Long ago, Ben Graham taught me that "Price is what you pay; value is what you get." Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down.
-- Warren Buffett
Those words from Ben Graham and Warren Buffett make a lot of sense. Value stocks can often be huge winners for investors. There are two key ingredients to that success, though: Finding the right stocks and being patient.
With this in mind, we asked three Motley Fool investors to pick value stocks that they think would be great ones to buy and hold for a decade. Here's why they chose Kinder Morgan (NYSE:KMI), International Business Machines (NYSE:IBM), and Express Scripts (NASDAQ: ESRX).
Matt DiLallo (Kinder Morgan): Natural gas pipeline giant Kinder Morgan has vastly underperformed the market over the past few years due to the impact the oil market downturn has had on its ability to raise cheap capital to finance growth. That said, while that stock has gotten pummeled, its underlying cash flow has only declined modestly, falling from a peak of $2.14 per share in 2015 to an expected $1.99 per share this year. Because of this combination, the company's valuation has significantly compressed, going from a rather nosebleed 20 times cash flow to less than 10 times at its current stock price.
That gives price-conscious investors the opportunity to earn an excellent return on Kinder Morgan due to the catalysts that lie ahead. In the near term, it has clear visibility to increase its dividend at a rapid rate simply by increasing its payout percentage. It currently expects to increase the dividend 60% next year and by 25% in both 2019 and 2020. At the current stock price, that implies a nearly 6.5% dividend yield in 2020 for a company that still expects to pay out less than half its cash flow. That rising yield should draw income investors and lift the stock price.
Meanwhile, there's plenty more growth left in the tank. That's because North America needs to invest $26 billion per year on new energy-related infrastructure through 2035 according to a recent study. Given that 60% of those investments will be on natural gas-related infrastructure, there should be ample opportunities for Kinder Morgan to expand its industry-leading network.
When we add Kinder Morgan's cheap valuation with its dividend and growth potential, it suggests that the stock could deliver a robust total return over the next 10 years, which is why value investors should seriously consider buying and holding this pipeline stock for the long term.
Tim Green (International Business Machines): IBM has had a rough few years. Revenue has slumped for 21 straight quarters, profits are well below their peak, and the company is viewed as an also-ran in the cloud computing battle between Amazon.com and Microsoft. The stock is cheap based on earnings, trading for just about 10.5 times full-year guidance, but a recovery won't happen until the company returns to growth.
For investors with long time horizons, willing to wait for IBM's growth initiatives to pick up steam, the stock looks like a good buy-and-hold candidate. IBM has the benefit of long-standing relationships with its existing customers, many large companies and organizations. As those organizations shift workloads to the cloud, IBM will be in a position to capture that business. A recent $1.7 billion cloud services pact with a major U.K. bank is an example of the kind of deals that will drive IBM's cloud business in the coming years.
Beyond cloud computing, IBM is betting that blockchain will turn into a big business down the road. Blockchain, a distributed database that underlies cryptocurrencies like bitcoin, is being tried in a wide variety of industries, most notably financial services. The core idea: Blockchain can make keeping track of complicated transactions more efficient, saving companies money and removing friction. Here, too, IBM has signed some major deals, including an agreement with major European banks to build a blockchain-based platform for trade finance.
These growth businesses aren't yet big enough to offset declines in IBM's legacy business. But for patient investors, the payoff has a good chance of being worth the wait
A looming loss doesn't overshadow long-term potential
Keith Speights (Express Scripts): Express Scripts is one of the worst-performing stocks that I own. Shares of the pharmacy benefits manager (PBM) have taken a beating due to the likely loss of one of its biggest customers, Anthem (NYSE:ANTM).
Thanks to the steep drop, though, Express Scripts stock is now very cheap. Its shares trade at only eight times expected earnings. Granted, the impact of a loss from Anthem looms after 2019. The contract with the giant health insurer represents 19% of Express Scripts' total revenue, so the loss would hurt -- a lot. However, I think the market has already largely baked the Anthem departure into Express Scripts stock's price.
I also think the company will be able to bounce back over time even if it loses Anthem as expected. Demand for PBM services should grow for years to come because of a couple of factors. First, baby boomers are aging. That means prescription drug usage is destined to increase, which means organizations will need help in controlling the associated costs more than ever. Second, biopharmaceutical companies are focusing much more heavily on developing specialty drugs than ever before. These drugs tend to have high price tags, which makes it more likely for employers and payers to turn to PBMs for help.
The consensus among Wall Street analysts is that Express Scripts will be able to grow earnings by close to 11% annually over the next five years. Those analysts are fully aware of the situation with Anthem. I suspect their estimates won't be too far off, which makes this cheap stock one to hang on to for years to come.