One thing about money my parents tried to convey to me when I was younger was distinguishing between buying something cheap and getting a bargain. It sounds like the same thing, but there is a subtle difference. Something that is cheap is probably some piece of junk that you will regret buying, whereas something selling for a bargain is something of quality that you can get utility from for years to come. The same applies to stocks. There are tons of cheap stocks out there, but most of them inevitably turn into regrets and a lesson learned. Buying a quality stock that you can hang on to for decades when it is selling at a decent valuation -- now that's a bargain.
If you are looking to buy a quality stock at a price you can be proud you paid, then three companies you may want to look at now are railcar manufacturer The Greenbrier Companies (GBX -0.08%), telecom giant Verizon Communications (VZ -4.67%), and grocery behemoth The Kroger Co. (KR 0.64%). Here's a look at why investors can get a great bang for their buck with these stocks today.
Image source: Getty Images.
Ready for a recovery
Let's start with the long-term thesis for anything related to the rail industry. Until we can invent Star Trek-type technologies like teleporters or replicators, we will need to transport goods. With that in mind, rail is hands down the most cost effective means to move goods over long distances. In many cases, moving goods via rail is pennies on the dollar cheaper than via truck or via planes on a per ton-mile basis. So we need rail and the railcars to hold material. This is where The Greenbrier Companies comes in, and the company's stock sells for a very cheap valuation right now.
The past couple years have been less than ideal for the rail car industry. Declining use of coal and the recent oil price crash meant demand for hoppers to move coal and frack sand almost disappeared. The company has responded, though, by cutting operational costs. Even after some sharp declines in revenue recently, the company was able to improve gross margins and maintain a 16% return on equity despite the market headwinds.
The good news is that one of these markets -- frack sand -- is on the mend, so we can reasonably expect some better results from its wheels & parts and leasing & services segment. Also, Greenbrier recently announced a partnership with a Japanese railcar manufacturer for a multi-year purchase agreement that lasts through 2023.
So the market for this business is improving, the company has drastically improved its operations and balance sheet in recent years, and some longer term catalysts suggest the company is in the midst of an upswing in this cyclical industry. With Greenbrier's stock trading at a modest 4.0 times EBITDA, this seems like a very good time to look at adding Greenbrier to one's portfolio.
An underlying business that can support a few corporate risks
If you were to follow financial media as of late, the one thing that Verizon Communications is doing right now is coming up with crappy new names for its media branch. I think we can all agree that Oath -- the name Verizon has settled on for its media arm that mostly entails Yahoo and AOL -- is both a dumb name and probably a waste of corporate time and money. Also, AOL and Yahoo haven't exactly been the best-performing media companies, so there is a real possibility that Oath will be a flop for Verizon.
Here's the thing, though. With Verizon's core business of wireless communications, it can afford to take a few risky swings from time to time.
Providing wireless phone and data service to customers with subscription contracts is probably the closest thing possible to a regulated utility without actually being regulated. There are only four major players in the U.S., but Verizon and AT&T are head and shoulders above the other two. Also, wireless subscriptions are a pretty sticky business. In 2016, Verizon's churn rate -- total customer turnover -- was only 1.26%. That means that clients who sign up tend to stick around and pay those monthly bills.
It takes a lot of capital spending to maintain and improve Verizon's network infrastructure, particularly as it is making some massive investments in the shift to 5G data. Verizon expects to test 5G in 11 cities in 2017 and will do a full roll-out in the early 2020s. Not only does the company's current subscription base more than support these investments with operational cash flow, but increased data usage in the coming years means that those investments will be well worth it.
For investors thinking on a shorter time scale, Oath blowing up in Verizon's face is enough reason to push shares down to an enterprise value to EBITDA ratio of 5.3 times and a dividend yield of 4.7%, the underlying business at Verizon is strong enough to take a few risks like Oath and still churn out plenty of cash to reward shareholders.
Separating itself from the pack
It's hard to argue that there is a better grocery store operator than Kroger. There are the simple operating metrics one can point to that show this. Kroger's asset turnover rate -- total sales divided by total assets, a measure of how efficiently it is stocking its stores and managing its inventory -- is 3.16 times. Compare that to Whole Foods Market or Sprouts Farmers Market -- 2.48 times and 2.81 times, respectively -- and you get an idea of how Kroger can do the behind-the-scenes things better than others.
At the same time, the business of selling groceries is changing fast. Between e-commerce retailers such as Amazon finding ways to deliver things like groceries quickly and meal delivery services like Blue Apron changing the meal preparation game, Kroger and traditional grocers face a real challenge of getting shoppers in the door and to fill their carts.
Kroger is taking on this challenge with a multi-faceted attack. One way is to improve the in-store experience, as evidenced by its recent acquisition of specialty food purveyor Murray's Cheese. Kroger's successful store-within-a-store partnership with Murray's has helped to boost specialty and organic sales, so the company wants to roll the idea out across more of its stores. Another approach is through its online ordering platform ClickList. This service allows shoppers to order online and either pick up in store or have the items delivered to their homes, essentially turning Kroger's existing locations into fulfillment centers. While we can't say for certain if these initiatives will stave off these new competitors, Kroger's strong customer loyalty and its best in class operations suggest it has a good shot.
Groceries isn't the fastest growing business, but Kroger's high rates of return and propensity to reward shareholders with a growing dividend and share buybacks suggest that the company's stock valuation of 6.9 times EBITDA is a bargain that any price conscious shopper can appreciate.
