The value of a business is determined by what a company earns and what it expects to earn in the future, discounted back to the present by a discount rate. Prices paid for a company’s stock are determined by the supply and demand in the market for those shares. Traders and investors bid up prices when expectations for the future are bright, and they sell those shares when the expectations for future are not so rosy.
Quite often the market creates a wide discrepancy between the fair value of the business and the price of the company’s shares. When the market pushes the price of shares are quality businesses well below the fair value of that business, investors who are willing to wait for the market to again bring the market value of the business back to its intrinsic value can make a great deal of money without a lot of risk.
Recent events have spooked many market participants into selling shares of excellent companies well below what those businesses may be worth. Below I highlight three companies that may be worth further investigation.
American Express (NYSE:AXP)
Amex is in an excellent business that offers excellent returns on invested capital. Recently Amex reported that cards in force increased 10% and spending on cards in force increased by 8%. Amex consistently earns well over 20% Returns on Equity.
On a PE basis, Amex shares haven’t been this cheap since 2002, and are as low as they’ve been in the last 10 years. Buying American Express below $60 gives investors a stake in a great business with a reasonable margin of safety.
Bank of America (NYSE:BAC)
Bank of America is the largest retail bank in the US with an extensive branch system that is becoming as ubiquitous as Starbucks (NASDAQ:SBUX). The bank operates 5800 branches in 29 states and provides a wide range of services for its customers.
The market has overreacted to the sub-prime mortgage problems and the credit crunch, just as the market overreacted to the currency crisis in 1998, and has pushed the price of Bank of America to ridiculously low prices. B of A shares have a PE of just under 11 -- below its five-year average, and at the low end of its average PE over the past 10 years.
The price to book is just 1.7, again below the five-year average and the low end for 10 years. It currently yields a handsome 4.3%, and investors who buy the stock on or before September 7 are entitled to the 14% increase in the dividend the company announced last month.
Proctor & Gamble (NYSE:PG)
The great thing about consumer products companies is that they make items that people almost have to have. People need to bathe, shave, brush teeth, diaper the baby, wash the clothes, etc, regardless of the what the economy is doing.
Many people are loyal to their brand of toothpaste or whatever, and are willing to pay a bit more for Crest, for example, than for the Kroger store brand. So when the opportunity arises to pick up the shares of one of these solid cash cows, you should not hesitate.
P&G generates steady free cash flow and generates Returns on Equity in excess of 20% each year. I calculate the value of P&G's shares to be around $77, and if purchased below $66 would give an investor a margin of at least 15%.
Disclosure: I own shares in AXP, PG, and BAC.
AXP/ PG / BAC 1-year chart