3 Undervalued Stocks with High ROE (Sep 2013)

by on September 16, 2013

in Dividend Value Stocks, Mid Cap Value Stocks, Small Cap Value Stocks

There is a value in growth, however it is difficult to figure out and bound to be inaccurate. Since the future growth can only be estimated, and the estimates tend to turn out widely different from the reality, it is hard to ascribe value to the growth with any real sense of confidence. One thing we can do in lieu of this though, is to make sure that the stock represents a reasonably good value based on recent financial performance, and then look back to the recent past to see how well the company has utilized its resources to generate new income. A good performance in this regard may indicate profitable use of the current resources and a management that is judicious in the projects and initiatives it takes to generate highest possible shareholder wealth. These key traits, one hopes will carry forward in the future.

For this particular screen, I am focusing on the Return on Equity as this indicator. I required the ROE to be in the highest 20% in the market. Additionally, to ensure that we do not end up with highly speculative bunch of names in the list, I bound the P/B ratio at 0.8 and the P/E ratio at 9. Finally, only stocks with price above $1 and market capitalization above $30 million were considered. All Chinese stocks were removed from the shortlist (lack of confidence on their books on my part).

1. Independent Bank Corp (IBCP, Market Cap: $94.36 m, Type: Small Cap)

Independent Bank Corporation is a bank holding company for Independent Bank in Ionia, Michigan with 72 branch offices. The company provides traditional deposit and savings products as well as consumer financing, mortgages, investments and insurance services. With ttm ROE of about 54.38%, the bank appears to be doing quite well. The company has $151.74 million in cash holdings with only about $67.68 m in debt so it appears that 89% of the market value is made up of Cash ex-debt. The ttm P/E ratio of 2.78 and the P/B ratio of 0.77 do point towards attractive valuation despite the fact that the stock is up 265% in the last 1 year.

2. MFC Industrial Ltd (MIL, Market Cap: $529.19 m, Type: Small Cap, Dividend)

MFC Industrial out of Vancouver, BC is a commodity supply chain company that sources and delivers various commodities around the world. Trailing P/E of 2.53 and P/B or 0.71 along with Return on Equity of 32% show great valuation although one has to consider the macro economic factors when investing in a commodities business. Some of the challenges facing the company is increasing expenses due to increased commodity costs and integration of recent acquisitions as well as foreign exchange losses. The stock pays a dividend yielding 2.8%. Your investment thesis in this stock is likely to depend on your estimation of the future commodity price movements and demand, but as far as current valuation is concerned, the stock at the first glance appears to be a good value and merits deeper evaluation.

3. MBIA Inc (MBI, Market Cap: $2.23 B, Type: Mid Cap)

MBIA provides structured finance insurance and reinsurance services to governments, corporations, pensions, insurance companies,etc. Essentially, it is in the business of assuming risks in financial products (loans, bonds, CDOs, etc). These kind of companies can be hard to value, precisely because the assets on the balance sheet are difficult to understand and in many cases may not have sufficient market to assign a reasonable value. That being said, the stock trades at 0.74 times Book Value and 3.57 times trailing Earnings. The company returned 22.62% on its Equity in the last 1 year.

Financial companies continue to show up quite frequently in my screens and they do require much careful review, perhaps even more so than industrials or other sector companies. Also please note that since this is a first pass screen, you should at least consider pulling up the latest annual report and quarterly filings to review any recent events and financial transactions that may have skewed the ratios.

Leave a Comment

Andy September 17, 2013 at 4:51 pm

How much would you risk for each of them?

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Shailesh Kumar September 18, 2013 at 12:37 pm

Depends on whether they pass the muster upon further review as well as the level of undervaluation. For a stock that provides best risk/reward ratio, I will go as much as 10% of the portfolio.

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