Four New Winners For Your Portfolio

Just when you thought the list of society’s outcast stocks couldn’t get any longer, I’ve found four stocks in the bunch that are poised for a bounce back to more rational levels. The market correction over the past two weeks has brought these stocks to the front of the pack, and it is time for investors to take a look at these companies for inclusion into their portfolios, which have taken a beating of over 6% since July 19, 2007.

The first pick is a company that many people may never have heard of, even though they manufacture products that we use everyday. The company is Genlyte Group Incorporated (GLYT) and the industry is lighting. The company operates in a historically recession-proof industry and has recently come under pressure—falling 25% from its 52-week high of $87.80.

The company is trading at a forward price to earnings ratio of 12.19 and has a projected five-year growth rate of 16%. Genlyte Group has averaged a P/E ratio of 15 over the past 5 years. It appears that the stock has caught support at the $66 level and is currently trading at $67.16. My 1 year target price for GLYT is $82.65 [Forward EPS of $5.51 times the average P/E ratio of 15], which represents a 23% return from the current level.

Next, allow me to examine the retail sector. I often wonder why would anyone want to be invested in a company involved in this industry? Consumers are dealing with high gas prices, weather-related incidents, and a driving up of credit. Despite all the negative aspects of this sector, there is one company that has caught my attention, and it appears to be on the fast track to growth in handling these situations. In fact, if any of the above concerns improve, investors will see a nice jump in the stock price.

The company I am describing is a department store called The Bon-Ton (BONT). A recent article that appeared in Stores magazine announced that The Bon-Ton was the #1 fastest growing retailer in their annual “Hot 100” list, which is a list of companies with the fastest-growing annual sales.

A slight problem with the disbursement of earnings with BONT is that they have negative earnings three quarters of the year with a strong fourth quarter that effectively puts BONT into overall positive earnings for the year. They have since made a few acquisitions to help evenly disburse the earnings, but it is projected that this trend will continue. They are trading at a forward price to earnings ratio of 5.5, which—by itself—appears abnormally low. However, by looking at the historical high/low P/E ratios over the past 10 years, one will notice that this is within the range, and it is not unusual to find this company trading at this low of a P/E ratio.

The company is projected to grow at 14.5% per annum over the next five years, which, when combined with a forward P/E ratio of 5.5, gives the investor a value and growth stock. The company is highly leveraged, which is the primary reason for the fall from over $50 a share to a price of a little over $21 in less than two months. This is more of a speculative play than Genlyte, but I am a buyer at this level, and from past filings, George Soros is an investor who believes as well.

What’s in your wallet? That’s right, it’s Capital One Financial (COF) that I am recommending as an addition to any portfolio. This company has been punished over the past couple months for diversifying away from its core credit card business into a more Citigroup-style company. They made two strategic acquisitions: Hibernia and North Folk Bankcorp. Subsequently, the market has scolded them because of the timing of those purchases.

The sub-prime fear in the market has placed a cloud over the real growth experienced within this company. Capital One Financial is trading at a forward P/E ratio of 8.48 and is currently projected to grow at approximately 11.50% per annum over the next five years. The company has a stable management, which has been in place since its IPO in 1994, and has rewarded shareholders with a total return of 1400%.

As of Wednesday, August 8, 2007, Capital One Financial has announced the acquisition of NetSpend, a marketer of prepaid debit cards; this acquisition is yet another example of diversification within in the company and an additional potential source of growth. The company has been beaten down to an irrational level and it is time for investors to act in order to give this company the price it deserves.

As I pointed out in my post about the fire sale prices of some stocks, the energy industry is full of bargains lately, especially with the continued growth of the area. Lufkin Industries (LUFK) is one of those companies that stand to profit from the continued exploration of natural resources by providing those companies with the equipment.

The company currently has no debt on the books and recently announced a $30 million share buyback. The company has a forward price to earnings ratio of 9.76, which is at the lower end of its historical price to earnings ratio range. Furthermore, the company is projected to grow at 19% per year over the next five years. Along with the share buyback, the company has recently announced a 9.5% increase to its dividend, which currently yields 1.70%. If the price of oil continues to hover at its current level, more firms will enter into the exploration of natural resources, thus driving the demand for equipment that Lufkin Industries supply.

The companies that were mentioned in this article all exhibit the characteristics of being out-of-favor to Joe Investor but have a reasonable growth rate and a low price to earnings ratio. The key to smart investing in today’s market is trying to find companies that will give you the best bang for your buck.

These companies have what it takes to give an investor’s portfolio a boost from improving fundamentals, especially those dealing with the macroeconomic environment. So, sit back and enjoy a return to rationality when these star stocks start to make their rise to fame again.

BONT / COF / GLYT / LUFK 1-year chart

Comments

[jonreagan]

Totally agree with you on LUFK and COF; I don't know enough about GLYT, but it sounds interesting, and thanks for the tip.
Couldn't disagree with you more, though on Bon-Ton. The retail sector is definitely beat up right now; if you're looking for a real opportunity, why not go with a stock which has had solid fundamentals, and taken a price beating, than one which consistenly posts negative same-store sales?

Either Nordstrom (JWN) or Penney (JCP) would make a better play at this point. Nordstrom was at $59 in Feb, and $48 today. In between, they had a first quarter with a 9% revenue increase, and 25% increase in EPS. For July, same store sales came in at +10%. All of this in a pretty unforgiving retail climate.

JC has an incredible growth plan between now and 2010, with approx. 300 new "off-mall", smaller stores, and a continued growth in their private label brands. Penney's emphasis on private brands has helped innoculate them for the gross margin erosion that usually comes in a promotional, price-driven environment. And they have a multi-channel strategy--stores, catalog, and e-commerce--that is the best in the industry. At $64 today, ($87 in Feb), either Penney or Kohl's (KSS) represent great value in the "mid-tier" of retailers.

Sadly, I believe regional retailers like Gottschalks (CA) and Bon Ton (Northeast/Midwest) are dinosaurs that will collapse of their own weight. Even Macy's is finding out after their acquistion of May Company, that just getting bigger is not a guarantee of success. In a sector this competitive, winning is more about smart growth, and above all, giving the consumer added value.

[Bryan Moore]

Jon,

Thank you for your comments. It is always nice to get a good commentary going on the companies that I look at because it helps me complete further due diligence for each of them.

I appreciate your comment on The Bon-Ton (BONT), and I do see the risk associated with the company. I agree that risk is inherent in any regional retailer, especially BONT, which has a history of citing regional situations as to why they failed to deliver on their forecasts. It is difficult to value BONT, due to its relatively small size compared to the bigger, more stable companies in the retail sector. However, I did run a Comparable Ratio Valuation on BONT and, excluding the Price to Sales ratio, which was excessively high due to the amount of leverage employed by BONT, I came out with an intrinsic value estimate of $43.43. I then apply a 20% discount to this estimate (due to the regional nature of this company); this gives me a one-year price target of $34.75, or an approximate 60% undervaluation at its current trading price.

This valuation does come at the idea that the retail sector will recover and stabilize from this point forward. Due to the historic weakness in the retail sector over the summer months, I think a buy of BONT in the months of September or October, which has represented the bottom of the stock each year over the past five years, represents an ideal time to ride the strong 4th quarter that BONT has historically experienced. BONT does employ a great deal of leverage as a result of acquiring additional store brands over the past two years, and eventually because of that leverage it will suffer in a declining retail environment, but I don’t feel that its time to suffer is now.

Furthermore, I do have some concerns over the insider trading activities of their executive chairman, Mr. Tim Grumbacher, who sold stock at the very top of the 52 week price range back in May, but did not feel it necessary to raise more equity and bring BONT debt ratios back more in line with historical levels. Now the company is feeling the pains of being leveraged more than is normally accepted in a negative retail environment, thus a 60% drop in stock price from the $50+ level.

Another point to consider is the increase in institutional ownership, which has been on the rise since the stock started falling; I always see this as a buy signal because it shows that the institutional investors are at least showing support to the company at these levels.

Thank you for the suggestions on companies in the retail sector and I will really take a good look at those for an additional and safer play into the retail market. At this point, BONT is a very speculative play; if the retail market recovers in some capacity, you can expect a strong outperformance despite potential declining same store sales due to the amount of leverage the store currently has. It just depends on how much risk one is willing to undertake in his portfolio.

Again, thank you for your comment and I hope that this response further clarifies my reasoning for the BONT recommendation.

Bryan Moore