A Recipe for Long-Term Success

 | Jun 20, 2014 | 2:00 PM EDT
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Warren Buffett once famously said that value and growth were joined at the hip. To profit from the stock market, find a company that can be purchased at a discount to what it is worth. The trick is to find those companies that can reverse the conditions that created the discounted valuation and grow the value of the company.

The best investments you will ever make in your lifetime will involve buying a company at a deeply discounted valuation. When the value of the company grows faster each year than the stock price does -- and keeps doing so for an extended period of time – it could become a 10- or 20-bagger stock.

I ran a simple "joined at the hips" screen in which I looked for companies whose shares are trading below book value and whose management has grown book value over one-, five- and 10-year time frames. It is an interesting list of companies and there are some potential big winners in here. Some are cheap for cyclical reason and will recover when the economy eventually does. Some are companies that are not followed by the Street and investors are not paying attention to their positive developments yet. Whatever the reason, they are all cheap and they have all been growing.

One of the more consistently undervalued growth stocks is Rowan Companies (RDC). Despite management's fantastic track record of growing the value of the company, the stock is currently trading at just 81% if book value. The offshore oil-and-gas contractor has a fleet of 34 jack-up and ultra-deepwater drilling vessels and the stock has been weak due to the slowdown in drilling activity. Rowan is one of the best companies in the industry, and I believe the stock is too cheap. Management has grown the book value of this company by 14% over the past decade and 10% over the past five years. Year-over-year book value has grown by 8%. This company is a consistent performer and the stock is available at an attractive discount to the value of the asset.

Republic Bancorp (RBCAA) has grown its assets at a mid-teens rate for the five- and 10-year periods. It has slowed a little in the near term as management worked out the problem surrounding their tax refund lending business. But with that behind them, I am confident that the bank can continue its growth trajectory. The Louisville, Ky. based bank has about $3.5 billion in assets and operates 42 branches. The company is focusing on loan growth. It had a 70% surge in the commercial loan pipeline in the first quarter and the warehouse mortgage lines of credit in March were its highest ever. The company's processing segment's profits increased by 28% as tax refunds processed grew by more than 70%. Trading at 88% of book value, the stock is a solid bargain and would be a "back up the truck" type of purchase if the shares were to fall back below $21.

There are some surprising cyclical names on the list as well. The problems that a weak economy and surplus iron ore stocks have created for Cliffs Natural Resources (CLF) are well known and the stock trades at about half of book value. The five- and 10-year growth rates are positive and book value at the end of the first quarter is higher than at the end of the comparable quarter in 2014. Teck Resources (TCK) has faced similar issues in the market for their end-products, which include copper, coal and zinc. The shares are cheap, trading at just 75% of book value, and all three time frames show decent book value growth.

Have you ever wished you could own a money machine? Owning shares of quiet sleepy little National Western Life Insurance (NWLI) has worked like that for most of my career. Since 1990, the stock has returned more than 15% a year to long-term investors. Since 2000, the shares have averaged more than 9% annually while the S&P 500 has managed less than 3% average annual return. They constantly grow the book value year after year and somehow the stock price never seems to catch up with the asset value. The stock currently trades at about 60% of book value. Investors should buy some of these shares in every market correction and just hold them forever.

Buying shares in growing companies at a discount to their asset value is a recipe for long-term investment success. These stocks are cheap and have demonstrated an ability grow their book value over time.



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