By: Chuck Carnevale, F.A.S.T. Graphs, Inc.
Positioning Statements and Principles
We don’t believe in investing in the stock market. Instead, we believe in investing in great businesses. Therefore, we tend to focus more on how the business is performing on an operating basis than we do on stock price volatility. In other words, we are most interested in whether or not the company is generating growth in earnings and cash flows and thereby increasing their intrinsic value. True Worth™ valuation is what we monitor and measure most closely.
Our rationale is based on the reality that any business, public or private, ultimately derives its value from the amount of cash flows and earnings it can generate for stakeholders. Investors, true investors, buy income streams when they invest. The bigger the income stream they can buy, the bigger the value they will eventually receive. Consequently, the faster a company is capable of growing their business, the more valuable they are to their stakeholders. To us, this is only common sense.
In this same vein, any income stream has a value greater than one. In other words, when purchasing a future stream of income the investor is required to pay a multiple to buy it. Therefore, even a fixed income vehicle like a Bond or CD will command a multiple based on its yield, even with no growth. For example, a 10% bond would be selling at a price to interest ratio of 10 (100/10% = 10). An 8% bond would be selling at a price to interest ratio of 12.5 (100/8% = 12.5). And currently, the 30-year 3.55% Treasury Bond is selling at a price to interest ratio of 28 (100/3.55% = 28.16), again, even though it offers no growth of income.
Therefore, we logically conclude from the above paragraph that a growing income stream should be worth more than a fixed or non-growing income stream. Again, this is based on our principal that a bigger income stream is worth more than a smaller one. Of course, risk would also come into play on the notion that a bird in the hand is worth more than two in the bush. However, our main point is that the actual yield that an income stream provides the investor is where its ultimate value comes from.
We believe that what we have said thus far represents the key to understanding Ben Graham’s famous voting machine vs weighing machine metaphor. In the short run (the voting part), stocks will be priced in an auction market based on the supply and demand of buy and sell orders. These short run periods of time are most often dominated by the emotions of fear or greed. Consequently, the common stocks representing the underlying businesses can rise or fall regardless of their income generating potential. However, we also agree with Mr. Graham that in the long run the weight or the cash flows and earnings of the business, will become manifest. But we also acknowledge that the precise timing of when this would occur is unknown.
The most important takeaway from what has been written so far is the inevitability that True Worth™ valuation will and must come to fruition. The voting machine market, which is often quite irrational, can remain that way for some time. However, eventually the true investor can be assured that the real value of the business based on the weight of its operating success will become a reality. We believe this statement to be true whether the market is over-pricing or under-pricing a business at any given moment in time. Eventually, the company’s stock price will rise or fall and become aligned with its True Worth™ value based on its earnings and cash flows.
8 Strong Growth Stocks Significantly Under-valued by Mr. Market
The following table lists eight companies whose past, present and future business results warrant much higher prices than the market is currently applying to them based on their earnings and cash flows. Each of these companies possesses above-average historical operating records and each are expected to continue to grow at above-average rates in the future. When you understand that a normal price earnings ratio for an average company has been 15 over the last 150 years, the single-digit price earnings ratios applied to these eight above-average companies immediately becomes ludicrous.
Most importantly, our contention that these stocks are undervalued is not based on esoteric statistical inferences. Our valuation model is based on the factual earnings yields and fundamental strengths of each of the companies on this list. From the table below you will discover that most of this group has very low levels of debt and historical normal valuations that are significantly greater than what they are today. The only way these valuations would make any sense, is to assume that each of these companies is perilously close to going out of business.
Yet, as we will develop further later in the article, nothing could be farther from the truth. These companies are healthy and strong companies with bright futures and growing income streams. Consequently, we consider it a conservative assumption and a realistic forecast to state emphatically that each of these companies should command an average PE ratio of 15 as a bare minimum. Therefore, because they are at such low valuations, we believe the rewards from owning these companies over the next 3 to 5 years are potentially extraordinary, and the risks relatively low.
To better understand our position we would ask the reader to focus on the five columns following each company’s name and stock symbol on the table below. For perspective, note that the historical earnings per share growth rate of the S&P 500 over that same 11-year (10 years eight months) time frame has been 5.3% per annum. The historical EPS growth rate of each of these eight companies has been significantly above that average. But perhaps even more importantly, the consensus of leading analysts forecast of earnings growth over the next five years is also above average.
Consequently, the five-year estimated potential annual total return for each is enormous. Finally, the single-digit PE ratio the market is currently applying to these companies in contrast to their historical normal PE ratio simply makes no economic sense. Based on the strength, and therefore, value of their cash flow and earnings generation capabilities, these companies represent a classic case of a market gone mad, at least in our humble opinion. In other words, the fundamental value of these businesses is clearly greater than their current market value.
8 Under-valued Companies Through the Lens of F.A.S.T. Graphs™
The following F.A.S.T. Graphs™ provide graphic evidence of the fundamental strengths of each of these companies. The historical earnings and price correlated graphs vividly illustrate how the fundamentals have remained strong (the orange earnings line) while the stock price (black line) has fallen.
The performance table associated with each graph illustrates each company’s superior shareholder returns even considering their current undervaluation. Finally, the estimated earnings and return calculator (forecasting graph) illustrates the value these above-average companies should be trading at if the market was pricing them at a normal (average) PE ratio. NOTE: The red circle shows current market price, and the red arrow points to fair value.
Chevron Inc. (CVX)
Chevron (CVX) is the world’s fourth-largest