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Stock Screen: Bargain Basement Stocks - June 15, 2012
The investing world is often broken down into two broad camps: growth and value. The growth group looks for companies with earnings that are advancing at a material clip. The value camp, meanwhile, looks for stocks that are trading on the cheap. The desire to find undervalued stocks is both emotionally and intellectually appealing—after all, who doesn’t like to take advantage of a sale? Moreover, value investing follows one of the oldest, and most obvious, sayings on Wall Street, “buy low, sell high.”
The problem is that everyone is trying to buy low and sell high, even the growth investors. So it’s important to properly define “cheap” and have a systematic way of identifying candidates that meet that criterion. Equally paramount is remembering that some merchandise winds up on the sale heap because it is damaged in some way. A fact that is as true for stocks as it is for consumer goods.
To help investors cull through the list of potential investments, Value Line provides weekly screens. One of the more useful screens for value investors is the Bargain Basement Stocks screen. The screen is fairly simple, highlighting companies with price-to-earnings multiples and price to “net” working capital ratios near the bottom of the Value Line universe. The idea is to identify companies that are trading cheaply relative to earnings and to the money that would be “left over” if the company were to be liquidated. Note, that most stocks never trade below their liquidation value, but even trading at two or three times that value is noteworthy.
This screen is available every week in the Index section of The Value Line Investment Survey. Subscribers can access the most recent Index here to see all 35 names on the list. Some recent names of interest that moved to the top, or the bottom as the case may be, were Hi-Tech Pharmacal (HITK) and Avnet, Inc. (AVT).
Hi-Tech Pharmacal provides generic, prescription, and over-the-counter products that treat a range of diseases, including glaucoma, asthma, bronchial disorders, dermatological disorders, allergies, and pain. The company operates in three business segments, with the largest being the Hi-Tech Generics group (about 81% of revenues for the fiscal year ended April 30, 2011). The other two divisions are ECR Pharmaceuticals (branded prescription drugs—12%) and Health Care Products (branded OTC products—7%).
Third-quarter earnings per share were about 6% lower than the year-earlier tally, stemming from a mild cough and cold season, plus a rise in operating expenses (reflecting higher marketing spend to support new medications). Meanwhile, profit margins were constrained by a combination of diminished sales in the ECR Pharmaceuticals group and lower prices for generic Flonase on one hand, and by the costs for additional sales representatives on the other. Although the upcoming allergy season should be a positive for Hi-Tech, it appears that the higher cost structure will remain in place for the next several quarters, at least. Consequently, we have reduced our full fiscal year estimate, but if accurate, it would still be significantly higher than the prior fiscal-year tally.
The stock price has fallen sharply since our last full-page report went to press in April. We think that can be attributed, in part, to the lower third-quarter profits. A turbulent market (reflecting global economic concerns) has not helped these shares’ performance, either. Even at the recent quotation, recovery potential is subpar. However, future acquisitions could prompt us to raise the equity’s 2015-2017 Target Price Range.
Avnet, Inc. is the top distributor of semiconductors and computer and peripheral equipment to resellers and end users, based on sales (which were $26.5 billion in fiscal 2011). The company operates through two segments, the Electronics division (57% of last year’s sales) markets semiconductors, connectors, and passive components; and the Technology Solutions unit (43% of sales), which sells servers, computing, and data storage products.
We anticipate decent earnings growth going forward. The economy, though less than spectacular, has perked up a bit as of late, providing many large manufacturers with an increased appetite for electronic devices. Moreover, corporate IT budgets and overall order sizes ought to reestablish themselves in the coming quarters, with the pace of the ongoing economic recovery picking up steam. Also, as customers begin to loosen their purse strings, excess inventory now present in the supply chain should begin to diminish, paving the way for higher prices. All things considered, we believe that share net will advance during both fiscal 2012 and fiscal 2013. (Years end June 30th).
Meanwhile, the company has been aggressive on the acquisition front. In fact, it recently announced the purchase of four technology businesses, namely Pinnacle Data Systems, Nexicore Services, ROUND2 Technologies, and DE2-SAS. These additions ought to allow Avnet to broaden its array of products, bolster margins, and enhance operating leverage. Moreover, investors should note that we look for the company to expand further via business combinations, since a number of industry peers still trade at attractive valuations.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.