It's not easy finding discounted stocks at a good value after the stock market run we've seen since the beginning of September. To some investors, looking for cheap stocks in this frantic-liquidity-infused market is a sucker's bet, equivalent to "fighting the Fed." Why not chase a high-growth tech stock like Apple or a commodity name like Freeport McMoran?
However, if the Federal Reserve's quantitative easing proves unsuccessful in sparking economic growth and turning around the country's unemployment, I prefer to have a cushion under any stock I choose to buy, especially after a 14% move in the S&P since the beginning of September.
Benjamin Graham's deep value search
In situations like these, I look for quality companies that fit value investing legend Benjamin Graham's Net Current Asset Value model (NCAV). Whereas book value only measures assets less liabilities, NCAV is a bit more complex. 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
Basically, the idea is to look for companies that trade near or below what they'd fetch if they got liquidated. In that case, all you'd have left would be the cash and other assets that shareholders still own. Graham preferred to buy stocks that traded at or near two-thirds or less of their NCAV.
Most the stocks matching this definition are penny stocks and other microcaps that I can't discuss in this space. Instead, I suggest looking for companies that come close to meeting these requirements, providing a nice cushion for worst-case scenarios.
The screen
In my research, I found a company that doesn't necessarily pass the rigorous Graham specifications. However, it comes close, providing the nice margin of safety I'm looking for.
Imation
Believe it or not, Imation was hit particularly hard by the financial crisis. Many troubled financial institutions such as Lehman Brothers and AIG, used Imation's magnetic tapes in their data storage centers.
However, Imation has maintained a pristine balance sheet, and it seems to have adapted to the rapid pace of change in data storage. The company has a market capitalization of $366 million, with about $257 million of cash and zero long-term debt on its balance sheet. If you were to buy the entire company at its current market value, you'd get 67% of the value back in cash -- before you even factored in the rest of the business.
Imation shares closed Thursday at $9.43, which means the company trades at about 87% of its NCAV of 10.78, and at a price-to-book ratio of 0.41.
In addition to the cash cushion, Imation traditionally has been a big proponent of returning cash to shareholders. Though the company was forced to eliminate its dividend in 2009 during the credit crisis, it has returned almost $200 million to shareholders over the last for years. On a company conference call in July, Imation CEO Mark Lucas hinted to analysts that shareholder cash returns would be reinstated soon, saying, "We get that math."
While Imation doesn't meet Graham's specifications exactly, it illustrates the value you can find by looking beyond traditional valuation metrics like price-to-book. While values are tough to find in the brave new world of quantitative easing, there will always be opportunities to stay involved in the market.
