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  1. Home
  2. / Investing
  3. / Energy

How to Find Safe and Cheap Income Stocks

Using Graham's method reveals 4 with potential.
By TIM MELVIN May 22, 2015 | 03:00 PM EDT
Stocks quotes in this article: AP, MIL, MN, GIFI

Today I want to continue our search for income stocks that are reasonably priced and have a margin of safety.

It seems that among investors I talk to these days, the search for income is at or near the top of their list. The current low-rate environment has been with us for a long time, and all indications are it will be for some time to come. Even if the Fed were to raise rates a bit this year to appease the politicians and economists who are pushing for it, it will be years before rates will be high enough to allow investors to return to traditional fixed-income investments to meet their needs.

In all too many cases, the research involved in investing in a particular security consists of "It has a good dividend," with no thought given to the underlying value or earnings power of the company involved. Yield seeking has always been the most dangerous of behaviors, and unfortunately it is no different this time.  

Yesterday, we looked at using Ben Graham's two-factor model to build an income portfolio. We only found two stocks, so we have to move on to other methods of finding safe and cheap income stocks. Today, I am going to steal from the 10-criteria checklist he discussed in the 1970s. Half the checklist deals with risk, half with reward. It is pretty strict, but the more checkpoints you hit, the better the potential returns, according to a report done by Societe Generale. My own research suggests that the checkpoints relate to book value, low debt and high current rations. To that we will simply add a requirement to yield more than the dividend ETFs investors have fallen in love with the past few years.

Ampco-Pittsburgh (AP) has been showing up on deep-value lists for some time now. The steel company has struggled in the weak economy and earnings have been a major disappointment to the short-term-focused world of Wall Street. In the most recent earnings release, CEO John Stanik told investors, "During the first quarter, we made significant strides to revitalize the corporation, reduce costs that will bear fruit later this year and in 2016, and made much progress in our strategic planning process. While I am concerned about future short-term revenue because of the ongoing steel industry problems, I am excited about the progress we have made and the direction of Ampco-Pittsburgh." The stock trades at 81% of book value, has very little long-term debt and a current ratio of 2.8, so it passes my three key filters. At today's price, the stock yields 4.5%.

I have owned shares of MFC Industrial (MIL) for some time with less-than-wonderful results. The company is reliant on commodities markets, so it may be a while more, but I do expect to sell this stock sometime in the next decade at a huge profit. MFC is involved in sourcing and supplying commodities, like metals, ceramics, minerals, natural gas, various steel products and ferroalloys, chemicals, plastics, food and beverage additives, animal feed and wood products. It also has interests in iron ore mines and provides supply-chain logistics. The stock is trading at less than 50% of book value, has a debt to equity ratio of 0.35 and a current ratio of 2.8. The yield right now is 5.4%.

Manning & Napier (MN) is an investment management firm that offers mutual funds, separate accounts and other programs for individual and institutional clients. As of the end of April, the Rochester, N.Y., firm had $46 billion at April 30, 2015, compared with $45.6 billion at March 31, 2015, and $47.8 billion at Dec. 31, 2014. The stock is trading at just 89% of book value with no long-term debt and a current ratio of 3.3. The stock is yielding 5.94%, so it is an excellent addition to an income portfolio.

Gulf Island Fabrication (GIFI) is another stock that has not been kind to me so far, and I am getting ready to add to my stake in the company as it has fallen below my estimate of liquidation value. Gulf Island is a fabricator of offshore drilling and production platforms, so it is really dependent on capex spending by exploration and production companies, and that has not exactly been robust so far this year. It has no debt, a current ratio of 3 and the stock trades at 65% of book value. It could take some time, but this company should be able to survive and thrive until industry conditions improve, and I think it trades a lot higher over the next few years. In the meantime, we collect a 3.17% dividend.

Using the second screen, based on interviews Graham gave in the 1970s, gets us up to a total of six stocks. Next week, we will dig deeper in the toolbox to continue working toward a 30-stock safe and cheap income portfolio.

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At the time of publication, Melvin was long GIFI and MIL, although positions may change at any time.

TAGS: Investing | U.S. Equity | Energy

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