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When I’m researching stocks and the companies behind them, I go through a whole lot of fundamentals. I examine their revenues, cost of goods, margins and balance sheets. But then I go through how each stock is priced in the market as I only want to recommend value stocks. These are names that are undervalued compared to the market or their peers.
Value is a word that is thrown around by analysts, investment managers and plenty of others in the market. But for me, it comes down to how a stock is priced against its trailing sales or against its intrinsic value known as the book value.
Earnings, of course, are what most focus on when looking at valuation. However, earnings come with all sorts of caveats as companies report a lot of one-off items to smooth numbers for any given quarter. And it is always interesting to look at quarterly and annual reports. I like to compare the reported numbers and numbers that are reconciled with generally accepted accounting practices (GAAP).
I always run the numbers on a GAAP basis to get a better apples-to-apples comparison. This also helps get through some of the financial fluff. And it even gets more entertaining when looking at tax and U.S. Securities and Exchange filings which often can be quite different from standard releases. It’s not a good idea to fib to Uncle Sam.
In addition, I come from a credit and buy-side perspective. For decades I was in international banking and had to do plenty of credit analysis. And in fund management, I had to know that I wasn’t buying a pig-in-a-poke.
Harder to Fudge
It’s harder for a company to fudge its sales and book value. Sales are sales — unless there is fraud. And sure, companies can take sales in a particular quarter that may be actually pending. But again, it’s pretty easy to see through accounting abuses.
Book value takes all of a company’s assets and subtracts liabilities to come to an intrinsic value. But it can also include goodwill — particularly from acquired businesses. Goodwill takes into consideration an implied value in an enterprise such as its customer base. This value is intangible, but it’s still there.
So, taking sales, I use the trailing total sales for the last four quarters and then compare it to the market capitalization. This gives me the price-sales ratio. And I compare that ratio to the market and to a company’s peers to see how that company’s stock is valued.
Then when looking at book value, I do the same with the current book against the market capitalization to get the price-book ratio.
Now, the vast majority of stocks that I recommend are at premiums to sales or book value ratios. This means that I am paying some percentage more than the trailing sales or the current book value. I only do that at levels that are at discounts to the market and a stock’s peers.
But now and again I find some very good stocks that are valued by the market at discounts to trailing sales or book value. These are special value stocks that the market is incorrectly pricing.
The value stocks that I find make for very good buys, and I have a selection of some inside the model portfolios of my Profitable Investing. In addition, they all have dividend income. Here are four value stocks I’m recommending now:
Value Stocks: AllianceBernstein (AB)
AllianceBernstein (AB) Total Return
AllianceBernstein is an asset management company that is set up as a limited partnership. And the shares are held by 16 members of the company’s management team — so they have skin in the game. I have known the company for decades as it has been a customer of mine, and it’s run several funds that I have recommended or owned.
I have always liked the asset management sector because it provides a market-neutral quality. This means that if the stock and bond markets go up or down, asset management companies still get fee income on the assets under management (AUM). And sure, if the markets are up, AUM will reflect this with more fee income than when markets are down. But fee income keeps flowing — as long as the company is good at keeping existing customers’ assets as well as gathering more over time.
Even with the market’s severe drop in March, AUM is running at $542 billion. AllianceBernstein’s AUM continues to climb over the past seven years alone by a compound annual growth rate (CAGR) of 3.2%.
Sales are up over the past year through the most recent quarter despite market gyrations. And the company pays an ample and tax-advantaged dividend yielding 9.6%. Debt is minor compared to assets.
The shares have delivered a return of 53.6% over the past three years. And here’s where it gets good. The stock is priced at a discount to sales of 23.4% making for a discounted value. It should be bought in a taxable account.
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