Everyone likes to get something for nothing.
Whether it's a hot breakfast with your hotel room, a car wash with an oil change or an order of fries with a hamburger, it's always satisfying to feel like you're on the receiving end of a good deal. A little something to sweeten the pot makes us feel good about spending a few bucks.
So let me ask you: How'd you like to get your hands on a billion-dollar business for absolutely nothing?
Zilch. Nada. Nichts. Don't worry. No strings attached. No salesman will visit your home.
How's this possible? It's not hard: All you need is a brokerage account.
The secret to finding these companies is to learn to love the balance sheet. Once you do, it won't take you long to figure out how to determine what a business is worth. The top part of the balance sheet lists the company's assets. The bottom lists liabilities. The third part is the (hopefully positive) difference between assets and liabilities. This is called shareholder equity or "book" value. If you sold all the assets and paid all the debts, book value is what would be left over.
Say a company has $200 million in book value but has a market cap of $600 million on the stock market. Why the premium to what its assets are worth?
Because a company is worth more than the sum of its parts. A company isn't just desks, computers and inventory, it's also creative innovators, passionate entrepreneurs, and capable laborers and support staff. None of them, of course, can be listed on a balance sheet. But the difference between book value and market cap can be seen as the intangible value of the business as a going concern. It's the market's assessment of the company's future ability to generate profit.
Companies typically trade at a premium to book value. An S&P 500 company has an average price-to-book ratio of 2.0. This means half of the average company's market value is backed up by its net assets and the other half is attributable to the intangible value of its underlying business.
But "average" is just that -- an average. Some companies will be far above it, some below. Take Amazon (Nasdaq: AMZN), for example. It trades at 12.5 times its book value. Clearly investors have decided that Amazon's chances of continued future profits are very good.
But not every company enjoys such a favorable valuation. Some trade for less than book value. In these cases, the market has said that these companies are worth less than the cash that would be left over if the business was liquidated. These are the companies whose businesses you can buy for free. You paid for the assets, you get their future results for free.
Now to the fun stuff...
I sought U.S. companies with a market cap of greater than $10 billion and a price-to-book ratio of close to 1.0. Only 10 companies made the list. Here are my five favorites.
1. Wells Fargo (NYSE: WFC). The $131 billion bank is trading at almost exactly its book value, which means you get the banking operations and the world's best credit managers for nothing. That business has generated a profit for the past five quarters and the past five years, a feat few large banks can match.
2. WellPoint (NYSE: WLP). This health insurer covers almost 70 million people, or nearly a quarter of all Americans. It, too, has remained profitable for every minute of the Great Recession. What's the trouble? It insures people who have jobs, and the market doesn't see any jobs being added in the near future. That's myopic. As the economy rebounds and hiring picks up, the market should return WellPoint to a more reasonable valuation.
3. State Street (NYSE: STT) owns a bank and an (increasingly international) investment management business. It operates at a gorgeous 22.9% net profit margin, which is pretty close to Apple's (Nasdaq: AAPL), and State Street also has remained solidly in the black during the downturn. Plus, it's added billions to its book value in recent years, which is always good news for long-term investors.
4. Annaly Capital (NYSE: NLY). I love this real-estate investment trust (REIT). It borrows money at very low cost during the short-term and uses the cash to buy government-backed mortgages that pay a higher rate. The company rolls the loans between banks and pockets the spread between the net interest income and net interest cost, distributing 95% of it to shareholders. The current yield on these shares is 14.7%, which gives investors a nice income stream while they wait for the market to get its act together and put a reasonable value on this company.
Bonus Pick: Prologis (NYSE: PLD). Hey, after talking about getting something for free, I had to add in a bonus. Prologis owns warehousing space. The company has taken it on the chin because of investor anxiety about soft consumer demand, which have some merit, as the company has posted an annual loss in two of the past four years Nevertheless, shares have received a strong vote of confidence from institutional investors, which own just about all its shares. The stock also sports a 4% dividend.
Action to Take --> All of these stocks are rebound plays. There isn't a single one of them that is even close to its fair valuation. At a price-to-book ratio near 1.0, they have significant upside just to reach the average, though none of these outstanding companies has a reputation for being "average." They're excellent companies with strong upside, and each of them is worth adding to your portfolio.