As I always do as a value investor I am always perusing different opportunities no matter where the market has taken us. Obviously when the market is overvalued, like it is now (this is my opinion), it is much harder to find bargains. This is where I like to get the old trusty screener out, dust it off and begin to peruse through the low P/E aisle.
Typically I set the P/E ratio at 5 and under and begin my search there. I also like to use some other metrics that take into account the amount of debt that a company holds and then typically swing towards dividend payers if I am having trouble making a decision.
The screener that I use frequently you can actually find on embedded on this site here.
Anyways, now onto the companies that I am currently looking at due to ratios.
Cumulus Media Inc. (CMLS)
Innoviva, Inc. (INVA)
Warrior Met Coal, Inc. (HCC)
GrafTech International Ltd. (EAF)
Acorn International, Inc. (ATV)
Micron Technology, Inc. (MU)
Hennessy Advisors, Inc. (HNNA)
Now that I have a list of companies that are possibly undervalued based on P/E ratio I must take the next step. This step involves me looking at the underlying nature of each business and seeing if I am fully capable of understanding what each business does.
This step is the hardest for most because we all want to think that we are the smartest people in the room. That all sounds great, until you put money behind it and end up losing your shirt!
So off we go into the land of honesty and I find that I can immediately eliminate ATV. Now I do understand what they do, but unfortunately I don’t know enough about the business dealings of China to stake a significant portion of my portfolio into ATV. That means we can cross it off.
Down to 6…
I also am going to eliminate INVA because of the high risk, and often unpredictable, pharmaceutical industry. While there are a lot of things I will take chances on, I would rather be in a business that is not going to violently fluctuate based on the passing of phases. This one is a little to volatile for me based on news and rumors.
Down to 5…
I will also eliminate CMLS due to the staggering amount of debt that it holds on its balance sheets.
Down to 4…
Now that we have it down to four companies, what I really want to know is if there are any “gurus” buying any of these companies as of late. When I look at all of them there are a few things that stick out:
Joel Greenblatt has been buying up some HCC over the last year.
Greenblatt has also been adding some EAF to his portfolio.
Mohnish Pabrai has been adding MU (1 of only 2 US Holdings).
Brookfield Asset Management’s top holding is EAF.
HNNA is not a significant holding in portfolios, at least from what I can see.
While most of this does not surprise me, with the exception of Brookfield holding massive amounts of EAF, I do see a red flag in HNNA. While the company does seem to fit many of my requirements, being an actively managed fund really takes it out of the running for many gurus. Obviously if you are actively trading and looking to make some great returns why would you invest in another actively managed fund?
For this reason, HNNA is out.
Down to 3…
Now we are left with three companies that have all been picked up in the past year, and might I add at higher averages, by investors that are leaps and bounds smarter than I am.
Now let me go ahead and knock this down to two very quickly. I am eliminating HCC from contention because it was founded in only 2015. This doesn’t give me a very large history of data to work with and the long term prospects of a company is tough to estimate without a long term history. Sorry HCC but it looks like we are parting ways here.
Down to 2…
With only two companies left, EAF & MU, there needs to be some specific things going right for me to add either of these to my portfolio. First off I really want to see companies that have their debt in check, and create large amounts of free cash flow.
This immediately erases EAF from the running, with over two billion dollars in debt and cash flow that will need to increase substantially to pay it off this company is not one that I am currently willing to put into my portfolio for a long term hold.
Down to 1…
And finally we are left with one company standing:
But wait, just because it is the only company left after my rather hasty and rudimentary breakdown doesn’t mean that it automatically gets placed into my portfolio. Unlike many investors that put small portions of money into a large amount of holdings, I like to do the exact opposite. I want to take loaded bets and place large amounts on those bets.
So is MU a bet that I think that is worth the risk?
In terms of free cash flow MU is well equipped and total long term debt MU is very well positioned going forward. Currently MU is on the decline as DRAM prices have been getting crushed. Is this simply a short term speed bump for MU or is this a bumpy road that leads to nowhere?
Then there is the current trade war and the US conflict with China, and more specifically Huawei who makes up around 13% of MU’s revenue. Are these things to fret about or are they simply opening the door to buy a position for the cheap?
Also when reviewing the analysts expectations of EPS growth over the next five years, it points to a large decline. Why is that?
These are all questions that really need to be answered when looking at a company like MU. There are a lot of factors that MU cannot control but what they can control will be an important indication as to how they will do in the long term. With all of these questions, MU warrants further research before adding it to my portfolio.
While we didn’t quite make it to a decision to invest in any of the companies that I mentioned in this article, I hope that you can get your head around the exercise. It is more important to know the how to find the answer than it is for me to just give it to you.
Most low P/E stocks are that way because of something underlying in the business. Some you will not understand, and some will simply not meet important criteria that you hold dear to you philosophy. The main thing to remember though is that you don’t have to find something to add to your portfolio. You need patience in this game and must take your time to make your decisions. You can’t lose money by passing but you can by rushing into investments that you don’t fully understand.
MU is the only company that survived and I am off to do further research as to why exactly a value investor such as Mohnish Pabrai would add it to his portfolio. That being said, just because he did doesn’t mean that I need to. If I don’t understand the reason why then there is no reason for me to own the company.
I hope that you all enjoyed the post and good luck in your future endeavors.