Greetings! As editor of the Cabot Benjamin Graham Value Letter, I am delighted to write to you today. In my first contribution to Cabot Wealth Advisory, I would like to impart some words of wisdom to help you better understand some of the alternative choices that you have as an informed investor.
Many years ago, I was taught to believe that value investing, using fundamental analysis, is the best long-term approach when making investment decisions. I was taught to buy stocks at bargain prices and wait patiently until they become overpriced.
In the years since, I learned some growth and momentum techniques as well. I never argue whether one approach is better than another approach. But I do believe in using more than one methodology when choosing stocks to diversify my portfolio; broad diversification reduces risk significantly. Thus my portfolio contains a mixture of growth stocks and value stocks.
In previous Cabot Wealth Advisories, Timothy Lutts, Michael Cintolo and Paul Goodwin have described how to find the best growth stock opportunities. Today I will describe my methodology for discovering sound value stock opportunities.
Finding Stocks Selling at Bargain Prices
I use a couple of value approaches to find stocks that are selling at bargain prices.
My first approach is to find stocks that are cheap, and I use Benjamin Graham's criteria to guide me. Benjamin Graham is known as the father of value investing and Warren Buffett is his most famous protégé. Why try to re-invent the wheel when a proven, excellent system is there for the taking?
In his book, "The Intelligent Investor," Mr. Graham details seven criteria that differentiate between a bargain stock and a stock that is priced too high. Included in his criteria are: low price to book value ratio, low price to earnings ratio, strong balance sheet, some earnings growth and no earnings deficits during the past five years. In addition, the company must be currently paying a dividend, and the future outlook for the company must be positive. (This eliminates banks and homebuilders for now.)
I know what you are thinking--this is old-fashioned stuff and won't work in today's fast-paced stock market. But that's not true; Warren Buffett has become the richest man in the world using the old-fashioned knowledge he gained from Benjamin Graham.
I won't get into my second value approach, also created by Mr. Graham, in this issue. I'll save that for another day.
After I buy a value stock, I use my checklist as described above and wait ... and wait ... and if necessary I wait some more for the stock to reach my Minimum Sell Price.
Warren Buffett has said, "Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years."
What about us ordinary investors who can't wait 10 years? I have an easy solution--I buy when a stock is undervalued and sell when it becomes overvalued. The time frame is usually about two years.
The basic principal is simple: the stock market and the individual stocks that make up the stock market have always bounced back and forth from overvalued to undervalued to overvalued, over and over again. As a value investor, I am simply taking advantage of the fluctuations of the stock market.
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SUPERVALU: A Buy Recommendation
My stock recommendation for today is SUPERVALU (SVU). The company was founded in 1871 and is a leading U.S. food wholesaler and grocery store retailer with 2,500 stores throughout the country.
Growth of sales and earnings was slow earlier in the decade, but in June 2006, the company acquired 1,124 stores from Albertsons for $12.4 billion. SVU's purchase of Albertsons stores was obviously a major undertaking that has doubled SVU's revenues and increased the bottom line significantly. Cost savings from the acquisition will continue during the next three years and will help earnings pick up even more steam. Sales should also pick up because of Albertsons higher same-store sales.
I forecast a 12% EPS increase during the next 12-month period, compared with SVU's average 6.2% growth during the last 10 years. Closing underperforming stores will boost same-store sales growth and profitability. While the balance sheet contains excessive debt, the company's high cash flow will enable SVU to pay down total debt quickly.
Back in early January, SVU lowered its EPS forecast by a very small amount, but in reaction the stock price dropped dramatically, hitting a low at 26 before stabilizing at 28.
Now is the time to pounce. SVU shares are clearly undervalued at a mere nine times trailing earnings and at only 0.84 times book value. I believe SVU's shares will advance to $44.33 within one to two years.
Very few quality companies sell at less than book value, even in today's beaten-down market. In the current economic turmoil, a recession-proof investment is certainly worth a look. I strongly recommend buying SVU at its current price.
Sincerely, J. Royden Ward
Analyst and editor of Cabot Benjamin Graham Value Letter
Editor's Note: SUPERVALU is featured in the latest issue of Cabot Benjamin Graham Value Letter, and updates on it (and other value stocks) will be provided in the newsletter until the stock reaches its Minimum Sell Price. In the newsletter, you will find all the tools you need for value investing, the same tools used by Warren Buffet. Turbulent times in the market are the right times to diversify your portfolio by adding some value stocks. Click the link below to read more.
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