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  1. Home
  2. / Investing

3 Cheap Stocks With Long-Term Growth Potential

Using enterprise multiples to evaluate stock offers up some surprising value plays.
By TIM MELVIN Aug 06, 2015 | 02:00 PM EDT
Stocks quotes in this article: AGX, BZC, CTB

Since reading Quantitative Value by Tobias Carlisle and Wesley Gary -- and Carlisle's standalone book Deep Value -- I have spent a lot of time on testing the use of enterprise multiples to value stocks. I have had extensive conversations with Carlisle (who is a great guy, and probably regrets giving me his phone number), and the inescapable conclusion is that using the enterprise value to earnings before interest and taxes (EV/EBIT) multiple works at least as well as price-to-book, and in some cases even a little better. Now, that doesn't meant that I will stop using P/B, but I will add the EV/EBIT multiple to the search for value on a more regular basis.

As is the case with P/B, I found that EV/EBIT works even better if you add a safety measure, like the Altman Z-Score, into the mix. I cannot do anything about market or economic risk, but I can take strong measures to eliminate financial and balance-sheet risk -- and the Z-Score is a very effective tool for doing so.

I sat down this morning and ran some screens to look for cheap stocks on the EV/EBIT ratio that also had Z-Scores indicating financial health. I used a cutoff of 7 for EV/EBIT, as that is slightly less than half the 15.6 median multiple of S&P 500 companies. I also added a growth element and only included those companies that had grown book value by at least 10% annually over the past 5 years. I ended up with a short list of some really interesting companies.

Argan (AGX) is a company that I have followed for some time. This company provides development, consulting, engineering, procurement, construction, commissioning, operations, and maintenance services to the power generation and renewable energy markets. They also provide telecommunication construction and wiring services through their Southern Maryland Cable subsidiary. Because they provide services to traditional gas-fired power plants and alternative plants fueled with biodiesel and ethanol, and to renewable plants using wind and solar, the company wins-- regardless of how our energy policies shift in the years ahead.

The company certainly has great numbers. Argan has grown book value by 15% annually for the past 5 years. They are financially strong -- as reflected in a Z-Score of 4.06. The EV/EBIT ratio is just 3.1 -- so the stock is definitely cheap at the current price. I might wait for a market pullback to be a buyer, but Argan belongs in a long-term investment portfolio.

We have talked about Breeze-Eastern (BZC) in the past as well, and I have to say I am a little surprised this company did not end up in some private equity firm's portfolio a long time ago. The company makes helicopter hoists used in rescues and cargo handling. They also make weapons-handling equipment for land-based rocket launchers and munitions hoists for loading missiles. Most of their sales are obviously to the military and to aerospace contractors. The company has grown book value by 17% a year for the past five years, and they are financially strong -- with a robust Z-Score of 4.6. The EV/EBIT ratio is just 5.1, so the stock is still cheap at the current price.

Cooper Tire and Rubber (CTB) makes the list of cheap stocks as well. Cooper is the 11th largest tire manufacturer in the world. The business has struggled somewhat: revenue is down as sales have been soft in Europe and it sold its China venture last year. The strong dollar hasn't helped much either. Looking long term, Cooper is moving back into China by partnering with dealers there: it has opened 4 tire and service superstores in the country and plans to open 2 more this year. In the U.S., strong car sales over the past few years bode well for the firm. Eventually these cars will need new tires, and Cooper should get its share of that business.

The numbers look good: Cooper Tire has grown book value by a robust 23% over the past five years. The Z-Score is a healthy 4.1 and the shares trade with an EV/EBIT ratio of just 5. Patient investors should see solid long-term returns from this stock.

Adding the EV/EBIT ratio to our toolbox should help us to uncover more safe and cheap stocks with the potential for very high long-term returns.

BIT
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At the time of publication, Melvin had no positions in the stocks mentioned.

TAGS: Investing | U.S. Equity

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