by Tim Melvin | February 28, 2014 9:05 am
I have long been a fan of using Ben Graham’s “net-net” strategy to find bargain issues. This approach is simple to execute … in theory. You simply buy stocks that trade for less than the value of current assets minus all liabilities. This model assigns no value to any long-lived assets like land, property and machinery.
These super-cheap stocks have produced spectacular returns during my 28-year career. The problem comes in practice — as only in serious bear markets are there enough of these gems to be fully invested in these super-cheap, high-potential stocks.
But I have been able to incorporate the concept of net current asset value in combination with price-to-book-value to find super-cheap stocks where half the value of the company is assets that can be quickly converted to cash. Using this screen in combination with Piotroski F-scores, I am able to uncover safe and cheap stocks that have strong recovery potential over the next few years.
Richardson Electronics (RELL) makes power grids and microwave tubes and related components to customers in industries like alternative energy, aviation, broadcast, and communications, as well as the military and scientific community. The stock trades at 86% of book value and only 10% above the company net current asset value.
The F-score is a solid 7 out of 9, indicating that business conditions and financial conditions are improving at a rate that should lead to a higher stock price over the next year. The company has lots of cash on the books and is using it to reward long-term shareholders. The stock yields 2.1% and management has been buying back stock in the open market. Richardson is not an exciting company, but the stock is safe and cheap.
Lake Entertainment (LACO) runs Rocky Gap Casino Resort with a hotel, spa, two restaurants, and a golf course located in Allegany County, Md. It also holds an interest the Horseshoe Casino Cleveland, the Horseshoe Casino Cincinnati, and the ThistleDown Racino in North Randall, Ohio. The company received a large cash payment last year from the Shingle Springs Indian tribe as part of the cancellation of a management agreement and is flush with cash right now.
Initial results from Rocky Gap have been strong and management is adding a conference center to attract large groups to the property. The shares trade at just 95% of book value and 1.75 times net current asset value. Most of that value is in the form of cash right now.
Most of the so-called investors I talk to today are simply traders in disguise trying to ride the momentum of hot stocks like Tesla (TSLA) and Facebook (FB). That has never worked for me — but finding and holding safe and cheap stocks has produced market-beating returns over time. These stocks have a huge margin of safety in the balance sheet and are too cheap not to own, no matter what your thoughts on market direction.
At the time of publication, Melvin was long RELL and LACO.
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