100%|
|52% (12/31/11)||2.5+ yrs||38%||31%|
|The Andersons||44% (12/31/11)||1.5 yrs||108%||139%|
|Murphy Oil||36% (12/31/11)||1.5 yrs||11%||52%|
|Chevron||47% (12/31/11)||2.7 yrs||23%||54%|
|Stancorp Financial||45% (12/31/09||4.7+ yrs||50%||118%|
|General Dynamics||37% (12/31/11)||2.0 yrs||87%||105%|
|HCC Insurance||44% (12/31/09)||4.7+ yrs||67%||85%|
|Meredith Corp||46% (9/30/11)||1.5 yrs||103%||96%|
|Albemarle||44% (9/30/11)||1.7 yrs||52%||12%|
|Norfolk Southern||33% (12/31/12)||1.5 yrs||60%||56%|
|IBM||22% (5/28/10)||1.0 yrs||49%||13%|
|Novartis||32% (12/31/11)||1.5 yrs||54%||66%|
|UGI Corp||24% (9/30/11)||1.3 yrs||94%||90%|
+ yrs means still not recovered to within 5% of the orange FV line.
The stocks were then sorted by % below fair value in descending order: the top 17 dipped to an average of 45% below FV, and the lower 16 stocks dipped to an average of 28% below FV. The average time for the 1st group to recover - when they did - was 2.4 years, and the time for the latter group was 1.4 years. The average price appreciation from the biggest post-recession dip back to FV or the present was 67% for the more discounted group compared to 54% for the less discounted group. The average, current 3-year total returns have been 77% versus 74%. When examined individually instead of grouping the stocks, there was no significant correlation between % discount below fair value and either the time to recover (r2 = 0.02), the price return since the dip (r2 = 0.01) or the 3-year total return (r2 = 0.01). Thus, the size initial discount did not substantially improve the return, however good it was.
Some stocks did quite well even while taking a long time to recover. For example:
Medtronic (NYSE:MDT) was 35% below fair value in late 2010, but its price increased 61% as it crossed the orange fair value line 3 years later, and the latest 3-year total return = 110%.
General Dynamics (NYSE:GD) is another example. GD dipped by 37% below FV in late 2011 after a slightly smaller dip in late 2010. GD did not become fairly valued again until late 2013 by which time its stock had appreciated by 87% over a 2-year period. In the past 3 years GD has returned a total of 105%.
Thus, the 33 stocks in the table above, either combined or divided into 2 groups according to the discount size, have done quite well over the last 3 years. But the size of the discount did not seem to matter much.
I next used FAST Graphs to look at undervaluations on some of the largest cap tech stocks. Apple's (NASDAQ:AAPL) stock price has been more than 20% below fair value for more than 4 years now - its current, total 3-year return is 87%.
The 2nd largest cap tech is Microsoft (NASDAQ:MSFT) which was undervalued for 3 years, but is now slightly overvalued, and has returned 89% over the past 3 years.
Google (NASDAQ:GOOGL) returning 93% over the past 3 years was undervalued for most of the 4 years prior to 2014.
Intel (NASDAQ:INTC), which was undervalued for the past 3 years, has a 3-year total return slightly beating that of the S&P 500 at 78%.
Among the 10 largest caps in the tech sector, only Cisco (NASDAQ:CSCO) has underperformed the market (slightly) with a 70% 3-year total return. Yet many of them remain undervalued.
4 of the 5 largest cap tech stocks that are or have recently been >=20% below fair value for more than 3 years have beaten the 76% 3-year return on the S&P 500 (NYSEARCA:SPY). And 4 of the 9 stocks in the table above that were undervalued for 3 or more years have also returned more than the S&P 500.
Thus, a 3+ year period of undervaluation does not mean the stock is a value trap.
Disclosure: The author is long MSFT. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.