Rarely is there a time when you can get a Dow stock that is profitable and selling at 50% its tangible book value. Perhaps just as rare is being able to buy a Dow stock that is expected by analysts to grow EPS in double digits next year selling at only 5.5 times earnings. That is exactly what we are seeing today though with Bank of America and Hewlett-Packard.
These two strong and giant companies are selling at prices of maximum pessimism. For the patient investor, this is a rare opportunity to invest into two of the largest companies in the country at substantial discounts to their intrinsic value.
I have also included three other heavily discounted companies that are in the process of turning around: MetLife, The Hartford Financial Services Group, and 21st Century Holding Company.
Bank of America (BAC) is currently trading around $7 a share, with a tangible book value per share of $14. Not only is BAC trading at a heavy discount to its tangible book value, the tangible book value is growing.
The lack of earnings is what is keeping the stock down. While earnings have been disappointing the past few years, BAC is capable of earning $15 billion to $20 billion a year in the future. Bank of America earned $14 billion in 2004, $16.5 billion in 2005, $21 billion in 2006, and $15 billion in 2007, all before the Merrill Lynch and Countrywide acquisitions. Bank of America currently has a market cap of $78 billion.
Bank of America's operations are not permanently damaged and unprofitable. However, the transition from where the company is operating today and what it is capable doing in the future is not going to happen overnight either. It will take a few years for Bank of America to get back to maximizing its profit potential, but it should handsomely reward the patient investor.
If Bank of America gets back to earning $15 billion to $20 billion a year, the company will likely sell at a price near its tangible book value, which means the stock could more than double between now and that time.
Hewlett Packard (HPQ) is one of the most consistently beaten up companies in the financial media. Many bears are right in that HP does have has significant challenges and is still figuring out what operations to invest more heavily into. However, they are wrong in their valuation of HP's businesses. Many uninformed writers point to the struggling PC division as evidence PC is going to have a difficult future, even though its PC division accounts for a mere 13% of company earnings.
Meg Whitman has only been at HP a short-time, but has done a great job so far by many standards. She is focusing on building the right culture at HP, communicating clearly to investors and employees, and focusing on high margin lines of business to invest into. She already announced that 8% of the employees would be laid off, which will save HP $3 billion to $3.5 billion annually after 2014; a substantial sum considering HP recently earned between $7 billion to $8.8 billion a year after -tax the past 3 years. In other words, the recent layoffs could boost pre-tax earnings by as much as 35%. HP has also bought back 1 billion shares since 2004. With the earnings boost from payroll savings and likelihood of continued buybacks, EPS could be as much as 50% higher in 2015.
As far as the jokes many make about HP's board of directors and challenges with the CEO position in the past decade, HP has performed well by many standards as shown below. It is not surprising that since the recession and financial crisis in 2008-2009 the company has not grown significantly. Lower corporate spending from clients and customers have played a significant role in the lack of growth the past few years.
|Fiscal Year||Earnings Per Share||Sales Per Share|
With a share price of $22.30 and expected earnings of $4.07 per share in fiscal 2012, HP sells at a mere 5.5 times earnings. With the savings from lower payroll, lower share count from buybacks, and earnings from any future acquisitions, HP will likely see significantly higher EPS in a few years.
The Hartford Financial Services Group (HIG) is one of the largest providers of property and casualty insurance, life insurance, and investment products in the U.S. As a result of the 2008-2009 financial crisis, Hartford has struggled the past few years and the company is in the process of turning itself around. The company has sharpened its focus on long-term growth of its profitable lines of business and is getting rid of its less profitable businesses.
HIG is focusing on property and casualty, group benefits, and its mutual funds businesses. Meanwhile it will be getting rid of its individual annuity, individual life, retirement plans, and Woodbury Financial Services business.
Below is a snap-shot of the operating profits for HIG's different lines of business, separated by the ones management said they want to keep with the ones management wants to sell. It is not perfectly accurate because we do not know how "Corporate" will be split and if "Life Other Operations" is being kept or not.
|Property and Casualty Commercial||528||995||899|
|Property and Casualty Other Operations||-117||-53||-78|
|Total Continued Operations||170||967||462|
|Life Other Operations||358||-90||-698|
|Total Businesses Selling||492||713||-1349|
The question for shareholders and investors is how much will HIG get for the businesses it is selling? And what will HIG do with the proceeds?
HIG sells at $7.6 billion and has a tangible book value of $22 billion. If Hartford can get book value for the businesses it is selling, HIG's stock has tremendous opportunity. At nearly 1/3 its book value and a book value that is growing along with profits, HIG looks extremely undervalued. It should definitely be selling at a discount to tangible book value, perhaps 70%-80% of tangible book value. This steep of a discount offers tremendous upside potential to investors and a large "margin of safety".
MetLife (MET) is the largest life insurance company in the U.S. and was growing rapidly until the financial crisis of 2008-2009. Since then the company has faced some challenges, much like every other company in the financial and insurance industry. One of these challenges is being designated as a bank holding company, which has resulted in tighter capital controls and the inability for the company to return excess cash to shareholders. MetLife plans to deregister as a bank holding company this quarter and start returning free cash flow to shareholders.
MetLife has a tangible book value of $45 a share and it should continue to grow at a decent pace. At $30 a share MetLife trades at less than 6 times this years expected earnings and at a substantial discount to tangible book value.
Given MetLife's history of good risk management, its competitive position in its lines of business, opportunity for acquisitions, and opportunity to grow in emerging markets and other countries, MetLife is very likely to grow going forward. Seeing MetLife at $45 a share soon-9 times EPS and at tangible book value-is a realistic expectation. Long-term it has even greater potential.
21st Century Holding Co. (TCHC) is a small homeowner's insurance company in Southeast Florida. After a few years of unprofitability, the company's efforts to cut costs and develop a better book of business are starting to pay off. TCHC has reported a profit for the last 3 consecutive quarters and that trend will likely continue.
During the past two years TCHC let old, unprofitable policies expire. It was not an easy or quick process, but the correct one from a management and shareholder perspective. The last few years' rates have been low and reinsurance costs were high for TCHC, which lead to the company's unprofitability.
The company has gotten approval to raise rates significantly in Florida a few times in the past two years. This gave them the opportunity to not only write profitable policies, but to write a larger number of policies. The benefits of the cost savings and increased policy prices have turned the company around and the company should see continued profitability.
TCHC has $60.5 million in tangible book value and it has grown 8.5% over the last two quarters. With the likely continued profitability of TCHC, the tangible book value should continue to grow.
The investment portfolio for the company is invested very conservatively and 86% of the long-term investments consist of highly rated bonds. TCHC also has over $18 million in equities, which should help the book value grow over time if intelligently invested. After the 2008-2009 financial crisis TCHC hired a company to manage their investment portfolio.
Before the 2008-2009 financial crisis TCHC earned $10 million to $20 million a year. And that is what they are capable of earning during the next few years going forward. With $60 million in tangible book value and the ability to earn $10 million to $20 million a year, TCHC has a significant "margin of safety" at a market cap of $33 million and tremendous upside potential.
Additional disclosure: Some clients of mine own positions in the companies mentioned