Combining Value and Growth

 | Jun 14, 2013 | 4:00 PM EDT  | Comments
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Stock quotes in this article:

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You could not find two individuals more different than my fellow Real Money contributor Brian Sozzi and myself. Brain loves Red Bull, healthy food and gyms. I prefer red wine, steak subs and the couch. His website has references to battlegrounds and fight clubs. Mine has articles about baseball and philosophy that were written on the couch.

In spite of this, we have become friends, and we often exchange barbs over Twitter and other social media. This morning, my intense friend sent me a Tweet advising me to research only stocks that have a return on equity over 17%. Naturally I suggested that he substitute stocks below tangible book value. When my coffee kicked in, it occurred to me that perhaps we could put together a list that made us both happy.

This is not a new idea. In his excellent book Investment Fables, Aswath Damodoran looked at what does and does not work in the stock market. He discovered that adding a return-on-equity component to a portfolio of stocks that trade below book value improves performance by a substantial amount. Cheap stocks that generate high returns on equity beat the market by a large amount over an extended period of time.

This morning, I ran a simple screen looking for stocks that trade below book value and have an ROE over 17%. I found a few stocks that Brian can discuss at the gym and I can own while watching a ballgame on my couch.

The first stock I will mention is a bank that I have owned as part of the "Trade of the Decade" and which I have also suggested as a great long-shot stock. Synovous Financial (SNV) is a $26 billion bank that has 279 branches in the Southeast. The bank has spun off some operations, raised capital and sold distressed assets as part of the recovery process from the credit crisis. The turnaround seems to be working, and the stock is still cheap enough to be a tremendous bargain. Right now, the company is earning a return on equity of over 2%, so it meets Sozzi's research criteria as well as my own.

KKR Financial (KFN) is a specialty finance company that makes loans and invests in high-yield and bank debt. It has also been a buyer of real assets and currently operates, through the finance division, a master limited partnership that holds producing interests in oil and gas wells, and a real estate investment trust that has been selectively buying commercial real estate assets. The company has a return on equity right at 17%, and the stock is trading at 96% of tangible book value. KKR Financial pays out about half of its cash flow, and the shares yield a generous 7.75% right now. That should pay for a few bottles of wine for me and cover Brian's gym membership for a while.

MFC Industrial (MIL) is another stock that passes both our investing thresholds. The company is in the commodity supply-chain business, and it sources and delivers various commodities to clients around the globe. It handles an incredible range of commodity products, including minerals, metals, energy, chemicals, plastics, food and animal feed additives, industrial products and wood products. MFC Industrial also provides financing and risk management services for client companies. It also functions as a merchant bank, and it will buy companies that it deems are overvalued and are a good fit for its supply chain. It owns petroleum companies and interests in mines.

MFC Industrial consistently earns a return on equity north of 20% and trades at just 60% of tangible book value. The company has a strong balance sheet and should be able to navigate the weak global economy for a long time. When we get a sustained recovery, MFC's earnings and stock price could soar to the point where I can buy a library with a wine cellar and Brian can install a home gym and a Red Bull cooler.

At first glance, Brian and I have very different styles. But if you insist on being dogmatic instead of open-minded, you will miss opportunities to learn new approaches to finding solid investments. Arguing over value and growth is one of the more foolish discussions of all time, as they can be combined to find stocks that have characteristics of both.

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