Finding Value the Old-Fashioned Way

 | Jun 09, 2014 | 3:00 PM EDT  | Comments
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It has been a while since we combed through an issue of Value Line looking for potential bargains, turnarounds and long shots. Flipping through the latest issue is one of my favorite weekend activities; over the years, it has also been one of my more profitable endeavors. In addition to traditional book-value bargains, I have found the list of stocks that the service projects as having the highest three- to five-year appreciation potential can be fertile ground for potentially profitable stock ideas. If you took away my computers and media but left me with the weekly issue of Value Line, I am pretty sure I could still find market-beating stocks without too much additional effort.

My first observation is that the Value Line Median Appreciation Index is still down at just 35%. As we know, the academics have studied this as a measure of market valuation, and when the index is above 100%, it's a great time to buy stocks. We are way below that now and below the 55% level that research has shown to be a pretty good place to start selling stocks. It is certainly now a precise timing indicator and, as we know, markets can always become more overvalued, but it should serve as something of an early warning light for investors.

Turning to the list of stocks with the highest appreciation potential, there are some intriguing names on the list. Avon Products (AVP) has struggled the past few years, especially with its North American operations. The number of Avon representatives in North America fell by 18% in the first quarter and revenues fell by more than 20%. The U.S. isn't even the company's largest market anymore, as that honor now belongs to Brazil. That is probably not going to get better this year but as part of the turnaround, Avon is hoping to leverage its success in Latin American markets to increase its presence in the Latin community here at home. Avon has finally settled its problems with the Justice Department and paid $135 million for violating the Foreign Corrupt Practices Act. The research service is estimating the stock will be two to three times the current quote over the next five years. That is reasonable, provided it is not bought out before then.

Now that SLM Corp. (SLM) has spun off Navient (NAVIV), its student-loan-servicing business, the piece that is left represents the largest originator of student loans in the U.S. As part of the separation process, Sallie Mae suspended its divided and that encouraged many income-oriented owners to dump the stock. With all the negative publicity around student loans today, the stock has been something of a pariah on Wall Street, trading at levels not seen since 2009. Value Line projections have to stock between two and a little more than three times the current price, but note that it is probably going to be a volatile journey that is not without substantial risks. The private-student-loan portfolio has been improving as far as credit quality, with delinquent loans falling to 6.9% from 7.8% a year ago. Loan originations were up 8.5% as students are still looking to finance their education in spite of all the controversy about the high amount of debt graduates carry. This is a classic long-shot stock that no one likes and has been sold heavily following the spinoff and dividend cut. Aggressive, but patient, investors might want to use the volatility to scale into the stock in hopes of a huge five-year return.

Many of my favorite energy-related stocks are also on the list. Noble Corp. (NE), Rowan Cos. (RDC), Diamond Offshore (DO), ION Geophysical (IO), Pengrowth Energy (PGH) and Petrobras (PBR) all make the list of stocks with the potential for huge three- to five-year returns, according to Value Line projections. I believe that energy is one of the more interesting sectors right now as there are lots of cheap stocks that should be dramatically higher 10 years from now. Value Line's picks would make solid start toward putting together an energy stock portfolio.

While the market may be on the high side of fair, there is nothing to keep it from going mildly overvalued to ridiculously overpriced. I have no crystal ball that can tell me where stocks are going in the short run, but these high-appreciation potential picks form Value Line should give solid long-term returns regardless of what the market does in the short term.

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