Trawling for Dirt-Cheap Large-Caps

 | Feb 01, 2013 | 12:30 PM EST
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A couple of years ago, a few of us gathered in Manhattan for a spirited round of cocktails and conversation. In addition to basics -- such as the inherently evil nature of the Boston Red Sox -- one of the major discussions centered on a search for the cheapest large-cap stocks in the world, based on price to tangible book value. With the help of a laptop and a bartender who was generous with the Wi-Fi password, we found that large banks in Europe and Japan were the cheapest stocks in the world, with Mitsubishi UFJ (MTU) taking ultimate honors as the very cheapest.

That conversation centered around stocks like Royal Bank of Scotland, Japanese bank Mizhou Financial (MFG), Bank of Ireland (IRE) and Dutch insurer Aegon (AEG). A few folks at the table bought some of these stocks. I was lucky enough that my inner cheapness won the day, and I bought them all. Since then, they have all risen somewhere between 50% and 100%.

While I refused to leave the 70-degree weather here in Orlando, Fla., to recreate that Manhattan evening, I sat down to replicate the experiment this morning. To my surprise, the cheapest large-cap stock in the world today comes from that original list. Trading at just 30% of tangible book value, the honor goes to Aegon.

The insurance and financial services company is well on the road to recovery: It began to grow revenue again in 2012, and the U.S. life and variable annuity business is strong, even as it allows the fixed annuity business to run off. The company has almost eliminated its exposure to the U.K. at this point, as its products are no longer a good fit for that market. Aegon is profitable in its home market -- but its results are lumpy, as much of its business is corporate annuity products which occur only occasionally.

The stock has been on a tear of late, having risen 45% for the past year. But the shares are still cheap enough that I would not hesitate to buy the stock here.

Korea Electric Power (KEP) just missed top honors, with a stock that trades at 38% of tangible book value. The company is the only electric company in South Korea, so it has a pretty solid monopoly. The company will lose money again for 2012, but that should change in 2013 as cost pressures abate and the firm's nuclear operations come back on line. The firm was also able to raise rates by 4% recently, and that should also assist the return to profitability. While there is nothing overly exciting about the stock, it is super cheap and should reward long term shareholders from this level. Still, hares have shot up 20% in the last quarter, so I would wait for a pullback before I bought.

Elsewhere, even though it has flirted with new highs, Hartford Financial Services (HIG) is the cheapest U.S. stock on the list at 50% of book value. The company recently decided to sell its life-insurance business, and to concentrate on investments and property and casualty insurance -- and this has been well-received by the stock market. Hartford has also put the annuity division in run-off, and that segment will no longer write new business.

Hartford is one of the largest U.S. insurers for commercial property and casualty, and its strong relationship with AARP gives it a strong presence in the personal-lines markets as well. I expect the stock to trade closer to tangible book value over the next couple of years, which would provide solid returns for shareholders. As with the first two stocks on the list, do not chase a rising tape; instead, wait for a decent pullback before you start buying the shares.

Our final super cheap large-cap stock is ArcelorMittal (MT), the Luxembourg-based steel company. As one of the largest integrated steel producers in the world, the company faces the same problems as everyone else does. Demand has been very weak, and inventories have piled up all over the globe. It will take some time to work off the excess, and the company's top and bottom lines will likely suffer until that happens.

There is a good chance ArcelorMittal will have to reduce the dividend until the steel markets fully recover. But the shares are extremely cheap from a long-term perspective, so patient investors will be rewarded when the global economy is able to fully recover.

So, overall, you'll probably want to wait for a bit of a pullback in these stock prices -- but the last time we attempted this approach a couple of years back, buying the cheapest large-cap stocks worked very well. It seems highly likely to work as well over the next two years, as well.

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