Screaming Values Are Out There

The Dow Jones Industrial Average stands within 5% of its all-time high, so you may be wondering how there can possibly be any values out there, let alone bargains that are screaming buy me!

Yet now is a fantastic time to be a value investor. I believed that back in August, when panic had set in, and I believe it today. In August, the focus wasn't on the positive gains. Instead, it was on the overwhelming sense of loss, because the S&P 500 index was down 9.3% after hitting a high of 1,555 in July.

The market has since recovered, and stocks are mostly in the green -- mostly. There are many superior companies still trading at discount prices. Let's look at a few.

A few screaming values to chew on
I encourage risk-averse investors to look long and hard at blue-chip market leaders such as McGraw-Hill (NYSE: MHP  ) , Citigroup (NYSE: C  ) , and Lowe's (NYSE: LOW  ) .

These three stalwarts have less than 3% earnings growth built into their share prices in my estimation, yet all are capable of growing at least in the high single digits. Citigroup sports a 5.6% dividend yield, while McGraw-Hill and Lowe's have 1.7% and 1.2% yields, respectively.

All three companies have had recent scares -- which is the best, and in fact only, time you can get stalwarts on the cheap. Citigroup, for example, revealed that it will write down $5 billion to $7 billion after tax on losses stemming from subprime-related mortgage-backed securities. CEO Charles Prince was forced to resign, yet as mind-boggling as these writedowns are, the company still has the financial muscle to ride out the storm.

McGraw-Hill has a declining ratings business for asset-backed securities in its Standard & Poor's division, but a very strong educational business.

Lowe's is affected by the current housing recession, but it will do just fine when housing returns to normal -- as it inevitably will. Best of all, you can buy these rock-solid companies for roughly $0.70 on the dollar.

Two less blue-chip options
For investors who can stomach higher risks and more volatility, check out recently spun-off credit card company Discover Financial Services (NYSE: DFS  ) , as well as mortgage insurer MGIC Investment (NYSE: MTG  ) . Both companies can be had for close to 60% of my fair value estimate.

Discover is the smallest of the U.S.-based credit card companies, behind American Express, Visa, and MasterCard (NYSE: MA  ) . Its three key advantages are owning its own network, the high credit quality of its cardholders, and DOJ rulings that cut down restrictive practices of Visa and MasterCard. The share price is down because of concerns that Discover may not get adequate returns on securitizing credit card receivables, along with the predictable drop after a spin-off. By my estimates, though, Discover is trading around 40% below its intrinsic value.

MGIC Investment is a high-risk investment because the company is expecting negative earnings in 2007 and 2008. Mortgage losses and loss reserves are already three times the five-year average level, and I expect them to go higher during 2008. Oddly enough, the tightening credit crunch actually plays to the company's advantage, since many avoided mortgage insurance (insurance is generally needed when the loan-to-home-value ratio is greater than 80%) by using piggyback (second) mortgages.

Second mortgages are the first to go as house prices fall and borrowers default, and it's almost certain that lenders will insist on mortgage insurance instead of encouraging piggyback mortgages. The falling home prices also mean that the duration of the insurance policies increase as the loan-to-value ratio stays above 80% for longer. By my estimates, MGIC is selling at around half its intrinsic value. But be warned: It could trade a lot lower before realizing its value.

More screaming values
The historical outperformance of value investing should give you the confidence to buy in the face of pessimism. Buying superior companies at excellent prices -- and keeping an eye on the long term -- is how we advise investors at Motley Fool Inside Value.

We recently published our annual review issue of Inside Value, where we revealed our 12 favorite investment ideas -- most of which still remain cheap. As the advisor of the service, I invite you to take a sneak peek of the review with a 30-day free trial. There's absolutely no obligation to buy -- and while you're there, don't forget to check out all our past picks, research, and back issues.

This article was first published Aug. 17, 2007. It has been updated.

Philip Durell, advisor/analyst of Inside Value, does not own shares of any company mentioned. McGraw-Hill and Discover Financial are Inside Value recommendations. The Fool has a disclosure policy.


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