Value investing is trying to find investments that are priced below their true worth. In other words, value investors are laying out cash today under the assumption that they will receive more cash in the future. And this strategy can apply to all sums of money, whether it's a big fund managing billions of dollars or even an individual starting with $5,000.
Anybody can hunt for overlooked stocks that should be worth more in the future. So let's take a look at three stocks that fit that criteria.
Nelnet
Nelnet (NNI 0.71%) is a $3.4 billion holding company based in Lincoln, Nebraska that doesn't attract a whole lot of attention, and that's just the way its management team likes it. The company doesn't host quarterly conference calls or attend big investment conferences, it simply focuses on allocating capital the best way it knows how, and so far it's done a pretty good job of that.
Nelnet sits on a roughly $14 billion portfolio of student loans that generates consistent cash flow each quarter. The primary way Nelnet issued loans used to be through the Family Federal Education Loan Program -- but the government took that program in-house in 2008. Since then, Nelnet has had to find new ways to put its cash to work.
The company now uses its cash to build out a diverse mix of assets including both wholly owned businesses and minority investments. Some of these assets include the largest student loan servicing operation in the U.S., a collection of education-related software businesses, a fiber-internet company, and even a 20% stake in the sports analysis software company Hudl.
Across all of its investments, Nelnet has generated 16.6% annual growth in its book value per share since 2004, compared to just 10.8% growth from the S&P 500 index during the same time period. However, due to the company's culture of reinvestment and its unique mix of assets, this underlying growth isn't always properly reflected by Nelnet's earnings figures according to generally accepted accounting principles (GAAP). This often discourages investors.
But if you strip away Nelnet's cash balance and the stated value of its minority investments, the company trades at an enterprise value of roughly $1.2 billion. Last year, Nelnet generated just under $140 million in operating income from its wholly owned subsidiaries, implying that the remainder of its businesses are valued at just under 9 times operating income. That feels like quite a bargain for a management team with such a stellar capital allocation track record.
Ally Financial
Ally Financial (ALLY 0.41%) is the largest digital-only bank in the U.S. Since it doesn't have to pay out the costs associated with operating physical bank branches, the company is able to pass those cost savings on to customers in the form of higher interest rates on Ally savings accounts. This advantage has led to remarkable growth in customer deposits. As of the latest quarter, the company is home to $139 billion in total retail customer deposits, which is 70% higher than the same period five years ago.
Ally uses these consumer deposits to earn interest in a number of ways, but its preferred method is to issue automotive loans. Thanks to its roots as the financing arm of General Motors, Ally has a vast dealer network that relies on the company for financing. Today, Ally Financial is the largest auto lender in the U.S. with roughly $114 billion in auto-related loans.
Over the last decade, this model of high savings rates attracting consumer deposits coupled with conservative underwriting of auto loans proved to be a great recipe for success. However, due to the supply chain delays brought about by the pandemic, used car prices have been extremely volatile, leading to concern from Ally's investors and even a sharp increase in Ally's delinquency rates.
However, the company's results are still well within their historical norms and the recent decline in the company's stock price seems to be overblown. Ally's market cap currently values the business at just 6 times its pre-pandemic earnings. Assuming the auto market remains relatively stable and Ally returns to its long-run average in net interest margins, the stock should provide good returns for shareholders.
Alphabet
While it feels a bit strange to call the fourth-largest company in the world overlooked, it seems as though many investors underappreciate Alphabet's (GOOG 9.96%) (GOOGL 10.22%) ability to continuously grow its earnings. Alphabet is home to several giant technology businesses, including Google Search, YouTube, Android, Google Cloud, and plenty of others, but by far the largest cash generator is the company's search business.
Google search claims roughly 90% market share of the overall global search industry and generates more than $165 billion in revenue per year. While investors have become skeptical of this segment over the last year due to the rise of the generative AI platform ChatGPT, Google Search has maintained its dominance and exemplified its advantages over competitors.
While many other services have tried to copy Google's ranking algorithm, there's no search company that can replicate the sheer number of search queries that Google receives. This enables the company to continuously improve and fine-tune its search algorithm in a way that competitors cannot.
Google's position as the leader in search and digital advertising has enabled the company to grow its free cash flow per share more than sixfold over the last decade.
GOOG Free Cash Flow Per Share data by YCharts
Despite Google proving its resilience over the last year, the stock still trades near its average enterprise value to earnings before interest and taxes (EBIT) multiple of 21 times. Assuming the company maintains its search dominance and can continue to profitably grow its other subsidiaries, Alphabet should keep delivering its impressive returns for shareholders.
