Three Undervalued Stocks to Add to Your Portfolio

The major indexes are at all-time highs, and many stocks have already delivered double-digit returns year-to-date. It might seem like the worst time for value investors to be doing new buying.

But in the latest Investment Digest issue, just published last week, many of our contributors managed to find still-undervalued stocks to add to their portfolios! In fact, it seems the market’s high levels have made the undervalued stocks even more attractive.

My first idea today comes from Validea Editor John Reese. This retailer stock has already appreciated about 25% since the beginning of 2013, but Reese still sees good value in the shares at today’s levels (the stock was trading around $56 when he wrote this). Here are some excerpts from his analysis of the stock using the criteria of his Price/Sales Investor strategy based on Kenneth Fisher:

Williams-Sonoma, Inc. (WSM)—This San Francisco-based cookware and kitchen supply store, which also owns home products and furniture stores like Pottery Barn and West Elm, has nearly 600 stores across the U.S. and Canada. Earlier this year, it announced a big boost to its dividend, as well as a significant share repurchase program.

“[Under this methodology,] the prospective company should have a low price/sales ratio. Non-cyclical (non-smokestack) companies with price/sales ratio between 0.75 and 1.5 are good values. WSM’s P/S ratio of 1.36 based on trailing 12 month sales falls within the ‘good values’ range for non- cyclical companies and is considered attractive.

“Less debt equals less risk according to this methodology. WSM’s debt/equity of 0.42% is acceptable, thus passing the test. …

“This methodology looks for companies that have an inflation-adjusted EPS growth rate greater than 15%. WSM’s inflation-adjusted EPS growth rate of 41.93% passes the test.

“This methodology looks for companies that have a positive free cash per share. Companies should have enough free cash available to sustain three years of losses. This is based on the premise that companies without cash will soon be out of business. WSM’s free cash per share of 0.70 passes this criterion.

“This methodology looks for companies that have an average net profit margin of 5% or greater over a three-year period. WSM, whose three-year net profit margin averages 6.14%, passes this evaluation. … We are adding [WSM] to the portfolio.” – John Reese, Validea Hot List Newsletter, 5/10/13

My second idea today is another stock that’s up about 25% this year. It’s also gained around 100% since mid-2011… but is still more than 90% off its pre-2008 highs. Yes, it’s one of the central figures of the financial crisis, American International Group, Inc. (AIG). AIG was singled out for its value relative to its industry by John Eade, Editor of the Argus Weekly Staff Report. Here’s part of his analysis:

“Our rating on Focus List selection American International Group, Inc. (AIG) is BUY and our 12-month target price is $50, up from a prior $45. The company has paid back its debt to the U.S. government, and in our view is poised to grow faster than the industry as it works to lower its high combined ratio.

“AIG shares also appear inexpensive relative to peers. The price/book ratio is 0.7, versus an industry average of 1.2. The forward P/E ratio is 11.7, versus 12.5. However, forecast ROE is below the industry average of 9.9%. In our view, that’s the opportunity. As management reduces the combined ratio in the PC group, we expect profitability to improve, and look for an ROE greater than 10% by 2015. And as the profitability gap with the peer group closes, the price/book gap should close as well. Assuming expansion of the price/book multiple to the industry average, we believe that the shares could rise to $61 by 2015. Our revised target price of $50 implies a price/book ratio of 0.84. …

“AIG shares have been relatively strong performers over the past quarter, rising 15% while the S&P 500 has gained 6%. Over the past year, they have outperformed the market, rising 40% compared to a 20% gain for the index. The technical outlook remains intriguing, as the shares have demonstrated a pattern of higher highs and higher lows since establishing a double-low at $20 in 4Q11.” – John Eade, Argus Weekly Staff Report, 5/20/13

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My last idea today is a stock that’s been in a downtrend since September 2012—and mostly moved side-to-side before that. But Sam Subramanian, Editor of AlphaProfit Sector Investors’ Newsletter, thinks the stock is about to break that trend.

Imperial Oil Ltd.’s (IMO) business is poised to turn for the better. Canada’s largest integrated oil company has started production from its key Kearl oil sands project. Kearl is Imperial’s largest project with 4.6 billion barrels of bitumen. Owned 70% by Exxon-Mobil, Imperial has the means to overcome financial and technological challenges. Imperial expects production from Kearl to ramp up from 110,000 barrels a day in 2013 to 345,000 barrels a day by about 2020. Imperial shares suit conservative value investors. They trade at 8.6X-forward EPS and two times book value. Buy Below $37.00, Sell Above $40.45, Stop Loss $26.90, Risk Rating: Average.” – Sam Subramanian, AlphaProfit Sector Investors’ Newsletter, May 2013

We have seen a well-deserved pullback in the market this week, which should give you an opportunity to get into these value names at great prices. Just don’t wait too long; things could turn up again any minute!

Chloe Lutts

Editor of Investment of the Week

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