The investing world is often broken down into two broad camps: growth and value. The growth group looks for companies with earnings that are advancing at a material clip. The value camp, meanwhile, looks for stocks that are trading on the cheap. The desire to find undervalued stocks is both emotionally and intellectually appealing—after all, who doesn’t like to take advantage of a sale? Moreover, value investing follows one of the oldest, and most obvious, sayings on Wall Street, “buy low, sell high.”
The problem is that everyone is trying to buy low and sell high, even the growth investors. So it’s important to properly define “cheap” and have a systematic way of identifying candidates that meet that criterion. Equally paramount is remembering that some merchandise winds up on the sale heap because it is damaged in some way. A fact that is as true for stocks as it is for consumer goods.
To help investors cull through the list of potential investments, Value Line provides weekly screens. One of the more useful screens for value investors is the Bargain Basement Stocks screen. The screen is fairly simple, highlighting companies with price-to-earnings multiples and price-to“-net” working capital ratios near the bottom of the Value Line universe. The idea is to identify companies that are trading cheaply relative to earnings, while also trading at a discount to the money that would be “left over” if the company were to be liquidated. Note that most stocks never trade below their liquidation value, but even trading at two or three times that value is noteworthy.
This screen is available every week in the Index section of The Value Line Investment Survey. Subscribers can access the most recent Index here to see all 35 names on the list. Two companies of interest that we have highlighted are D.R. Horton, Inc. (DHI) and Universal Forest Products, Inc. (UFPI).
D.R. Horton, Inc.
D.R. Horton, "America’s Builder," is one of the largest homebuilding companies in the United States, constructing and selling homes throughout 77 markets in 27 states, under the D.R. Horton, Emerald Homes, Express Homes, Breland Homes, and Regent Homes brand names. To wit, approximately 90% of home sales revenues were from single-family detached units, with the remaining from attached homes, such as town homes, duplexes, triplexes, and condominiums. Its residences are typically between 1,000 to 4,000 square feet, with prices in the $100,000-$1,000,000 range. As of March 31, 2014, the average closing price was $267,400. In addition, the company provides mortgage financing and title agency services through its financial services segment.
The company has remained on a healthy road to recovery since the housing market collapse of the late 2000s. Demand for new homes, combined with low supply growth, has generated increased sales volume, as well as higher average sales and closing prices. In fact, the number of homes closed and homes sales revenues rose 14% and 28%, respectively, over the past six months. Moreover, the company’s backlog grew significantly during the recent quarter, to $2.8 billion, which will likely bolster revenues and profits in the balance of fiscal 2014. Overall, this growth primarily reflects favorable housing market conditions, which has created pricing power and reduced sales incentives, among other things.
Looking ahead, we anticipate the economic picture will continue to improve, particularly in regard to job growth, household incomes, household formations, and consumer confidence. These factors augur well for D.R. Horton’s business, as they are correlated to performance. Moreover, the company has made substantial investments in land, lot, and home inventories over the last several years, which should drive growth by helping to satisfy customer demand. In fact, the company recently acquired the homebuilding operations of Crown Communities, based in Georgia, South Carolina, and eastern Alabama.
Most importantly, being that the company is rather diversified from a geographic standpoint, DHI has concentrated on expanding its product offerings, with homes for entry-level, move-up, and luxury buyers. This ought to drive market-share gains across all categories. The company’s Emerald brand, which focuses on the luxury buyer, in addition to the recently launched Express brand, which is aimed at the economically-sensitive entry-level buyer, should create substantial short- and long-term opportunities. All told, we look for double-digit top- and bottom-line gains over the 3- to 5-year haul. Moreover, the stock’s price-to-earnings multiple is well below the Value Line median, likely appealing to bargain hunters.
Universal Forest Products, Inc.
Universal Forest Products is a holding company that provides capital, management, and administrative resources to subsidiaries that design, manufacture, supply, and market wood, wood composite, and other products to three core markets: retail, construction, and industrial. The company operates in five segments: Retail Building Materials (36% of March-period sales, excluding sales allowances); Industrial (30%); Manufactured Housing (15%); Residential Construction (14%); and Commercial Construction & Concrete Forming (5%). In addition, Universal Forest offers framing services, concrete construction products, lawn and garden supplies, and outdoor living goods. Notably, the company also separates its sales into value-added products (58%), which generate higher margins, and commodity-based offerings (42%).
Fiscal first-quarter sales results reflected an increase in unit sales, driven by growth in the industrial, commercial construction, and concrete forming markets. Some of the progress was somewhat offset by weakness in the manufactured housing, retail building materials, and residential construction segments. A decline in selling prices, due to the commodity lumber market, and harsh winter conditions (which delayed home improvement and building projects) were additional headwinds. However, earnings per share increased substantially, due to increased margins for its framing operations. On the plus side, we anticipate a stronger showing during the remainder of 2014. This outlook largely stems from an expected rise in housing starts, which should lift lumber prices.
Moreover, the lumber and building products supplier has been active on the acquisition front and will likely continue to search for valuable bolt-on opportunities. This should help to widen its worldwide footprint, as management expects to add approximately $25 million in annual sales through international purchases in 2014. Universal Forest is also working to expand its customer base and product offerings, with a particular focus on value-added products. In fact, new product sales increased 13% year over year, in the March period. Over the long term, management expects double-digit top- and bottom-line growth through 2017, with sales of at least $3 billion. Operating margin is expected to improve moderately to 4%-6% of sales.
The small-cap stock is currently trading at a discount, as its valuation is below the Value Line average as well as its historical median. In addition, the company’s healthy balance sheet (long-term debt was a mere 18% of total capital in the March interim) should further appeal to value investors.