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  1. Home
  2. / Investing

Second-Half Stars

These stocks trade below book value and should outperform the market for the next year and beyond.
By TIM MELVIN May 24, 2012 | 04:30 PM EDT
Stocks quotes in this article: KRG, AEG, RBS, MET, LNC, C, MS, KEY, HES, NBR, UDRL

This morning brought a mixed bag of economic reports that supplied fodder for bulls and bears alike. The unemployment report was flat and the headline durable goods number wasn't awful, but digging a bit deeper showed that the internals aren't pretty. The data shows us an economy that may be better, but still not good. There is fear of further declines in the economy and in the stock market. I won't make any predictions (as I have a flawed macro crystal ball), but I am taking steps to be ready if there's a larger inventory-creation event.

So, I screened stocks with the highest 12-month performance rankings from Standard and Poor's that are also trading below book value. The ensuing list would make a solid portfolio all its own, regardless of market performance in the second half. These stocks are cheap enough to be long-term winners, and one of the best and oldest research services on Wall Street believes they will outperform in the near term as fundamentals improve.

I have to say I really like this list of stocks as a potential portfolio. Several of my current holdings, including long-term favorites Kite Realty Group (KRG) and Dutch Insurer AEGON  (AEG), make the grade, according to S&P. Royal Bank of Scotland (RBS) is a long-term holding that at 20% of tangible book may now be the cheapest big-cap stock on the planet, and it  is also on the list.

Insurance companies have continued to decline, and the list contains some blue chips in the sector, including MetLife (MET) and Lincoln National (LNC), that are historically very cheap. The big banks are represented, as well, by Citigroup (C) and Morgan Stanley (MS). Smaller banks are represented by best-in-class Midwestern regional bank KeyCorp (KEY), another of my long-term holdings.

The list is heavily overweight energy. Hess (HES), a stock I have just started to buy, is on the list. It's trading below tangible book value for the first time in more than a decade and insiders are buying large amounts of stock in the open market. Nabors Industries (NBR) has been falling steadily and is back on my radar. The stock has returned to 80% of tangible book value and is a strong candidate for option-selling to back into the stock.

One of the more interesting, cheap, and highly ranked stocks is Union Drilling (UDRL), a small-cap land-based drilling outfit. The stock has been hurt by weakness in onshore drilling due to low natural gas prices. Union should see some uptick in demand because of increased horizontal drilling for oil in Texas in 2012, and should see higher utilization and day rates as it shifts its rig fleet to the Permian Basin. The shares trade at half of tangible book value at the current price and could easily double when drilling activity picks up. Long-term, I see no reason Union Drilling cannot trade back into the mid-teens over the next five years or so.

I have no idea what the market will do in the back half of the year, but a portfolio of stocks with highest rankings from S&P that trade below book value should outperform the overall stock market for the next year and beyond.

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At the time of publication, Melvin was long RBS, AEG, KRG, RBS, HES and KEY, although positions may change at any time.

TAGS: Investing | U.S. Equity

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