Yesterday I took the value, strength and quality measures outlined by Wesley Gray of Alpha Architect and searched for cheap stocks based on his favorite value measure: enterprise value/EBIT. I am a big fan of Gray and his work on using a combination of value and momentum to manage your portfolio. His ideas make a lot of sense for individual investors.
Gray's two approaches have both outperformed the market. More importantly, though, they do not correlate, so the performance of the combined strategy tends to be high as well as smoother than indexes over time.
Using price-to-book value in place of the EV/EBIT measure also produces a very short list of stocks with a market capitalization of $2 billion or more. Just nine names out of an 8,000-stock database trade for book value or less and also pass the financial strength and quality hurdles. Thanks to the lower-for-longer interest rate policy adopted by the Federal Reserve, stocks have been moving steadily higher for seven years now and it's tough to find bargains.
Trading at just 60% of book value, First Solar (FSLR) makes this list of cheap stocks. Taking the very long view of the world, solar is going to be a huge industry. Not today, or even tomorrow, but eventually we will derive a huge percentage of power from solar. As storage gets more advanced solar becomes a more viable long-term solution to meeting energy needs. It is just a small part of that equation today, but that will grow steadily for decades.
First Solar has very little debt and plenty of cash so I see the company as a long-term survivor. The short term is a lot cloudier for the company, however, and the stock price. The outcome of the presidential election could also be a catalyst for the direction of the stock price over the next few months. A buyer with a decade-long timeframe owning this stock should be a big winner, but there are likely to be some very uncomfortable moments along the way.
Prudential Financial (PRU) also makes our list of strong value stocks. While this insurance and financial services giant has struggled with the weak global economy and low-interest rate environment since the credit crisis, it has done a decent job with earnings growth, averaging almost 15% over the past five years.
Digging back in the archives, I first suggested buying Prudential back in 2012, and it has worked out pretty well for those who followed my lead. Book value has grown along with the stock price and at a current 64% of book, PRU is still cheap today. You also get paid to wait for the price to go up as the shares currently yield 3.53%. The payout has been raised about 15% annually for the last five years, and it is reasonable to expect solid dividend growth going forward.
I have long been a fan of business development companies, especially those affiliated with large alternative investment firms, and Ares Capital (ARCC) fits the bill nicely. When the $3.4 billion merger with American Capital (ACAS) closes, Ares will have more than $12 billion in assets, solidifying its position as the largest BDC in the U.S. The de-risking of banks since the credit crisis has created a huge opportunity for BDCs and Ares should be able to successfully leverage its relationship with Ares Management (ARES) .
CEO Kipp deVeer was bullish about his firm's prospects on a recent conference call saying, "We believe that ARCC trading below book value is an attractive proposition for investors, particularly in a world dominated by negative real interest rates. With this much inconsistency in investor approaches to the asset class, we continue to focus on playing what we consider the long game, and we intend to continue to do what we've done since our IPO: create shareholder value and let the rest take care of itself."
ARCC is trading at just 90% of the book value and yields 9.84% at the current price.
Right now there are not a lot of bargains using any measure, but we can still find a few undervalued names that pass quality and financial strength metrics worth considering as long-term investments.