There are many ways to estimate the right share price and try to find undervalued stocks. One of the clearest and most effective ways is Benjamin Graham’s Net Current Asset Value strategy. It is easy to count and if you want, you will find a screener which will do the work for you. Sometimes you will find more companies, sometimes less. If you want to expand the number of the companies to choose from, you have to also use other metrics.
I have done the following research using some other metrics. In this research, the single most important valuation ratio was EV/EBIT. Recent examinations have shown that as a standalone ratio, EV/EBIT is probably more profitable than any other valuation ratio. I also checked the price-earning (P/E) ratio, price-book (P/B) ratio compared to return on equity (ROE) and price-sales (P/S) ratio compared to net-margin. I need to clarify that the P/E ratio can be misleading when evaluating strongly cyclical stocks. Many times stocks are cheap when the P/E ratio is high and vice versa. So be aware.
I do not want to touch heavily leveraged companies. Financial risk of the companies should be as low as possible. I looked at debt to equity levels. The Piotroski F-Score told me how financially strong and healthy these bargain stocks were and the Altman Z-Score indicates how much financial distress a company is in and its risk of bankruptcy.
After these more or less quantitative measures, I have appraised the short quality of the companies and their business. My research covered mainly Western markets and, coincidentally, in the end, stocks I discoverd all came from one country and one industry.
Homebuilding industry in United Kingdom
The homebuilding and construction industry is extremely cyclical. Surely in the future there will be booms and busts. Recent economic data has been favorable for homebuilders. Favorable government policies in the U.K. and pent-up demand outweigh supply, helping this industry.
This sector is highly competitive and the business is like a commodity in that prices are determined by the laws of supply and demand. However, there are many future trends that will support the industry. People around the world are moving to cities and need more houses. The number of people living in single-family units will increase significantly.
Urban areas have expanded and because of developing technology, suburban living conquers the field. People do not need to go to the city center to work or take care of business every day. Transportation is also getting cheaper. The Brexit vote in June of 2016 hurt the sector and some companies plunged violently. Now investors need to decide whether or not the market is incorrect in its assumption that the sector's high return days are numbered.
Abbey PLC (LSE:ABBY, Financial)
Abbey PLC is engaged in building and property development, plant hire and property rental. The company operates in Ireland, the United Kingdom and the Czech Republic. Abbey's housebuilding division completed 252 sales during the half-year 2016, with 219 in the UK, 18 in the Czech Republic and 15 in Ireland.
The immediate outlook continues to be good and a strong second half should allow physical activity to surpass last year. In England, uncertainty is affecting sentiment, which may impact the business in 2017. Although the UK business is by far the most important, the Czech Republic can provide further opportunities for expansion in the future.
Financials:
- Market cap: 256.2 million pounds ($331.7 million)
- EV/EBIT: 3.8
- P/E ratio: 7.2
- P/B ratio: 1.1
- Â ROE: 16.4%
- P/S ratio: 1.5
- Net-margin: 21.8%
- Debt to Equity ratio: 0.0
- Piotroski F-Score: 8
- Altman Z-Score: 6.34
Valuation
The company has grown rapidly in recent years. The big question is, can growth continue at this rate? Prospects for the short, medium and long term are now very unclear. Even if growth does not continue at the same rate, the company should earn steady 1.50 to1.70 pounds per share. Abbey is not expensive at a market price of 12 pounds. A profitable and growing company should be valued higher than its book value. There is also room to increase dividends. The payout ratio is 0.10 and the yield is 1%. The company is debt-free and has a strong balance sheet.
Abbey is largely owned by the Gallagher family (74% Gallagher Holdings Limited). Charles H. Gallagher bought last 376,044 shares of the company Dec. 21, 2016, and 985,645 shares on Jan. 20.
Bellway PLCÂ (LSE:BWY, Financial)
Bellway PLC is a is a holding company engaged in the business of building houses in the United Kingdom. The company provides bedroom apartments to luxury penthouses and executive houses.
The Newcastle, England-based company is among the biggest homebuilding businesses operating across the U.K. Its sales are spread throughout the country with products ranging from one-bedroom apartments to luxury penthouses. As the homebuilding industry is flourishing, the market has been in its favor.
Bellway notched up its seventh successive year of volume growth. Shareholders were rewarded with a 40% hike in the dividend payout, which is not meaningless.
Financials:
- Market cap: 3.05 billion pounds
- EV/EBIT: 5.9
- P/E ratio: 7.6
- P/B ratio: 1.6
- ROE: 13.5%
- P/S ratio: 1.4
- Net-margin: 18%
- Debt to Equity: 0.02
- Piotroski F-Score: 7
- Altman Z-Score: 5.29
Valuation
Bellway is growing. It should easily reach the 3.50 pounds EPS level, which means 14% earnings yield. The dividend yield is a great 4.4% and dividend growth over the past few years has been enormous. The payout ratio is 0.25%. The balance sheet is strong, but cash flow – although increasing – could be larger. The quickly rising net margin proves the company is profitable. The company is broadly owned by institutional investors.
Bovis Homes Group PLCÂ (LSE:BVS, Financial)
Bovis Homes manages a full range of housing development activities. It is engaged in designing, building, surveying, purchasing and selling new homes to private customers and Registered Social Landlords, mainly in England and Wales.
CEO David Ritchie announced his immediate departure from the company following a disappointing pre-close update sent just before the year-end. There has also been reputational damage among unhappy customers. Bovis allegedly persuaded buyers to move into unfinished homes by offering them incentives.
Bovis dragged on its return on capital, which is among the lowest of its peers. Recently, the company has made progress in increasing its ROC, particularly by increasing the hurdle rates for land purchases. This should pay off over the longer term.
Financials:
- Market cap: 1.14 billion pounds
- EV/EBIT: 6.6
- P/E ratio: 8.5
- P/B ratio: 1.2
- ROE: 14.3%
- P/S ratio: 1.2
- Net-margin: 13.3%
- Debt to Equity: 0.02
- Piotroski F-Score: 6
- Altman Z-Score: 3.64
Valuation
The company is plagued by bad news and is under increasing pressure. Investors should concentrate on the facts however and should wait for the full-year 2016 financial report to see how revenue and earnings have developed. Bovis already revealed that volume delivery for 2016 would be lower than previously expected. Bovis met that downturn with a much stronger balance sheet than its peers, but has since struggled to rebuild its profitability. In the absence of further bad news, any good news may push the share price up.
M Winkworth PLCÂ (LSE:WINK, Financial)
The last company operates in real estate service. M Winkworth is engaged in franchising the Winkworth estate agencies. Its operations occur in the U.K. with limited business in other territories. The company also offers additional products such as financial services, auctions, surveying and commercial property sales.
The business model works on a franchised basis, with each independent outlet paying a percentage of revenue in exchange for using the brand and other services.
Some uncertainty continues to weigh on transactions as some sellers withdraw from the market with the intention of reviewing their situation during 2017. The fundamentals of the housing market in London and its surrounding areas remain strong however.
Financials:
- Market cap: 12.48 million pounds
- EV/EBIT: 5.1
- P/E ratio: 8.2
- P/B ratio: 2.3
- ROE: 30.5%
- P/S ratio: 2.1
- Net-margin: 26%
- Debt to Equity: 0.0
- Piotroski F-Score: 3
- Altman Z-Score: 11.69
Valuation
After the profit warning announcement in November 2016, revenue and earnings are under pressure. The company's long-term outlook does not look so bad. M Winkworth is debt-free and, as a whole, financials are decent. There are two main factors behind the company's fading market price: markets hate uncertainty, which is reflected in the share price, and the ownership structure. The number of shares not in public hands represents 50.3% of the issued share capital. Chairman Simon Agace and his family maintain control of the company. Insiders are consistently increasing their stakes. In spite of these shortcomings, M Winkworth’s undervalued stock offers an interesting opportunity for enterprising investors.
Disclosure: The author owns no stock mentioned.
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