A List Of Classic Value Stocks Part II: Low P/Es With Strong Balance Sheets

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Includes: AREX, CLD, CREG, GLF, NDRO-OLD, OGZPY
by: Ruerd Heeg

Summary

I expect to launch an exclusive newsletter on Seeking Alpha next week.

My research will focus on U.S. and foreign-listed deep-value stocks such as net-nets, and low PE companies with strong balance sheets.

Benjamin Graham has recommended these 2 stock selection strategies. Stock researchers have confirmed the great statistical returns for these types of stocks.

My previous article contains an example of an exclusive research posting focusing on companies trading below net current assets (net-nets).

This article contains an example of an exclusive research posting focusing on companies with low PE and strong balance sheets.

I am fascinated by deep-value investing based on statistics such as PE, PB and NCAV. Some people (hedge fund managers) see life as an ongoing attempt to place good bets and avoid the bad ones. For distinguishing good bets from bad ones statistics are very important. To show how bad some people are at applying basic statistics in daily life I will first give a common but extreme example, that has actually impressed me a lot. Then I will continue explaining why many investors neglect stock statistics and how they can improve their long-term returns using stock statistics.

Doctors strongly suspect that a patient has cancer but they are not completely sure. If the patient has cancer she will die soon for sure. So they suggest surgery that will provide the definitive diagnosis and if cancer is diagnosed then the same surgery will cure her. The patient doesn't like the inconveniences of the surgery and neither the reduced quality of life if any extended surgery will be necessary to cure her. After all she feels fine for the time being, so maybe she isn't sick at all. And wait, another doctor has told her that she can stop the cancer by following a diet. She has tried this diet for some time and she feels a lot better now than before. She told me about her dilemma and the choice she had made. We discussed the likelihood that she was ill and the potential consequences of not having surgery. Many months passed. I almost started to believe that her side of this bet turned out OK until, very sadly, she died. I wonder what I could have said instead to change her choice.

With investing in the stock market we often make bad bets as well. Fortunately losing money is not deadly, but it can still be very harmful. Most of us intuitively like to invest in growth investments. Or in big and well known companies. Because we all like similar companies, many investments are overpriced and have on average sub-optimal returns. To get better returns, one needs to look at smaller companies that people don't like. Simple stock measures like NCAV, PE and PB help me. Favorable values of these stock measures increase the chances of investing in companies that are disliked for no good reasons. To increase the chances of success in my betting even more, I use the findings of stock researchers. In particular, research into stock market returns of various types of value stocks over at least 4 decades.

Although finding good statistical stock picks is nowadays a lot easier than it used to be it is still extremely time consuming. So what I am offering is a newsletter within Seeking Alpha that lists net-nets and other great statistical value bets including some preliminary research. I intend to make about 2 different newsletters per month. This article is an example of one of the monthly newsletters I intend to make within Seeking Alpha.

Two stock picking strategies from Benjamin Graham

So in my newsletters, I will publish information on stocks that are great investments just based on their statistics. These are not high conviction ideas, but if you have a diversified portfolio of such stocks you will do great in the long run. My statistical bets fall into 2 categories:

  1. Net-nets: stocks with at least 1.5 times more liquid assets net of liabilities than the market cap.
  2. Stocks of profitable companies with very strong balance sheets.

Once per month I will publish a newsletter focusing on net-nets and once per month I will be publishing a newsletter on stocks of highly profitable companies with strong balance sheets. So subscribers will receive 2 newsletters per month (10 months per year). In the 2 vacation months, subscribers will still receive the newsletter with the net-nets.

Background of the 2 stock selection strategies

The two stock selection strategies above were suggested by Benjamin Graham. I can recommend everyone to read the interview "An hour with Benjamin Graham", which is unfortunately behind a pay wall. The category with the highly profitable stocks with great balance sheets usually contains larger and less obscure stocks but on average will perform less great than the net-nets. The statistical returns of these stocks are less well researched than those of net-nets. Graham mentioned a return of 15%. In their book Quantitative Value, Gray and Carlisle have found an annualized return of about 18%. They have found that the returns were very volatile because in some years there was only one American stock satisfying the criteria. I'm confident that this disadvantage will be overcome by including stocks listed on foreign exchanges.

Sell strategy

For both types of stocks, I suggest Graham's sell strategy: sell them as soon as the profit is 50%. If this is not possible then keep them at least 2 calendar years and sell them at market price. I think this strategy is better than the sell strategy of many statistical stock researchers: find new stocks satisfying the criteria and rebalance. The sell-at-50% strategy makes better use of the volatility of these stocks. Holding deep value investments only for a short while is still what many value investors today are doing, among others Seth Klarman.

Small-caps but not micro-caps

I will only discuss stocks with a market cap of at least 70 million USD. That makes the opportunity large enough for all of us. Micro-caps are a lot riskier as well. See also my experience with Trap Oil and the comment section in my previous article. To reduce risks further, I will ignore stocks with extremely low prices. On average the low PE stocks with strong balance sheets have a much larger market capitalization than the net-nets.

Foreign stocks

I will search for stocks that can be bought with an Interactive Brokers account. So these are stocks listed in the US, Mexico, Canada, Germany, the UK, France, Austria, Belgium, The Netherlands, Italy, Norway, Spain, Sweden, Switzerland, Australia, Hong Kong, Japan and Singapore. Many of these great statistical picks are Chinese stocks listed in Hong Kong. While these stocks come with their own risks, I can't help it that China is the cheapest stock market in the world. Or, more accurately formulated: the lack of these great statistical bets in other markets is a clear sign of how terribly overvalued these markets are. But this is no problem for me: I have no home bias since this is known to be bad for my returns.

Low PE companies with great balance sheets: excluding one-time earnings

Below are the low PE companies with great balance sheets I found with a market cap of more than 70 million USD and PE less than 7. Be aware that calculation errors may occur. Many results are pessimistically rounded towards the nearest half, whole, ten or hundred. Many numbers have been taken from Bloomberg and Yahoo and trusted. Most numbers have been checked via the financial reports but not all.

In my selection, I ignore earnings and expenses categorized as one-time earnings. With a great balance sheet, I mean that the total of the tangible assets is less than twice the book value. In some cases these assets need to be discounted, for instance capitalized exploration costs of mining companies. Just as with the exact meaning of one-time earnings this is a difficult exercise, but if I have an opinion I will add a note.

Unfortunately these stock screening criteria are much less selective than my stock screening criteria for net-nets. So I added an extra criterion, which is that the PB must be less than 0.8. Many stock researchers have found that companies that have a low PE and a low PB have better returns than companies that have either a low PE or a low PB but not both. So this extra criterion doesn't harm the expected returns. Moreover at the end of his life, Graham recommended investing in stocks with a PB of less than 0.83 that have strong balance sheets as well, although he preferred the low PE companies with strong balance sheets.

Even with the extra restriction that the PB must be less than 0.8 it takes an enormous amount of time to compose the full list. This is because the earnings almost always need to be checked in the financial reports. Usually one-time earnings and expenses need to be excluded from the officially reported profit. In addition, I encounter more special situations when screening for profitable companies with strong balance sheets than when screening for net-nets. Of course, I could compromise on the quality of my preliminary research. Instead I have chosen to compromise on the amount of companies I investigate for each low PE newsletter. Depending on the amount of low PE companies, I will split the list into 2 or 3 different lists. For example in the first low PE newsletter, I will investigate low PE companies with PB from 0.2 to 0.5, and in the next low PE newsletter, I will investigate low PE companies with PBs from 0.5 to 0.8. Below is the first low PE newsletter, dealing with companies with PB from 0.2 to 0.5.

Name

Ticker

Share price

Market cap (millions)

PE

PB

Yield (%)

Lai Fun Holdings

1125:HK

0.176 HKD

2610 HKD

3

0.21

1.9

One of the many Chinese property developers. You have to believe in the fair value gains of these companies.

Tai Sang Land Development

89:HK

4.07 HKD

1200 HKD

2

0.22

3

Most of the earnings over 2014 of this property developer are a result of increased fair value of real estate. Similar fair value increases occurred in 2011, 2012 and 2013. The annual report says that these increases are a result of rent increases during 2014. To me this seems plausible. To own this stock you have to believe in the Hong Kong real estate market although over 25% of the rental income comes from the US.

Chuang's Consortium International

367:HK

1.03 HKD

1800 HKD

4

0.24

5

Most of the earnings over 2014 of this property developer are a result of increased fair value of real estate. These increases are in principle one-time, but have occurred for several years in a row without substantial increases of the stock price. To own this stock you have to believe in the Hong Kong real estate market since most of the company's properties are in Hong Kong.

Highland Gold Mining

HGM:LN

0.4 GBP

125 GBP

5

0.23

12.5

Who dares to own shares in a Russian gold miner? The company seems to be slow with publishing its annual report. Otherwise this seems to be a great company. Increasing production and paying lots of dividend as well. The numbers here are outdated but since the production has increased and the costs should have gone down with the ruble, shareholders don't need to be worried. Beyond the scope of this article is an analysis of the proven and probable reserves and related future cash flows.

Soundwill Holdings

878:HK

12.76 HKD

3600 HKD

4

0.22

1.5

Even when not taking one-time profits into account, the PE is low. The problem with this company is that it doesn't pay out much. This is typical for companies with a majority owner. I guess it will take many years before this will change.

Emperor International Holding

163:HK

1.96

7200 HKD

5

0.27

5

Another property developer from Hong Kong. Again you have to believe in the fair value gains of the properties. This company has also some gaming subsidiaries in Macau and several hotels.

Shun Ho Technology Holdings

219:HK

2.58 HKD

1400 HKD

5

0.3

See the group reorganization. This company invests in and operates hotels mostly in Hong Kong. Will be renamed to Shun Ho Property Investments. The PE is excluding a large one time-profit from a sale of one of their assets. This company doesn't pay dividends and that might stay so for years to come. Again the CEO owns the 71% of the shares which is usually a predictor of meager payouts.

Wing Tai Properties

369:HK

5.05 HKD

6800 HKD

4

0.3

2.6

The PE includes an increase in fair value of the assets, without that the PE would be 17. Most of the company's properties are in Hong Kong, but the company has some business in Shanghai, Beijing, London, Singapore and Kuala Lumpur as well.

Itc Corp.

372:HK

0.75 HKD

1100 HKD

5

0.32

5

The investment business owns shares of several other companies. So some of fair value revaluation profits are hidden in the balance sheets of their investments. Among them about 25% of the shares of Rosedale Hotel Holding, 1189:HK, which is one of the cheapest net-nets on the planet, and has paid a large dividend last year. I don't understand why they sold about 5% of the shares in Rosedale in November 2014. The company's income results from the revaluation of their equity investments.

MMA Offshore

MRM:AU

0.76 AUD

260 AUD

4

0.31

15

This company provides logistics and supply services for offshore oil and gas development operations. With today's low oil price the catch is that there won't be enough demand for their services. Still they had a nice cash flow from operations in the second half of 2014 and despite large capex, they paid out about half of the cash flow from operations over 2014.

Enduro Royalty Trust (NYSE:NDRO-OLD)

NDRO

5.15 USD

167 USD

6

0.32

10

This is a so-called royalty trust. It receives royalties on production of oil and gas properties. Investors are often attracted by the high dividends of these trusts. Always investigate for how much longer the trust will continue to pay out and which parameters influence the payouts (e.g. oil price). Such analysis is beyond the scope of this list. See also here.

Playmates Holdings

635:HK

8.61 HKD

2000 HKD

5

0.32

4

This company sells toys and "family entertainment activity products" but is now mostly investing in real estate in Hong Kong. About 60% of the (mostly toy) revenue comes from the US. The property business might have originated from the toy manufacturer owning the real estate for its operations. The revaluation gain on the real estate is not included in the PE above. Without that the PE would be less than 3. The company is repurchasing shares (1.5% in 2014). Over half of the dividend is a special interim dividend.

CCT Fortis Holdings

138:HK

1 HKD

840 HKD

5

0.33

6

The PE is based on the profit from operations. This excludes a huge one-time gain from the partial sale of a subsidiary (CCT Land) in December 2014. At the moment they are negotiating a deal to buy some parts of CCT Land again. In 2014, the company has increased the number of shares by about a third.

Gazprom (OTCPK:OGZPY)

OGZPY

5.75

104 billion USD

2.5

0.34

6

Great statistics but a Russian company for a large part owned by the Russian state. Who dares to own this company? I recommend taking a small position in this extremely disliked company.

Golden Wheel Tiandi Holdings

1232:HK

0.84 HKD

1530 HKD

7

0.42

2

Excluding the cashless revaluation profit of the real estate, this company has suffered an operational loss in 2014. Therefore, I can't recommend it.

Medusa Mining

MML:AU

0.895

190 AUD

4

0.33

Beyond the scope of this article is an analysis of the proven and probable reserves and related future cash flows of this gold miner with operations in the Philippines. Good operational cash flow but because of capex a free cash flow of just below zero. Some option overhang but also some insider buying in 2014.

YT Realty Group

75:HK

2.55

2050 HKD

9

0.34

1.3

This property developer in Hong Kong real estate seems to be pretty stable. In the PE here I have excluded the profit from revaluation of the real estate. Including this revaluation profit the PE would be less than 5. This property developer does not pay out much dividend.

S E A Holdings

251:HK

6.12

4300 HKD

7

0.35

1.8

Without fair value gains the PE of this real estate investor would be about 17.

Pioneer Global Group

224:HK

1.29

1500 HKD

3

0.35

3

Without fair value gains the PE of this real estate investor would be about 9.

Cloud Peak Energy (NYSE:CLD)

CLD

6.25 USD

382 USD

5

0.35

The operating profit of this coal miner is about 60 million. The other 75 million or so comes from a gain on the sale of their interests in the Decker mine. Another drawback in 2014 is the termination of a presumably favorable tax agreement. I suppose that future profits will be at break-even level, at least with current coal prices.

Multifield International Holdings

898:HK

0.42

1800 HKD

4

0.36

3

Without the revaluation profit the PE of this real estate company would be about 7.

Tiong Woon Corporation Holding

TWC:SP

0.21 SGD

98 SGD

6

0.37

1.8

This construction company provides services to the oil and gas sector. I haven't found significant one-time items that need to be excluded from the computation of the PE.

Circle Oil

COP:LN

0.113 GBP

63 GBP

4

0.37

The numbers from this oil company (from June 2014) are outdated. Since then the oil price has decreased from a realized price of 104 USD in H1 2014. Therefore going forward, this company will operate at a loss unless new production capacity will come online. An analysis of the future production capacity and related cash flows is beyond the scope of this article. The company also has a convertible loan of 20 million USD at a conversion price of 0.136 GBP due in July 2017. This load has recently been extended. In this agreement the conversion price was lowered from 0.30 GBP to 0.136 GBP. So if the stock price goes up just a little bit there will be significant dilution.

Cequence Energy

CQE:CN

1 CAD

211 SGD

3

0.41

Oil exploration and production company. Almost the entire profit comes from a one-time gain related to the sale of the Ansell property. Because of the decrease of the oil price I think the company will write losses going forward, unless production will increase much.

GulfMark Offshore (NYSEMKT:GLF)

GLF

15.85 USD

400 USD

7

0.42

This company is similar to MMA Offshore above only a bit more expensive. The company has suspended the dividend. Before that the yield was 6%.

Wai Kee Holdings

610:HK

3 HKD

2400 HKD

5

0.42

5%

Most of the profit of this civil engineering company and concrete manufacturer is cashless since it is categorized as "Share of results of associates". But the "associates" have paid a dividend. Adding this dividend to the core cash profit the total cash profit is about 320 million HKD, so the "real" PE is about 7.5. Insiders own almost 50%.

China Recycling Energy Corporation (NASDAQ:CREG)

CREG

1.07 USD

89 USD

4

0.44

I don't recommend Chinese companies that are listed outside China. Moreover the profit of this company is cashless.

Takigami Steel Construction

5918:JP

604 JPY

16400 JPY

2

0.43

0.7

This company had a one-time gain of about 7.5 billion JPY. Without that gain the PE could be 20. Financial reports in Japanese only.

Look

8029:JP

231 JPY

8800 JPY

4

0.44

1.3

Interesting Japanese apparel company paying some dividend as well but unfortunately only reports in Japanese.

Nanyang Holdings Ltd.

212:HK

46.8 HKD

1700 HKD

6

0.45

2

The company repurchased 14% of the shares at 33 HKD in August 2014. The Yung family owns now 52% of the shares. This could (still) be a good squeeze out opportunity. Without revaluation profits and a one-time gain from the sale of a subsidiary the profit would be 2.08 HKD per share (PE 23) instead of 9.02 HKD. Of this 2.08 HKD the company has paid a dividend of 1.2 HKD.

Exillon Energy PLC

EXI:LN

108.5 GBP

180 GBP

6

0.45

Oil producer with assets in Russia. Going forward I don't think that the profits are sustainable, instead the company will probably book large losses. Production costs seem to be higher than oil price, at least higher than the current oil price. Last numbers are from June 2014.

Approach Resources (NASDAQ:AREX)

AREX

8.83 USD

350 USD

7

0.46

Another oil and gas producer that will hardly be profitable going forward. On paper the balance sheet looks good but what is Property, Plant & Equipment worth if these assets don't generate cash flow? Lots of capex and significant debt. At the beginning of 2015 the company had its PV-10 estimated at $1.5 billion but is still using an oil price of $94.56.

Yugang International

613:HK

0.125

1250 HKD

4

0.47

2.4

There is a share in the profits of an associate, which I think is from YT Realty Group discussed above. I estimate this associate profit at about 80 million HKD excluding revaluation profit. And there are also 2 one-time losses in Comprehensive Income without any notes. The PE without the revaluation profit and the 2 one-time losses is about 6. Worst case, the PE just without the revaluation profit and including the 2 one-time losses is about 15.

Tan Chong International

693:HK

2.75 HKD

5500 HKD

6

0.48

3.8

Included in the PE of 6 are currency losses and fair value gains on real estate. Worst case the "real" PE is about 11.

K Wah International Holdings

173:HK

4.5 HKD

12500 HKD

7

0.48

3

Property developer. About 1.4 billion profits are the consequence from a cashless gain related to the transfer of projects in development stage to investments. This gain might make sense. However, excluding this cashless gain and excluding the much smaller revaluation profit, the PE would be about 40. A good sign is that the payout ratio over 2014 is about 80%, based on the cash profit.

Tian An China Investments

28:HK

5.1 HKD

7600 HKD

7

0.49

2

This property developer sold a subsidiary in 2014. Almost the entire profit is related to this sale. This sale makes it impossible for me to estimate the profit going forward.

Miramar Hotel and Investment Co.

71:HK

11 HKD

6500 HKD

5

0.49

4

Without fair value revaluations on the real estate the PE would probably be more than 10. Slept in one of their hotels years ago for a couple of weeks in total. The first time it was OK, the second time the experience wasn't that great.

Zoltav Resources

ZOL:LN

0.455 GBP

67 GBP

2

0.49

This oil and gas exploration and production company with assets in Russia diluted shareholders at much higher prices to fund an acquisition. The numbers are from June 2014, so they are outdated. The operations of the company are in the red. The "profit" is related to a large cashless gain on an acquisition (when the oil price was still high). More details here.

Shun Tak Holdings Ltd.

242:HK

4.15 HKD

13000 HKD

3

0.49

1.6

Without revaluation profits the PE would be 6, which is still OK.

Which of these stocks are the most attractive?

A company's PE can often be disputed in multiple ways. For instance Chinese property developers include an increase in the fair value of their real estate. If this increase is based on the rent they receive then I'm OK with it. But if this increase is just based on a revaluation of the real estate investors need to be cautious. Increases in the value of any real estate are quite common, but volatile and cashless. Especially if the PB of a stock is very low we can expect relatively high fair value increases compared to the market cap. In that case the probability that there might be real value in the fair value increases is higher.

I also recommend checking the option overhang as well. One would like to compute a more reliable profit number taking the realized profits from employee option sales into account. This "real" profit can be approximated by subtracting the realized profit from option sales from the reported profit and adding back the fair value of the options when they were granted. This exercise is beyond the scope of my investigations. Fortunately there is a hidden advantage of buying companies with extremely depressed stock prices. With such companies employee options are often way out of the money.

There are many companies with a low PE and a strong balance sheet so investors should use extra selection criteria. I like the stocks with a (very) low PE that seem to be real and consistent, so without one-time items such as these fair value gains on real estate. Since profits can be volatile, some diversification of a company's revenue is preferred. I also like stocks of companies that appear shareholder friendly.

For net-nets our high returns come for a large part from the occurrence of expected and unexpected but positive events. But with low PE companies investors can simply bet that the profits of these companies don't decrease. In that case the stock price will often revert to a higher PE.

So it makes sense to select the more stable low PE companies. For that reason, I have excluded net-nets and stocks with extremely low share prices from my list. What is low depends on the particular exchange, but I guess in the US a share price below 0.50 USD is extremely low. In Hong Kong and Singapore I think a share price below 0.10 HKD or 0.10 SGD is extremely low. In the UK, a share price below 0.01 or 0.02 GBP might be extremely low. Similarly I have set a minimum PE of 1.5 and a minimum PB of 0.2 to focus the search results on the more stable companies. Finally, I also exclude investment funds such as closed-end-funds because the reported profit usually doesn't include the "look-through" profit of the investments.

Attractive low PE companies described here

What does this mean in practice? I should add "for me" since the list is long and my selection criteria allow plenty of freedom. In fact, there are 2 questions instead of one. The first question is which stocks are acceptable and cheap investments, so this is a pre-selection. Here I have selected stocks on low PE excluding one-time events and some signs of shareholder friendliness. So among the stocks in this list, I find the following stocks acceptable and cheap enough for investment:

Tai Sang Land Development, Highland Gold Mining, Playmates Holdings, MMA Offshore, CCT Fortis Holdings, Gazprom, Medusa Mining, Multifield International Holdings, Tiong Woon Corporation Holding, GulfMark Offshore, Wai Kee Holdings, Nanyang Holdings, Yugang International, Tan Chong International, Shun Tak Holdings.

Note that it could happen that I will publish a newsletter with a list as long as the first list above but without any stocks that I like in particular.

The second question is which stocks I personally find the most attractive. In principle I only invest in net-nets but if I would need to choose, I would choose the following stocks:

Tai Sang Land Development, Chuang's Consortium International, Emperor International Holding, Highland Gold Mining, Playmates Holdings, MMA Offshore, Gazprom, Wai Kee Holdings, Nanyang Holdings.

Final words

I hope this article gives people idea's for investing in low PE companies with strong balance sheets. I just wrote I like many of these stocks, but no, not really. In fact I don't like them at all. I suppose you agree with me. Unfortunately using a like factor for stocks doesn't earn me money, so I keep investing in stocks I dislike.

I will continue writing articles on companies and stocks that I find interesting. In addition I will issue about two newsletters per month to paid subscribers on Seeking Alpha. One newsletter will be similar to this article so it will contain a list of companies with a low PE and a strong balance sheet with some preliminary research. The other newsletter will contain a list of net-nets with some preliminary research. Stock market researchers have found that both categories of stocks have very high statistical returns.

My first exclusive newsletter will contain a similar list with descriptions of low PE companies with PB between 0.5 and 0.8. As soon as I have it ready SA readers will be able to subscribe to my newsletter. I expect that this will be possible in about a week.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I'm long Rosedale Hotel Holding (1189:HK).

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.