3 Bargain Stocks Hiding in an Overvalued Market

by Tim Melvin | January 3, 2014 6:00 am

From all the hoopla and noise surrounding the New Year predictions, projections, forecasts and wild guesses, you might think the world underwent some sort of dramatic change the instant the ball touched down in Times Square.

But it didn’t.

The market is still pretty extended, and most stocks’ valuations have stretched even further. Everybody still loves the “mo-mo” stocks like Amazon (AMZN[1]) and Netflix (NFLX[2]). Bargains are as thin as they were Tuesday afternoon. The market’s focus remains on global central banks, and the prospects for a continued flow of cheap money continue to drive global asset values higher. It remains a very challenging environment for a deep value investor.

I sat down this morning and spent some time looking for cheap stocks that might do well regardless of market action in 2014. While bargains are scarce there are still a few to be found.

One such bargain is mortgage REIT Apollo Residential Mortgage (AMTG[3]). The stock is trading at less than 80% of quarter-end book value, and management also announced a $50 million share buyback at the same time. There may be some erosion of book value as they look to adopt more credit-sensitive portfolio policies, but I doubt it will be substantial.

I like AMTG’s relationship with private equity giant Apollo Global Management (APO[4]), and AMTG has done very well investing in their offerings when they traded below asset value. The company has dialed back leverage in the past year and will be in a good position to dial it back up when spreads stabilize at higher rates as a result of continued tapering by the Fed in 2014. It may be a bumpy ride, but I think this mREIT can give us solid returns over the next couple of years.

There a lot of moving parts to Asta Funding (ASFI[5]), but there appears to be a great deal of value that isn’t reflected in the current stock price. ASFI stock is trading at less than 65% of book value, but several of its debt collection assets are carried at zero cost basis and yet may have substantial value. The balance sheet is strong with more than $90 million in cash. ASFI has been moving into other businesses including disability claims to increase its growth opportunities over the next few years. It’s a fairly complex business, but it is very cheap — and the first sign of good news could send the shares a lot higher.

SWS Group (SWS[6]) also catches my eye at the current valuation. The Dallas-based company is in the brokerage, investment banking and banking business in the Southwest. They struggled with losses at the banking subsidiary and eventually had to find a capital infusion. They ended up borrowing $100 million from noted investors Gerald Ford and Robert Bass. The core brokerage and investment banking business are well positioned and should do well over the next few years. I wouldn’t be shocked if this firm was eventually sold off, with Mr. Ford keeping the banking assets and selling the brokerage and I-Bank units to a larger firm. With the stock trading at just 65% of book value, the long-term potential is very high for this stock.

Bargain issues are harder to find but there are a few worth investigating by long-term, asset-based value investors.

As of this writing, Tim Melvin was long SWS.

  1. AMZN: http://studio-5.financialcontent.com/investplace/quote?Symbol=AMZN
  2. NFLX: http://studio-5.financialcontent.com/investplace/quote?Symbol=NFLX
  3. AMTG: http://studio-5.financialcontent.com/investplace/quote?Symbol=AMTG
  4. APO: http://studio-5.financialcontent.com/investplace/quote?Symbol=APO
  5. ASFI: http://studio-5.financialcontent.com/investplace/quote?Symbol=ASFI
  6. SWS: http://studio-5.financialcontent.com/investplace/quote?Symbol=SWS

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