As we approach the end of 2016, we can review the value screener record trends to further understand global market valuations and the predictability of companies. Each value screener lists stocks meeting specific criteria. Some value screeners list companies trading at deep discounts while others focus on the company’s predictability rank.
Intelligent investor seeks net-net bargains
Benjamin Graham, the “Father of Value Investing” and author of “The Intelligent Investor,” invested in companies that trade below their net-net working capital. Such companies also have no meaningful debt and positive operating cash flows over the past 12 months. Companies meet the former criterion if their interest coverage is at least 5. Emerson Radio Corp. (MSN), whose financial strength ranks a perfect 10 out of 10, is a classic Ben Graham net-net bargain: the hardware company’s price to net current asset value ratio and price to net-net working capital ratio is 41.2% and 44.4%, respectively, which are both less than the 66.67% threshold.
Figure 1 highlights the trend of global companies making Ben Graham’s screener. During the past five months, the number of Asian companies making Graham’s screener increased the most among all regions, suggesting that Asian stock markets are relatively undervalued compared to other global stock markets. The total market cap to gross domestic product ratio, as Warren Buffett (Trades, Portfolio) mentioned, presents good market valuation indicators. Figure 2 summarizes the ratio of TMC to GDP across global stock markets as of Dec. 2, while Figure 3 summarizes the expected annual return for various global stock markets based on these market valuations.
Figure 1
Figure 2
Figure 3
As observed in Figures 2 and 3, the Chinese stock market remains moderately undervalued with a TMC / GDP ratio of about 50%. Based on this market indicator, the Chinese stock market is projected to return 30.5% per year. On the other hand, the U.S. stock market is projected to return between -0.1% and 0% per year based on a TMC / GDP ratio of over 122%.
Undervalued predictable companies
As its name suggests, the Undervalued Predictable Screener lists the predictable companies (predict rank 4-star or higher) that trade below their intrinsic value based on discounted cash flow models. Although we can consider the intrinsic values based on free cash flow or earnings, we prefer earnings to free cash flow as the correlation between intrinsic value and margin of safety strengthens when earnings are used. As of Dec. 2, Open Text Corp. (OTEX), AmTrust Financial Services Inc. (AFSI) and Allegiant Travel Co. (ALGT, Financial) trade at least 60% below their DCF earnings fair value.
During the past five months, the number of U.S. companies that made the undervalued predictable screener increased by about one per month, as illustrated in Figure 4. This suggests that U.S. companies generally remained predictable during the past five months.
Figure 4
Buffett-Munger stock picks
Buffett and co Berkshire Hathaway Inc. (BRK.A, Financial) (BRK.B, Financial) CEO Charlie Munger (Trades, Portfolio) invest in companies using a four-criterion approach. Three of the criteria include: understandable business, strong competitive advantage and no meaningful debt. Finally, these companies are undervalued based on their PEG ratio, which is the price-earnings ratio without nonrecurring items divided by the five-year EBITDA growth rate.
As discussed in a previous article, technology companies like Wipro Ltd. (WIT, Financial) and F5 Networks Inc. (FFIV) meet all four Buffett-Munger criteria. Such companies make good defensive investments in a significantly overvalued U.S. stock market.
Figure 5 graphs the past five-month trend of companies meeting the Buffett-Munger investing strategy. Based on this chart, more companies trading in Asia and Canada made Buffett and Munger’s list of stocks, suggesting that these global markets offer good defensive investment opportunities. On the other hand, less U.S. and European companies made the Buffett-Munger Screener during the past five months.
Figure 5
Companies with historical low price-to-sales and price-to-book ratios
Both the historical low price-to-sales and historical low price-to-book screeners list the predictable companies that have low valuation ratios. Companies that make the historical low P/S screener generally have strong and consistent one-year, five-year and / or 10-year revenue growth rates. As these companies offer high growth and value potential, several gurus, including Arnold Van Den Berg (Trades, Portfolio) and Ken Fisher (Trades, Portfolio), invest in these companies quarter over quarter. Baidu Inc. (BIDU, Financial) and several biotech companies, including Biogen Inc. (BIIB, Financial) and Novo Nordisk A/S (NVO), also trade below their median P/S valuation and near their minimum P/S valuation.
Figures 6 and 7 highlight the past five-month trend of global companies making the historical low P/S screener and the historical low P/B screener respectively. While more U.S. companies made these two screeners, the number of European companies making these screeners generally decreased during these past five months. Canadian and African companies seldom made the historical low P/S screener.
Figure 6
Figure 7
Peter Lynch Low-Valuation Growers
The “Peter Lynch Growth with Lower Valuation” Screener lists the companies that have at least a two-star predictability rank, a trailing 12-month price-earnings ratio less than 14 and a 10-year revenue growth rate of at least 6%. Lynch excludes cyclical and one-star companies as these companies are more likely to have volatile earnings. As discussed in a previous article, several airlines, including Alaska Air Group Inc. (ALK, Financial) and Hawaiian Holdings Inc. (HA), made the Peter Lynch Growth screener, suggesting the airline industry presents good growth potential to investors. Buffett significantly expanded his airline empire during the third quarter, buying approximately 21.77 million shares of American Airlines Group Inc. (AAL, Financial), 6.33 million shares of Delta Air Lines Inc. (DAL, Financial) and 4.53 million shares of United Continental Holdings Inc. (UAL, Financial).
Figure 8 highlights the past five-month trend of global companies making Peter Lynch’s growth screener. Although most Asian stocks made the screener, the number of Asian stocks making the screener has generally declined during the past five months.
Figure 8
Walter Schloss’s cheap stocks
Finally, the Walter Schloss Screen lists the companies that have strong interest coverage and Altman Z-scores, trade no more than 25% above their three-year low, and have a price to tangible book value ratio less than one. These stocks generally also make the Ben Graham Net-Net Screener as both screeners look for companies trading at deep discounts.
However, the past five-month record suggests otherwise: although more companies made the Ben Graham screener, less companies are making Walter Schloss’s cheap stock screener, especially Asian companies. (See Figure 9.) This likely suggests that while the companies’ stock price dropped to cheap prices, these companies do not have strong financial strength.
Figure 9
Conclusions
Ben Graham and Walter Schloss’s screener can shed light on the global market valuations as these companies look for cheap stocks. Stock markets with high number of Ben Graham Net-Net and Walter Schloss stocks are likely undervalued compared to other stock markets.
The other value screeners can explain the trend of business predictability among companies. We will investigate this trend in a subsequent article.
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Disclosure: I do not have any positions in the stocks mentioned in this article.
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