"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
The hardest part of value investing is not mistaking "cheap" for a great value. With the market at or near all-time highs for much of the past few years, value investors may be having a harder time finding something worthwhile in the bargain bin. With that in mind, we asked three of our top contributors to give us an "under-the-radar" stock that Wall Street is missing out on right now.
They came up with three different yet relatively specialized companies with established positions in the markets they serve: Precision Castparts (UNKNOWN:PCP.DL), GenCorp (NYSE:AJRD), and Goodyear Tire & Rubber (NASDAQ:GT). Read on for what they had to say.
Jason Hall (PCP): The aircraft industry is going through a cyclical boom right now, driven by a combination of steady growth in demand from airlines, an aging fleet of commercial airliners in developed, mature markets, and huge profits over the past couple of years that will help pay for new fleets.
All of that is a real boon for Precision Castparts -- a real leader in its industry and a key supplier of highly engineered, complex components for the aerospace, military, power, and oil and gas industries.
And just as this long tailwind of demand is building, Mister Market is looking the other way. The stock currently trades at a price-to-earnings ratio of around 16. The last time it was this cheap was early 2010, and the stock has doubled since then.
Yes, the company is facing some challenges in its oil and gas business right now -- and that's likely to be the case for the next year or so -- as well as some cyclical weakness in its military business, but the 20% drubbing the stock has taken over the past 15 months seems overdone at this point. If you're looking for a stock with hidden value, Precision Castparts looks like it was custom-fit for that role.
Rich Smith (GY): GenCorp ended last year on a sour note, turning a nice profit, but with revenues slumping hard. Investors weren't quite sure what to make of these results, first selling the rocket-maker, then buying it back -- but when all was said and done, GenCorp shares today are just barely ahead of the S&P 500's performance for the past year, beating the market by less than 1%.
I think it can do better -- and will.
Here's why: Despite its lack of full-year profits last year, and the resulting lack of any positive P/E ratio, GenCorp is proving to be a money-printing machine. According to S&P Capital IQ's most recent data, GenCorp produced $107 million in positive free cash flow last year -- much better results than are suggested by its $53 million GAAP loss.
Valued on its market cap, that means GenCorp stock is selling for less than 13 times free cash flow. Add in net debt, and it still only costs about 17.6 times free cash flow. Either way you value it, though, GenCorp shares look cheap relative to the 20% long-term growth rate that analysts project for the stock. Now, add in the potential for GenCorp to win a multibillion-dollar contract to upgrade the engines on America's fleet of Minuteman III nuclear missiles, or to replace Russia as the primary provider of rocket engines for United Launch Alliance, and this is one rocket stock that really could go to the moon.
Asit Sharma (GT): In the last two years, Goodyear Tire and Rubber's stock has more than doubled, but it remains a company that investors treat with a smidgen of skepticism. Goodyear trades at just three times trailing-12-month earnings, and at only 7.75 times forward one-year earnings.
The lukewarm attitude toward Goodyear isn't without context: For years the company has operated with a high debt burden, as well as significant pension liabilities. But last year Goodyear paid down $1.17 billion out of more than $2.7 billion of pension obligations, fully funding its hourly U.S. pension plans. The company's overall debt-to-equity ratio, while still too high at 1.72, is down substantially from the untenable ratio of 5.5 at the end of 2013, and a massive improvement over the last five years, in which debt at times outnumbered equity nearly 20 to 1.
Goodyear has doubled its operating margin in just three years to 8.3%, and last year enjoyed nearly $1 billion in free cash flow. The company's recently instituted dividend has a current yield of 0.90%, and with a payout ratio of only 3%, it's got plenty of room to grow.
Management has taken a disciplined attitude to reducing Goodyear's debt load, and has improved North American operations -- the segment posted record earnings last year. North America is Goodyear's largest business segment, and this will prove a boon to the company as the U.S. economy continues to improve, and both commercial businesses and retail consumers buy into a revitalized Goodyear brand.