5 Takeover Targets Undervalued by the Graham Number

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 |  Includes: COF, CSC, GHC, GME, SFD
by: Kapitall

The following is a list of five companies that have been identified as potential takeover or leveraged buyout (LBO) candidates by various publications, including Barron’s, TheStreet.com, and StreetInsider. These companies are also significantly undervalued when comparing current price to the fair value price, calculated by the Graham Number equation. (To access the complete universe of takeover candidates, click here.)

Benjamin Graham, the man who developed this equation, was a former mentor of Warren Buffett and is the so-called godfather of value investing.

The Graham Number, or the maximum price an investor should pay for a stock, is derived using only two data points: current earnings per share and current book value per share.

The Graham Number = Fair Value of a Stock = Square Root of (22.5) x (Earnings per Share) x (Book Value per Share).

The math of the Graham number is relatively straightforward. It is predicated on the belief that the price-to-earnings (P/EPS) ratio should be no more than 15, and the price-to-book value (P/BVPS) ratio should be no more than 1.5. Therefore we only include companies that meet both of these criteria.

From these criteria, the product of the two should not be more than 22.5. In other words, (P/EPS of 15) x (P/BVPS of 1.5) = 22.5, from which the equation was created.

Do you think these companies are likely to be taken over?

Graham input data sourced from Yahoo Finance, all other data sourced from Finviz.

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned below. Analyst ratings sourced from Zacks Investment Research. Note: The numbers on top of items represent the forward P/E ratio, if available.

List sorted by implied potential upside.

1. Capital One Financial Corp. (NYSE:COF): Credit Services Industry. Market cap of $22.54B. Takeover/LBO rumor sourced from Dick Bove, banking analyst. BVPS at $58.76, diluted EPS at $6.01. Graham number = sqrt(22.5 x $58.76 x $6.01) = $89.14. Current price at $49.43 (implies a potential upside of 80.33%). COF may be undervalued at current levels, with a PEG ratio at 0.74, and P/FCF ratio at 2.92. The stock has gained 28.07% over the last year.

2. GameStop Corp. (NYSE:GME): Electronics Stores Industry. Market cap of $3.0B. Takeover/LBO rumor sourced from Barron’s and TheStreet. BVPS at $18.30, diluted EPS at $2.45. Graham number = sqrt(22.5 x $18.30 x $2.45) = $31.76. Current price at $19.79 (implies a potential upside of 60.49%). The stock is a short squeeze candidate, with a short float at 25.52% (equivalent to 9.98 days of average volume). The stock has gained 9.75% over the last year.

3. Computer Sciences Corporation (NYSE:CSC): Information Technology Services Industry. Market cap of $7.44B. Takeover/LBO rumor sourced from Street Insider, Barron’s, and Merrill Lynch. BVPS at $46.34, diluted EPS at $5.30. Graham number = sqrt(22.5 x $46.34 x $5.30) = $74.34. Current price at $48.33 (implies a potential upside of 53.81%). The stock has performed poorly over the last month, losing 13.93%.

4. The Washington Post Company (WPO): Newspapers Industry. Market cap of $3.47B. Takeover/LBO rumor sourced from John Dorfman, chairman of Thunderstorm Capital. BVPS at $330.42, diluted EPS at $31.04. Graham number = sqrt(22.5 x $330.42 x $31.04) = $480.38. Current price at $428.36 (implies a potential upside of 12.14%). Short float at 12.05% (equivalent to 17.41 days of average volume), implying WPO is a short squeeze candidate. The stock has lost 3.39% over the last year.

5. Smithfield Foods Inc. (NYSE:SFD): Meat Products Industry. Market cap of $3.73B. Takeover/LBO rumor sourced from Street Insider. BVPS at $18.72, diluted EPS at $1.51. Graham number = sqrt(22.5 x $18.72 x $1.51) = $25.22. Current price at $22.60 (implies a potential upside of 11.59%). The stock has gained 18.84% over the last year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.