Forget Bubbles: Bargains Abound In This Overlooked Industry

by: John P. Reese

Enough with the bubble talk.

Yes, stocks have been on a tear in 2013, and yes, valuations have risen significantly. But with the S&P 500 trading for 17.6 times trailing 12-month operating earnings, 1.46 times sales, and 2.2 times book value, we're hardly at bubble levels.

Don't trust the denominators of those metrics because you think the Federal Reserve's quantitative easing policies have propped them up? To an extent and in certain areas, sure. But again, not to bubble-like proportions -- particularly not when many of the same people crying bubble have also been saying (correctly) that QE's liquidity in large part has not been making it into the broader economy.

I think the bubble talk is indicative of where investor psyches are. After two bubbles burst within eight years of each other, causing terrible stress and pain, investors and the media -- the vast majority of whom were blindsided by the two previous bubbles -- don't want to be burned again. At the slightest hint of overvaluation, they are thus fretting about bubbles.

I'm not saying that stocks will keep rising indefinitely - no one knows what will happen in the short term. The reality, however, is that many stocks in many areas of the market remain quite reasonably priced for long-term investors. One area my Guru Strategies (each of which is based on the approach of a different investing great) are finding value right now is the far-from-glamorous construction and agricultural machinery industry. With an average PE-to-growth ratio of 0.60 and an average price/sales ratio of 1.1, the industry is one of the highest rated by my Validea Value Index. Many of the stocks in this industry have been hit hard thanks to concerns about slowing global growth (especially in China). But value investing is about finding beaten-down stocks whose shares have been hit harder than their fundamentals merit. Here are five stocks for which my models currently think that's the case. As always, you should invest in stocks like these as part of a broader, diversified portfolio.

Lindsay Corporation (NYSE:LNN): Omaha-based Lindsay ($1 billion market cap) manufactures irrigation equipment primarily used in agricultural markets to increase or stabilize crop production while conserving water, energy, and labor. It also manufactures infrastructure and road safety products.

Lindsay has grown earnings per share at a 33% pace over the long haul (I use an average of the three-, four-, and five-year EPS growth rates to determine a long-term rate), which my Peter Lynch-based model likes to see. Lynch famously used the P/E-to-Growth ratio to find bargain-priced growth stocks, and when we divide Lindsay's 14.1 price/earnings ratio by that long-term growth rate, we get a P/E/G of 0.42. That falls into this model's best-case category (below 0.5).

Lynch also liked conservatively financed firms, and the model I base on his writings targets companies with debt/equity ratios less than 80%. Lindsay has no long-term debt, a great sign.

Joy Global, Inc. (NYSE:JOY): Shares of this Milwaukee-based mining equipment provider ($5.8 billion market cap) have struggled for much of this year amid economic fears. But a couple of my models think the $5.8-billion-market-cap firm is a bargain.

One is the strategy I base on the writings of the late, great Benjamin Graham, the man known as the "Father of Value Investing". This stringent approach requires that a firm have a current ratio (current assets/current liabilities) of at least 2.0, and more net current assets than long-term debt. Joy has a current ratio of 2.03, and $1.6 billion in net current assets vs. $1.3 billion in long-term debt, passing both tests. It's also selling at a good price: Its P/E (using three-year average earnings, which Graham did) is just 9.4, and its price/book ratio is under 2.

My Joel Greenblatt-inspired model also likes Joy, thanks to its 15.9% earnings yield and 40.9% return on capital. Those figures make Joy one of the top 40 stocks in the entire U.S. market right now, according to this approach.

AGCO Corporation (NYSE:AGCO): Based in Deluth, Ga., AGCO makes tractors, combines, hay tools, sprayers, and forage and tillage equipment. Its products are sold through more than 3,100 independent dealers and distributors across more than 140 countries.

AGCO ($5.6 billion market cap) has taken in more than $10 billion in sales over the past 12 months, and gets approval from my Kenneth Fisher-based model. In his 1984 classic Super Stocks, Fisher pioneered the use of the price/sales ratio -- PSR -- as a valuation metric. This strategy likes AGCO's 0.53 PSR, 23.8% long-term inflation-adjusted growth rate, and $3.30 in free cash per share.

My Lynch-based model also likes AGCO, whose 10.2 P/E and 26.1% growth rate make for a stellar 0.39 PEG ratio.

Caterpillar Inc. (NYSE:CAT): This Illinois-based manufacturing bellwether ($52 billion market cap) makes everything from construction and mining equipment to diesel and natural gas engines to industrial gas turbines and diesel-electric locomotives. It posted some bad recent sales numbers, but my James O'Shaughnessy-based value model thinks its shares have gotten too cheap.

When looking for value plays, O'Shaughnessy targeted large firms with strong cash flows and high dividend yields. Caterpillar has more than $57 billion in trailing 12-month sales, $10.38 in cash flow per share (more than six times the market mean), and a solid 2.9% yield, all of which help it pass the O'Shaughnessy-based model.

Komatsu Ltd. (OTCPK:KMTUY): Tokyo-based Komatsu ($21 billion market cap) makes and sells construction machinery and vehicles, mining equipment, forestry machines and industrial machinery. It's another favorite of my Lynch-based strategy, thanks in large part to its 14.7 P/E ratio and 20.8% long-term growth rate, which make for a solid 0.71 PEG ratio. The strategy also likes that Komatsu's debt/equity ratio (48.6%) is well below the model's 80% upper limit.

I'm long JOY and AGCO.

Disclosure: I am long JOY, AGCO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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