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Why You Should Invest in Value Stocks This Year

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Up until a few days ago, we were wondering whether or not we would fall into a recession after all. But as the Fed’s minutes from Mar 21-22 revealed, the regulator is baking in a mild recession by the end of the year, which will gradually be neutralized over the next couple of years. Moreover, a final rate hike in May looks very much in the cards.

The Retail Sales report from last week shows that consumers spent less in March, particularly on electronics and appliances, building material and gardening equipment, autos and furniture. With the Supplemental Nutrition Assistance Program (SNAP) benefits to support lower-income families during the pandemic also expiring, personal income will be hit by about $4 billion (non-annualized), according to Morgan Stanley as quoted by Reuters. This will, of course, affect spending.

Consumer confidence in current conditions and future expectations dipped in March but increased slightly in April, remaining below Jan and Feb levels. We’ll have to wait a few more days for BEA numbers on March personal income, savings and spending to see if there is any deterioration in the trend.

From the data available thus far it looks like the slight slowdown in hiring could become more of a trend with the rate of job cuts also increasing. The CPI and PPI data shows that inflation is coming down, but apparently not quite fast enough.  

So why is this a good time to buy Value stocks? We call them Value stocks, but these are actually stocks that are undervalued. They are trading below their intrinsic value. Their growth track record and future growth potential make them solid bets for long-term holding. As the market is expected to head lower, there will be increased opportunities to buy such stocks below their intrinsic value.

Benjamin Graham, the great granddaddy of value investing, lays down certain principles when selecting stocks that you should hold for the long term. His book The Intelligent Investor is regarded by Warren Buffett as “by far the best book on investing ever written.”

First, we ensure that the companies we select have solid balance sheets, as measured by their debt and net current assets. Net current assets are a measure of the company’s ability to meet its long-term obligations on short notice. Therefore, a safe company that you want to hold for the long term should not have long-term debt that is far in excess of this figure. For instance, for industrial stocks, there could be an excess of up to 10%.

Second, there should be a reasonable amount of liquidity, i.e. current assets should be at least 1.5X the current liabilities.

Third, the company should be profitable and should be growing its earnings. Therefore, there needs to be a historical track record of earnings growth.

As far as valuation is concerned, he prefers stocks with a price-to-book (P/B) ratio not exceeding 1.5. Additionally, the price-to-equity (P/E) ratio should be low to moderate and the stock should be cheaper than peers on this metric.

And finally, it should have a good track record of dividend payments, standing you by as you wait for your holdings to gain in value over the years.

Now let’s take a look at some examples:

ArcelorMittal S.A. (MT - Free Report)

ArcelorMittal S.A. is an integrated steel and iron ore mining company with operations in the Americas, Europe, Asia and Africa. It offers a range of finished and semi-finished steel products, as well as mining products like iron ore lumps, fines, concentrates, pellets, and sinter feeds; and coking and pulverized coal. Products are sold to various customers in the automotive, appliance, engineering, construction, energy and machinery industries.

Balance Sheet: Long term debt is 61.5% of net current assets and Debt-Cap is 14.02%. Therefore, debt level is reasonable.

Current ratio of 1.66 indicates adequate liquidity.

Earnings Growth: In the last five years per share earnings have grown 36.2%.

Valuation: The P/B of 0.43 indicates that the shares are cheap. Additionally, P/E of 7.08X is low as required and also a discount to the industry’s 7.96X.

Dividend: ArcelorMittal’s dividend yields 1.08%. The dividend has grown 34.72% in the last 5 years.

No wonder, then, that Zacks has a #1 (Strong Buy) rating on the shares.

Ternium S.A. (TX - Free Report)

Ternium S.A. manufactures, processes and sells various steel products in Central and South America (Mexico, Argentina, Paraguay, Chile, Bolivia, Uruguay, Brazil, Colombia, Guatemala, Costa Rica, Honduras, El Salvador and Nicaragua), as well as in the U.S.

Balance Sheet: The company’s long-term debt of $723 million is well below its net current assets of $6.625 billion as of Dec 2022. The current debt cap ratio of 4.99% is also way below he maximum acceptable levels.

Its current ratio of 3.99 shows that there is ample liquidity.

Earnings Growth: In the last five years, Ternium has grown its earnings 29.3%.

Valuation: Its P/B ratio is 0.62 is low and P/E of 7.17X is at a slight discount to the industry’s 7.90X. Therefore, the shares are cheap.

Dividend: Its dividend yields 4.26% and the dividend has grown 21.0% in the last five years.

Therefore, Zacks #2 (Buy) ranked Ternium checks all boxes and may be considered a good value stock to hold for the long term.

Essential Properties Realty Trust, Inc. (EPRT - Free Report)

Essential Properties is a real estate company that acquires, owns and manages single-tenant properties in the U.S. The company leases its properties to restaurants, car washes, automotive services, medical and dental services, convenience stores, equipment rental, entertainment, early childhood education, grocery, and health and fitness operations on a long-term basis.

Balance Sheet: The company has huge long-term debts of $1.421 billion, many times more than its net current assets of $121 million although its Debt-Cap ratio of 36.3% is reasonable.

The current ratio of 5.13 also indicates sufficient liquidity. In this case, while the net current assets are very low compared to debt, the nature of the business requires the company to hold most of its assets long term.

Earnings Growth: In the last five years, Essential Properties has grown its earnings 10.98%.

Valuation: The P/B of 1.37 is acceptable. The P/E of 15.25X, although reasonable in itself, is a premium to the industry’s 13.52X. The two appear to be diverging since April with EPRT moving upward while the industry takes a turn down.

Dividend: The current dividend yields 4.57% and the dividend has grown 6.35% in the last five years.

This Zacks Rank #2 stock, while not perfect, appears to be a relatively good long-term holding.

KB Home (KBH - Free Report)

This homebuilding company operates through four segments: West Coast, Southwest, Central, and Southeast. It builds and sells various homes, including attached and detached single-family residential homes, townhomes and condominiums primarily for first-time, first move-up, second move-up, and active adult homebuyers.

Balance Sheet: The company has substantial assets but no debt.

The current ratio of 2.15 indicates sufficient liquidity.

Earnings Growth: In the last five years, earnings have grown 35.3%.

Valuation: The P/B of 1.37 is acceptable. The P/E of 15.25X, although reasonable in itself, is a premium to the industry’s 13.52X. The two appear to be diverging since April with EPRT moving upward while the industry takes a turn down.

Dividend: KB Homes’ dividend yields 1.5%. The dividend has increased 42.27% in the last 5 years.

This Zacks #2 stock is therefore an ideal long-term holding, although it may pay to buy it a bit lower.

One-Month Price Performance

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