In the 1976 interview where he discussed his simple two-factor stock selection model, Ben Graham mentioned you could substitute price to book for price to earnings and produce market-beating returns over time. I did some quick tests and found that you do indeed enjoy a substantial edge over the markets when you buy stock below book value in companies that have high equity-to-asset ratios.
It is a simple screen to run, so I sat down this morning and looked for asset-based bargains using Graham's two-factor approach. As you might expect, right now energy companies dominate the list, including some of my long-term favorites like Rowan (RDC), Tidewater (TDW), WPX Energy (WPX) and Gulfmark Offshore (GLF).
The list gets pretty short when you take out energy stocks, but there are some stocks that are interesting and worthy of further consideration by long-term value investors.
Forestar Group (FOR) is an interesting collection of assets trading at a pretty big discount. The Austin, Texas-based company operates in three areas: real estate, oil and gas and natural resources. The real estate division has more than 120 acres of land in 10 states, with the bulk of it in Texas and Georgia. It has several projects in various stages of planning and production on its land. Forestar is also active in multifamily projects, with three communities under construction and two development-ready sites. It also has several sites being evaluated for future development.
The oil and gas segment has about 948,000 net acres of oil and gas mineral interests, with approximately 590,000 acres of fee ownership located principally in Texas, Louisiana, Alabama and Georgia and approximately 358,000 net acres of leasehold interests principally in Nebraska, Kansas, Oklahoma, North Dakota and Texas. These leasehold interests include about 8,000 net mineral acres in the core of the Bakken and Three Forks formations.
The natural resources division owns 108,000 acres of timberland and has about 2,000 acres of timberland under lease, located primarily in Georgia, Texas and Alabama. Key end-use markets for the fiber produced on the lands include paper mills, solid wood products facilities, biomass plants and other industrial users. The timberlands are also leased for hunting and other recreational uses.
Forestar also holds groundwater leases on approximately 20,000 acres in the Simsboro aquifer in Lee County, Texas. Water could be sustainably produced from deep wells with an immediate annual yield of 15,000 acre-feet per year, with the capacity to produce up to 45,000 acre-feet per year. Texas is one of the Southwestern states that is eventually going to have water problems, and this asset could become quite valuable in the future.
Forestar Group is a pretty neat collection of potential valuable assets and the stock is cheap right now. The stock trades hands at just about 70% of tangible book value and the equity-to-asset ratio is 59%, so the company is reasonably financed. The shareholder list reads like a value investor hall of fame, with firms like Third Avenue, Keeley Asset Management and Franklin Templeton among the shareholders. The company also caught the eye of two activist funds that combined to form a group of shareholders calling itself the Value FOR Shareholders Group.
SpringOwl Asset Management LLC and Cove Street Capital LLC own a combined 7% of the company. In a recent letter to management, Andrew M. Wallach of SpringOwl said, "We believe that the company lacks clear and focused strategic direction, which is evident from its long-term stock price underperformance." Jeffrey Bronchick of Cove Street added, "Given the dismal results for shareholders over the past seven years, we have little confidence that the same group of board members led by the same adviser can deliver the changes necessary to create long-term value."
The group just reached an agreement with Forestar that gives them two seats on the board. The activist group wants the company to get out of the operating oil and gas business and focus on its core real estate operations. There appear to be some very valuable assets here and if the activists can help Forestar unlock the value, this stock could easily trade back above the $20.93-a-share book value in a fairly short period of time.
Roughly half the list of stocks using the asset-based version of Graham's two-factor model are energy related. I have talked about that sector extensively this year and my favorite picks are the four mentioned above. Outside of energy, the screen produced some companies that appear to be solid bargains like Forestar with the potential for large long returns. I will review a few more tomorrow.