Author: Beckerman Institutional
Covestor model: Flexible Value
By Senior Analyst and the co-model manager Jack Gindi, AAMS®
As of mid-September, market volatility has been high, despite fairly consistent corporate profits and earnings growth. U.S. productivity has grown since the financial crisis and it is the most productive large economy in the world, the largest manufacturing nation, and the source of the most innovation in product design, technology, and marketing. Also, international markets have been volatile. For example, the Shanghai index is down far more than the S&P 500 since April and the German DAX is down even more than that.
We have been able to identify companies with undiminished and even enhanced long term prospects that have sold off along with less promising ones. We think that some valuable companies are trading for fractions of what they are worth.
We recently decreased our cash position to take advantage of some of these mispriced stocks according to our valuation assessment. We used the sell-off as an opportunity to add STMicro, E-House China, and American Capital Agency Corp. Here’s a brief overview of each.
STMicroelectronics NV (NYSE: STM)
This is a company that fits our portfolio criteria well. It is the global leader in MEMS, motion sensing chips that include gyroscopes, accelerometers, digital compasses, and inertial modules. It is well into a restructuring that began in 2008 that we’re confident will result in higher margins and more efficient operations. The company continues to reduce capital intensity in order to optimize opportunities between internal and external front-end production, reduce dependence on market cycles, and decrease the impact of depreciation on financial performance. In the last three years, the company has significantly reduced its all-important capex-to-sales ratio.
One way to understand the unique positioning of STM is to look at its patent portfolio. (Source: FreshPatents as of 9/19/11 http://www.freshpatents.com/Stmicroelectronics-Inc-cndirs.php) Almost one quarter of its employees work in R&D and product design, and in 2010 the Company spent almost a quarter of its revenue in R&D. Among the industry’s most innovative companies, ST owns around 20,000 patents and pending patent applications. Their top 10 customers are Apple, Bosch, Cisco/Scientific Atlanta, Continental, Hewlett-Packard, Nokia, Research in Motion, Samsung, Seagate, Sony, Ericsson. The challenges facing some of these customers explain the pessimism around STM’s share price. We think that whoever comes out ahead in the technology industry, STM is positioned to benefit.
As of 9/19, shares trade at a low P/E of just over 6, but if you take into account the restructuring charges at Ericsson, the P/E would be even lower. STM has almost half its market cap in cash and generates about a quarter of its market cap in operating cash flow. The stock has an attractive dividend yield and PEG ratio. (Source: Yahoo Finance https://finance.yahoo.com/quote/STM/key-statistics?ltr=1
If STM just meets growth estimates, which we think are low, we believe the stock is extremely attractive at current levels.
E-House China
E-House China (NYSE: EJ) is the largest real estate agency in China, but it’s actually much more than a real estate agency. The company is an integrated real estate services provider that includes marketing and information systems. They are projected to grow earnings at a strong clip for the next 5 years and they now pay an attractive dividend.(Yahoo Finance https://finance.yahoo.com/quote/EJ?p=EJ, https://finance.yahoo.com/q/bs?s=EJ+Balance+Sheet&annual) At a price to book of .6 as of 9/19/11, the company is flush with cash and has the resources it needs to grow without requiring capital raises.
With this position, we’re looking beyond the current pessimism in Chinese equities. We expect Chinese equities to rise as P/Es normalize and we are particularly bullish on our EJ position going forward.
American Capital Agency Corp.
American Capital Agency (Nasdaq: AGNC) is a REIT that invests exclusively in agency pass-through securities and collateralized mortgage obligations. AGNC borrows at short term rates that are currently below 1% and uses the proceeds to fund portfolios of GSE backed mortgages that typically yield significantly more. They then employ leverage and protective options to generate return and lower their interest rate risk.
AGNC pays a heavy cash dividend, and with a large payout ratio, they are not returning capital to do it. AGNC provides low correlation to the general stock market and high current income.
