For value investors, a prolonged market run, with very few market pullbacks sprinkled in, is a very tough time to find deep-value stocks. High momentum names sporting huge price-to-earnings ratios (P/Es) -- think Amazon and F5 Networks -- continue to fly, but those companies are out of my price range. Many times it is those high-beta names that give up the most ground if a shallow pullback becomes a larger correction.
At these levels I'm more likely to search for stocks with a comfortable margin of safety and value on its balance sheet. I'd rather find those kinds of companies than the ones with high potential but lots of unrealized earnings.
My starting point in this type of environment is to take a page from the legendary Ben Graham and look for deep-value stocks using his Net Current Asset Value model (NCAV) screen.
Graham's deep value search
The screen is more complex than looking at book value, which only measures assets less liabilities. Graham's value screen only looked at current assets and subtracted all liabilities.
Cash and short-term investments + (0.75 * accounts receivable) + (0.5 * inventory) - total liabilities
The idea here is to look for companies that trade near or below their liquidation level if the company were to go out of business. In the event of liquidation, the cushion is the cash and other assets the shareholders still own. Graham liked stocks that traded at about two-thirds or less of their NCAV.
The point of this exercise is not to find the stocks that trade at the largest discount to NCAV -- because you'll mostly find penny stocks and other micro caps that I can't discuss in this space. Instead, I suggest looking for companies that come close to meeting these requirements and provide a nice cushion in a worst-case-scenario event.
The screen
One company that didn't necessarily pass Graham's rigid specifications but still looks like a value is Benchmark Electronics (NYSE: BHE). Benchmark competes in the super-low-margin business of contract manufacturing electronics, producing products for original equipment manufacturers. It has signed large contracts with technology giants EMC (NYSE: EMC) and Oracle's (Nasdaq: ORCL) Sun division, but it also supplies to companies like Cisco and Hewlett-Packard.
While Benchmark may not be considered best-in-breed in this industry, its margins are superior to competitors Jabil Circuit (NYSE: JBL), Sanmina-SCI (Nasdaq: SANM), and Flextronics (Nasdaq: FLEX), but trail Plexus (Nasdaq: PLXS). (Plexus leads the industry with double-digit gross margins.) Benchmark Electronics is also significantly cheaper than its peers on most price metrics, including price-to-tangible book value.
Even more important, Benchmark is growing revenues and gross margins after two years of declining sales, which was mostly caused by cutbacks in enterprise spending.
You'll find even more value in the company's balance sheet. Benchmark Electronics has more than $346 million in cash on its balance sheet, and a market capitalization of only $1.1 billion. Subtracting out the company's small $11 million debt burden, if you were to buy the company today, you would get a bit less than a third of the value back in hard cash -- in addition to the profitable business.
Benchmark Electronics shares closed at $18.11 on Wednesday, which is about 131% of its NCAV of 13.83. So the stock is still a little pricey by Graham's standards. But as I mentioned previously, this deep-value screen just isn't yielding many good companies at compelling valuations right now.
I'm not a buyer of Benchmark at these levels, but I am watching this stock closely in the event of a further market pullback. Patience is an investor's best friend, and I believe we'll have an opportunity to pick up this company at even more attractive levels.
Add Benchmark Electronics to your watchlist by clicking here.
