On April 8, 2013, we recommended American International Group. We said that AIG was “a poster child of all that went wrong leading up to the Great Recession, and it’s a company that is struggling to free itself of the past as it forges a new identity for the future.”
Since then AIG has returned over 30%, outpacing the S&P 500 by over 10%. It’s a familiar story for many successful investors – find a stock that is significantly undervalued, buy it, then sit back and profit while the rest of the investing world plays catch up.
Today we’ll explore a few other companies that we feel are undervalued. All of these examples have taken hits in recent years – financially, in the publi’sc perception, or they’ve simply been beaten in a competitive niche. John Wooden said that “failure is not fatal, but failure to change might be.” We agree, and we think these companies do as well. –The Flaneur
3 Undervalued Stocks Poised for a Big Rebound
There are a variety of ways to evaluate if a stock will increase in value over time. The company could be positioned in an industry on the rise and simply ride the macro wave. The company could be uniquely positioned to outperform its peers in an established industry. The company may have a new or special product that is far better than any alternative.
Or, the company may simply be undervalued. Whether it is because of public perception, recent underperformance, or a change in strategy the bottom line is the same. It’s the opportunity to buy a great company on the cheap. Here are three companies we think may be undervalued right now.
Citigroup (NYSE: C) – A global bank trading way below book value
Of all the major U.S. banks, perhaps no other has fared worse since 2007. The company was infamously forced to cut its dividend in the lead up to the crisis before other banks, it has repeatedly failed to find the good graces of regulators, and its stock has continually lagged. Actually, that’s an understatement. Citigroup’s stock has been downright disgraceful.
Just last month Citigroup once again failed the Federal Reserve’s Comprehensive Capital Analysis and Review tests. The Fed requires banks to submit stress tests and capital plans for approval before implementing any dividends or share buybacks. Of all the U.S. banks larger than $50 billion in total assets, Citi was literally the only bank to have their plan rejected in two of the test’s three years in existence.
All that said, we think the company is undervalued. In spite of all the problems, Citi has a very solid business at its core and more than any other US mega bank, Citi is positioned very, very well for an increasingly globalized world.
First, how undervalued is Citigroup? In this example, we’ll use Citi’s market value relative to its book value to assess its value relative to its competitors and peers.
Citi currently trades at a price to book ratio of 0.71. This means that the company’s stock is worth just 71% of the actual net worth on the company’s books. Wells Fargo trades at 1.60 price to book, and JPMorgan Chase at 1.03. Of the largest banks, only Bank of America trades at a comparable multiple (0.72).
The rebound play at Citi is based on two primary factors – the bank’s problems assets are improving (meaning its book value is a valid measure of the company’s true worth) and the long term growth potential at Citigroup is huge because of its international strategy.
When the economy imploded, Citigroup created a new division to hold all of the bank’s problem assets. This unit is called “Citi Holdings”, and it’s been getting better and better every quarter. Currently, the unit represents just 6% of Citi’s total assets, declining from $149 billion to $114 billion over the past year. And even more significantly, the unit is losing less and less money as it shrinks in size. Citi Holdings lost $798 million in the first quarter of 2013. Fast forward to Q1 2014 and that loss was just $292 million. In the very near future, Citi Holdings will be dissolved and this huge drag on the company will be lifted.
At the same time, Citi is in prime position to take advantage of continued globalization and long term growth in emerging markets. Citi has a far larger presence overseas than any other major U.S. banks with operations in over 90 countries and growing. International business currently accounts for roughly 60% of Citi’s revenues. Wells Fargo is basically a U.S. only bank, and Bank of America is working very hard to reduce its international exposure as the bank tries to simplify. JPMorgan is an international player, but CEO Jamie Dimon has repeatedly stated that he prefers slow, organic growth overseas, which is in contrast to Citi’s more aggressive approach.
At 0.71 price to book value, Citi seems to be undervalued. Problem assets are on the decline, and the future seems primed for international growth. Citi could be the rebound stock you’ve been looking for.
BlackBerry (NASDAQ: BBRY) – It’s not about phones anymore
Let’s just get the obvious out of the way right up front: the iPhone killed the BlackBerry phone. In its heyday, BlackBerry was the ultimate status symbol. Its famous keypad with trackball mouse was an important, incremental step to the mobile first world we live in today. But then Apple stepped into the game and wiped the floor with BlackBerry (Nokia too for that matter). The iPhone is simply a better product. Then Google launched Android and took over the non-Apple smart phone segment, and BlackBerry was as good as dead. It still is. Blackberry lost in hardware and software. It was an ugly fall from grace.
But we don’t see BlackBerry today and tomorrow as a phone company. We see BlackBerry as a software company.
BlackBerry CEO John Chen has taken the lead and is pushing the company as far away from hardware as he can. Since taking the helm, he has slashed, cut, and outsourced as much of the company’s hardware business as fast as possible. The company far exceeded Wall Street expectations when it released Q4 earnings last month, largely on the 30% reduction in operating expenses related to Chen’s chopping. Chen said at the time that these results were a full quarter ahead of BlackBerry’s turnaround plan.
First and foremost is BlackBerry Messenger (BBM). This messaging app has 115 million active users and is a beloved tool in the enterprise messaging space. Messaging software has been a hot arena of late, with Facebook acquiring WhatsApp for $19 billion. For context, BlackBerry’s market cap today is $3.94 billion. It’s very feasible that BBM alone is worth more than $4 billion.
BlackBerry also owns, in addition to BBM, a very valuable portfolio of patents and intellectual property. It has a robust operating system as well called QNX that could have a wide variety of applications in the enterprise software space.
If the biggest question in BlackBerry’s short term is cutting its hardware business, the main problem in the medium term is cash flow. BlackBerry currently has cash and equivalents equal to about $2 per share (which is huge when you consider the share price is just currently $7.50 – 27% of market value, for those of you counting at home).
The problem though is that that cash pile is shrinking very, very quickly. In the fourth quarter, BlackBerry burned $800 million in free cash flow; that’s a 23% reduction in three short months.
We see the cash flow issues resolving themselves over the coming quarters as the company reduces its inventory levels of hardware during the scaling down of that business. The long term play here is that BlackBerry can successfully build a reputable software business in the enterprise space and unlocking the value hidden in the BBM network. BlackBerry will never return to its stature at the top of the tech universe, but we think it’s worth a whole lot more than $7.50 per share.
JPMorgan Chase (NYSE: JPM) – What happens when public vitriol outweighs business reality
Earlier, we discussed how Citigroup was undervalued based on its price to book ratio. The argument for Citi is for the return of a beaten down company that genuinely has financial and business issues to resolve. JPMorgan is a profit machine that trades below its real value because of public perception instead of its business reality.
JPMorgan reported earnings last month that, adjusted for non-recurring charges and gains, came to $23 billion for the first quarter. These translates to earnings per share of $5.94. At the time of this writing, that works out to a P/E ratio of just 9.4 times.
At the same moment, the Dow Jones Industrial Average is trading at 16 times earnings. Ask yourself, are JPMorgan’s earnings 6.5 times less valuable than the rest of the Dow?
Now more than ever, JPMorgan continues to strengthen its “fortress balance sheet.” In fact, JPMorgan has more than doubled its capital base under the Basel III standards since 2007. And it’s achieved this while maintaining 15% return on equity from 2011 to the present (using the adjusted earnings).
Why is JPMorgan so cheap? We think its public perception. The investing public is fearful of banks as large as JPMorgan, and headline grabbing fiascos exacerbate the point. The London Whale, settlements with the Justice Department, fines, and a myriad of other news stories have convinced the public that JPMorgan is somehow a danger.
But if you’ll just take a few minutes to read some of the company’s regulatory filings, you’ll see a remarkably consistent, remarkably strong, and remarkably profitable enterprise.
The bottom line for JPMorgan is that earnings will continue to grow and as they do the stock will continue to rise. We think that over the long term the market will realize that JPMorgan at 9.4 price to earnings is ridiculous. When that happens, expect JPMorgan to outperform in a very significant way.
Warren Buffett has made $60 BILLION using this same fundamental investing approach
Warren Buffett is a very, very rich dude. How did he get so much cash? By finding companies just like these that are undervalued, and then investing heavily.
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