PRICE AND VALUE ARE NOT THE SAME
One of the strangest biases among investors is the belief that high priced stocks are automatically expensive and low priced stocks are automatically cheap. But this is not the case. The value of a company's common shares is directly related to the percentage of ownership to which that share entitles the investor. As such, it's very possible for high priced stocks to offer great value if they entitle the shareholder to a proportionally large share of the company's profits.
Here is a list of 16 stocks with prices above $100 that we consider cheap. How did we decide that they were cheap? The stocks had to have forward P/Es of 15 or less and trailing return on assets of 10% or greater. We also qualitatively eliminate names with excessive capital structures or transitory income effects that overstate underlying profitability.
APPLE INC (AAPL)
Forward P/E: 13.16; ROA (ttm): 19.09%
With the exception of Google, no other technology stock is as hip, buzzworthy and important as Apple Inc. The stock price has finally caught up to the hype and in May 2010, Apple Inc's market capitalization surpassed that of the long time technology king, Microsoft (MSFT). Long viewed as an outsider, Apple now finds itself squarely in the position of as consumer technology benchmark.
Market watchers often cite the high stock price as evidence that Apple is overvalued and due for a fall, but this bias is not based on fundamentals. In the last five years, this company has grown its shareholder equity from $10 billion to $47 billion. Its nascent presence in Asia ensures that the company's best growth is not behind it. For example in 2010, Apple's Japanese sales grew 75% and its Asia-Pacific sales grew 160%.
As a premiere technology company with global growth opportunities, its forward P/E of 13.16 is extremely cheap. In addition, with $40-$60 billion of excess cash and investments, Apple's forward P/E net of excess cash and investments is closer to around 10.90! If this wasn't reason enough to be interested, Apple is also riding strong secular waves of increased global per capita consumption, growth of the smartphone market and increased internet accessibility. These trends should continue to benefit Apple in the coming years.
Going forward, investors should pay close attention to Apple's gross margins and its research & development expenditures. From 2009 to 2010, gross margins decreased from 40.1% to 39.4%. Any significant future declines in gross margins could signal a reduction in the company's pricing power. Research & development is a relatively minor expense, but generally, increases in R&D should eventually lead to increases in sales. If the company's R&D spikes without new products or increasing sales, this could also be a troubling indicator.
Finally, one of the most under appreciated risk factors for Apple investors may be the prospect of increased pricing power among the country's bandwidth providers. Smartphones (the iPhone in particular) are notorious bandwidth hogs. Verizon (VZ) has already announced a move away from unlimited data plans. If the rest of the industry does the same, and if the upcoming merger between AT&T (T) and T-Mobile increase wireless pricing power, this could lead to higher prices for consumers. These price increases will adversely affect Apple's pricing power, but the extent of this is unclear.
INTERNATIONAL BUSINESS MACHINES (IBM)
Forward P/E: 11.03; ROA (ttm): 11.21%
The company has long ago transitioned away from the computer sales that made it a household name. IBM is now a diversified global consulting business with the following segments: Global Technology Services, Global Business Services, Software, Systems and Technology and Global Financing. More than half of corporate sales come from outside of the Americas. Revenues from the BRIC countries grew 22.8% year over year in 2010.
Blue chip companies are among the cheapest stocks in the U.S. stock market. They offer low valuations, foreign exposure, diversification and in many cases, growth. IBM is no exception. Investors should set aside their bias against high priced stocks and look at this not-so-boring blue chip.
GOOGLE INC (GOOG)
Forward P/E: 14.49; ROA (ttm): 13.19%
Google is one of the world's most ubiquitous companies. Its flagship search engine is the most popular site in the world and its subsidiary YouTube operates the world's third most popular website. Despite this dominant position on the internet, many potential investors are turned off by the high stock price. This artifact of the company's success is unlikely to change in the near future. The founders have expressed admiration for Buffett's refusal to split his stock-- and as such, the company stock could continue its march higher so long as the earnings continue to grow.
For a company with such a dominant position in a secularly growing business, Google trades at a very reasonable forward P/E ratio of 14.49. Like Apple, Google is also a cash rich operation. If you exclude the excess cash and investments, Google's forward P/E is around 12.0. This valuation alone makes Google an interesting investment. With Android's market share around 50%, there is further potential for monetization in this space as well as other opportunities in social media and in China. At current valuations, investors pay a reasonable price for a strong business and get sizable upside potential for free.
CNOOC LIMITED (CEO)
Forward P/E: 10.37; ROA (ttm): 15.49%
CNOOC is a Hong Kong based explorer, producer and developer of petroleum products. Based on the company's most recent 20-F, the company has net proven reserves of 2.66 billion barrels of oil equivalents. Almost all of the reserves are located offshore in China and around half of the reserves are developed.
This company trades at low valuations, but no moreso than many other large integrated oil & natural gas companies. CNOOC offers investors direct exposure to both oil and China. Investors bullish of both themes should give this company strong consideration, but other investors may benefit from waiting for stock weakness before initiating a position. While short term trends in China and oil are uncertain, it is a near certainty that per capita oil consumption in China will continue to grow. Over the next five years, the company expects to expand production at an annualized growth rate of 6% to 10%.
FIRST SOLAR INC (FSLR)
Forward P/E: 13.55; ROA (ttm): 12.66%
AUTOZONE, INC (AZO)
Forward P/E: 12.91; ROA (ttm): 15.71%
The replacement auto parts retailer and distributor is a profitable retailer trading at reasonable valuations. The company faces many of the same headwinds as the rest of the retail industry because of rising gas prices and other inflationary pressures. AutoZone deserves a closer look from investors. Among other things, the company has grow opportunities as it continues to build out its e-commerce and Commercial segement which has posted three straight quarters of 20%+ sales growth. Finally, with Eddie Lampert as the largest shareholder, investors should be confident that management's feet will look to maximize shareholder value.
JOY GLOBAL INC (JOYG)
Forward P/E: 14.52; ROA (ttm): 14.49%
CIMAREX ENERGY CO (XEC)
Forward P/E: 13.10; ROA (ttm): 14.60%
This oil and gas exploration and production company has been on a tear since the March 2009 lows. Cimarex operates mainly in the Midcontinent (Oklahoma, Texas Panhandle), Permian Basin, Gulf Coast and Wyoming. In 2010, the company produced 595 MMcfe (million cubic feet equivilent) per day. About 43% of this came from the Midcontinent, 27% came from the Permian Basin and almost all of the rest came from the Gulf Coast.
While natural gas continues to hover near lows on the spot market, natural gas companies have strengthened as a result of a strong commodities and energy market, and because of a growing consensus that natural gas prices will rise in the coming years as producers right size production. More recently, the company's stock price has continued to benefit as the nuclear crisis in Japan has resulted in increased projections for global coal and natural gas demand. As a result, coal and natural gas companies have been some of the hottest relative stock performers. For more information on an undervalued coal name, see this article.
Going forward, investors should understand that this stock is highly dependent on natural gas price projections. According to the most recent 10-K, only 5-6% of the natural gas production and 40-45% of oil production is hedged. As such, this company is leveraged to higher energy prices. As one of the larger names in the industry, there is the short term risk if the company overpays for a large acquisition, but for investors bullish of natural gas, this remains an interesting opportunity. For another natural gas stock in news, see this article.
CF INDUSTRIES HOLDINGS (CF)
Forward P/E: 10.96; ROA (ttm): 12.09%
CR BARD INC (BCR)
Forward P/E: 13.98; ROA (ttm): 15.65%
LUBRIZOL CORPORATION (LZ)
Forward P/E: 10.77; ROA (ttm): 13.97%
Perhaps nothing validates a stock's investment worthiness like an acquisition by Warren Buffett's Berkshire Hathaway (BRK.A). The legendary investor recently agreed to purchase Lurbrizol Corporation for $135/share in cash. Statistically, the company is still inexpensive. Surprisingly, Lubrizol stock has recently traded as low as $132/share following the acquisition announcement. Considering that Buffett has never walked away from a deal, we think the discount results from the possibility that Lubrizol shareholders will vote against the deal because it provides insufficient value.
Further weakness in the Lubrizol stock price is an opportunity for investors. In the best case scenario, it provides a merger arbitrage with upside. In the worst case scenario, the deal falls through but the investor still owns a stock that Warren Buffett had wanted to buy for a higher price.
While Lubrizol and its competitors trade at similar valuations, investors should be cautious about jumping into competitors like NewMarket Corp (NEU) and Innospec (IOSP). As we've mentioned in the past, Buffett specifically states that a central reason for his interest in Lubrizol is CEO James Hambrick.
WALTER ENERGY, INC (WLT)
Forward P/E: 8.94; ROA (ttm): 25.86%
NORDSON CORPORATION (NDSN)
Forward P/E: 14.94; ROA (ttm): 17.53%
NATIONAL PRESTO (NPK)
Forward P/E: 10.99; ROA (ttm): 15.87%
This long time favorite of value investors produces a wide variety of products including kitchen equipment, products for the U.S. Department of Defense and adult incontinence and diaper products. With strong cash flows, $332 million of book value and around $150 million of excess cash and investments, this company is certainly an inexpensive high priced stock that deserves investor attention, but with half of its 2010 revenues and gross profits coming from defense contracts, investors should be cautious of this stock amid looming national budget cuts.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL, AZO, GOOG, IBM, LZ over the next 72 hours.
Additional disclosure: NakedValue.com does not receive compensation to write about any specific stock, sector or theme.