Margin of Safety Concept in Undervalued or Bargain Securities

The margin-of-safety idea becomes much more evident when we apply it to the field of undervalued or bargain securities. 

• We have here, by definition, a favorable difference between price on the one hand and indicated or appraised value on the other. 
• That difference is the safety margin. It is available for absorbing the effect of miscalculations or worse than average luck. 
• The buyer of bargain issues places particular emphasis on the ability of the investment to withstand adverse developments. 
• For in most such cases he has no real enthusiasm about the company’s prospects.

True, if the prospects are definitely bad the investor will prefer to avoid the security no matter how low the price. 

But the field of undervalued issues is drawn from the many concerns—perhaps a majority of the total—for which the future appears neither distinctly promising nor distinctly unpromising. 

• If these are bought on a bargain basis, even a moderate decline in the earning power need not prevent the investment from showing satisfactory results. 
• The margin of safety will then have served its proper purpose.

Ref:  The Intelligent Investors by Benjamin Graham

CHAPTER 20  “Margin of Safety” as the Central Concept of Investment





Also read:

• Margin of Safety Concept in The Business Venture of Buying and Selling Stocks
• Margin of Safety Concept in Conventional and Unconventional Investments
• Margin of Safety Concept in Speculation and Investment
• Margin of Safety Concept in Diversification
• Margin of Safety Concept in Undervalued or Bargain Stocks
• Margin of Safety Concept in Growth Stocks
• Margin of Safety in Good-Quality and Low-Quality Stocks.
• Margin of Safety Concept in Common Stocks
• Margin of Safety Concept in Bonds and Preferred Stocks

Margin of Safety Concept in Growth Stocks

The philosophy of investment in growth stocks parallels in part and in part contravenes the margin-of-safety principle.

• The growth-stock buyer relies on an expected earning power that is greater than the average shown in the past.
• Thus he may be said to substitute these expected earnings for the past record in calculating his margin of safety.
• In investment theory there is no reason why carefully estimated future earnings should be a less reliable guide than the bare record of the past; in fact, security analysis is coming more and more to prefer a competently executed evaluation of the future.
• Thus the growth-stock approach may supply as dependable a margin of safety as is found in the ordinary investment— provided the calculation of the future is conservatively made, and provided it shows a satisfactory margin in relation to the price paid.

The danger in a growth-stock program lies precisely here.

• For such favored issues the market has a tendency to set prices that will not be adequately protected by a conservative projection of future earnings.
• (It is a basic rule of prudent investment that all estimates, when they differ from past performance, must err at least slightly on the side of understatement.)

The margin of safety is always dependent on the price paid.

• It will be large at one price, small at some higher price, nonexistent at some still higher price.
• If, as we suggest, the average market level of most growth stocks is too high to provide an adequate margin of safety for the buyer, then a simple technique of diversified buying in this field may not work out satisfactorily.  
• A special degree of foresight and judgment will be needed, in order that wise individual selections may overcome the hazards inherent in the customary market level of such issues as a whole.

 Ref:  The Intelligent Investor by Benjamin Graham
CHAPTER 20 “Margin of Safety” as the Central Concept of Investment





Also read:

• Margin of Safety Concept in The Business Venture of Buying and Selling Stocks
• Margin of Safety Concept in Conventional and Unconventional Investments
• Margin of Safety Concept in Speculation and Investment
• Margin of Safety Concept in Diversification
• Margin of Safety Concept in Undervalued or Bargain Stockss
• Margin of Safety Concept in Growth Stocks
• Margin of Safety in Good-Quality and Low-Quality Stocks.
• Margin of Safety Concept in Common Stocks
• Margin of Safety Concept in Bonds and Preferred Stocks

Margin of Safety in Good-Quality and Low-Quality Stocks

However, the risk of paying too high a price for good-quality stocks—while a real one—is not the chief hazard confronting the average buyer of securities.

Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.

• The purchasers view the current good earnings as equivalent to “earning power*” and assume that prosperity is synonymous with safety.
• It is in those years that bonds and preferred stocks of inferior grade can be sold to the public at a price around par, because they carry a little higher income return or a deceptively attractive conversion privilege.
• It is then, also, that common stocks of obscure companies can be floated at prices far above the tangible investment, on the strength of two or three years of excellent growth.
• These securities do not offer an adequate margin of safety in any admissible sense of the term.
• Coverage of interest charges and preferred dividends must be tested over a number of years, including preferably a period of subnormal business such as in 1970–71.
• The same is ordinarily true of common-stock earnings if they are to qualify as indicators of earning power.
• Thus it follows that most of the fair-weather investments, acquired at fair-weather prices, are destined to suffer disturbing price declines when the horizon clouds over—and often sooner than that.
• Nor can the investor count with confidence on an eventual recovery—although this does come about in some proportion of the cases—for he has never had a real safety margin to tide him through adversity.

 Ref:  The Intelligent Investor by Benjamin Graham
CHAPTER 20 “Margin of Safety” as the Central Concept of Investment



Also read:

• Margin of Safety Concept in The Business Venture of Buying and Selling Stocks
• Margin of Safety Concept in Conventional and Unconventional Investments
• Margin of Safety Concept in Speculation and Investment
• Margin of Safety Concept in Diversification
• Margin of Safety Concept in Undervalued or Bargain Stockss
• Margin of Safety Concept in Growth Stocks
• Margin of Safety in Good-Quality and Low-Quality Stocks.
• Margin of Safety Concept in Common Stocks
• Margin of Safety Concept in Bonds and Preferred Stocks

Margin of Safety Concept in Common Stocks

So much for the margin-of-safety concept as applied to “fixed value investments.” Can it be carried over into the field of common stocks? Yes, but with some necessary modifications.

There are instances where a common stock may be considered sound because it enjoys a margin of safety as large as that of a good bond. 

This will occur, for example, when a company has outstanding only common stock that under depression conditions is selling for less than the amount of bonds that could safely be issued against its property and earning power.# 

• That was the position of a host of strongly financed industrial companies at the low price levels of 1932–33. In such instances the investor can obtain the margin of safety associated with a bond, plus all the chances of larger income and principal appreciation inherent in a common stock. 
• (The only thing he lacks is the legal power to insist on dividend payments “or else”—but this is a small drawback as compared with his advantages.) 
• Common stocks bought under such circumstances will supply an ideal, though infrequent, combination of safety and profit opportunity. 
• As a quite recent example of this condition, let us mention once more National Presto Industries stock, which sold for a total enterprise value of $43 million in 1972. With its $16 millions of recent earnings before taxes the company could easily have supported this amount of bonds.

In the ordinary common stock, bought for investment under normal conditions, the margin of safety lies in an expected earning power considerably above the going rate for bonds. In former editions we elucidated this point with the following figures:

• Assume in a typical case that the earning power is 9% on the price and that the bond rate is 4%; then the stock buyer will have an average annual margin of 5% accruing in his favor. 
• Some of the excess is paid to him in the dividend rate; even though spent by him, it enters into his overall investment result. The undistributed balance is reinvested in the business for his account. 
• In many cases such reinvested earnings fail to add commensurately to the earning power and value of his stock. (That is why the market has a stubborn habit of valuing earnings disbursed in dividends more generously than the portion retained in the business.)* 
• But, if the picture is viewed as a whole, there is a reasonably close connection between the growth of corporate surpluses through reinvested earnings and the growth of corporate values.
• Over a ten-year period the typical excess of stock earning power over bond interest may aggregate 50% of the price paid. 
• This figure is sufficient to provide a very real margin of safety— which, under favorable conditions, will prevent or minimize a loss. 
• If such a margin is present in each of a diversified list of twenty or more stocks, the probability of a favorable result under “fairly normal conditions” becomes very large. 
• That is why the policy of investing in representative common stocks does not require high qualities of insight and foresight to work out successfully.

If the purchases are made at the average level of the market over a span of years, the prices paid should carry with them assurance of an adequate margin of safety. 

The danger to investors lies in concentrating their purchases in the upper levels of the market, or in buying nonrepresentative common stocks that carry more than average risk of diminished earning power.

• As we see it, the whole problem of common-stock investment under 1972 conditions lies in the fact that “in a typical case” the earning power is now much less than 9% on the price paid.**
• Let us assume that by concentrating somewhat on the low-multiplier issues among the large companies a defensive investor may now acquire equities at 12 times recent earnings—i.e., with an earnings return of 8.33% on cost. 
• He may obtain a dividend yield of about 4%, and he will have 4.33% of his cost reinvested in the business for his account. 
• On this basis, the excess of stock earning power over bond interest over a ten-year basis would still be too small to constitute an adequate margin of safety. 
• For that reason we feel that there are real risks now even in a diversified list of sound common stocks. 
• The risks may be fully offset by the profit possibilities of the list; and indeed the investor may have no choice but to incur them—for otherwise he may run an even greater risk of holding only fixed claims payable in steadily depreciating dollars. 
• Nonetheless the investor would do well to recognize, and to accept as philosophically as he can, that the old package of good profit possibilities combined with small ultimate risk is no longer available to him.***

# “Earning power” is Graham’s term for a company’s potential profits or, as he puts it, the amount that a firm “might be expected to earn year after year if the business conditions prevailing during the period were to continue unchanged” (Security Analysis, 1934 ed., p. 354). Some of his lectures make it clear that Graham intended the term to cover periods of five years or more. You can crudely but conveniently approximate a company’s earning power per share by taking the inverse of its price/earnings ratio; a stock with a P/E ratio of 11 can be said to have earning power of 9% (or 1 divided by 11). Today “earning power” is often called “earnings yield.”

* This problem is discussed extensively in the commentary on Chapter 19.

** Graham elegantly summarized the discussion that follows in a lecture he gave in 1972: “The margin of safety is the difference between the percentage rate of the earnings on the stock at the price you pay for it and the rate of interest on bonds, and that margin of safety is the difference which would absorb unsatisfactory developments. At the time the 1965 edition of The 

Intelligent Investor was written the typical stock was selling at 11 times earnings, giving about 9% return as against 4% on bonds. In that case you had a margin of safety of over 100 per cent. Now [in 1972] there is no difference between the earnings rate on stocks and the interest rate on stocks, and I say there is no margin of safety . . . you have a negative margin of 

safety on stocks . . .” See “Benjamin Graham: Thoughts on Security Analysis” [transcript of lecture at the Northeast Missouri State University business school, March, 1972], Financial History, no. 42, March, 1991, p. 9.

*** This paragraph—which Graham wrote in early 1972—is an uncannily precise description of market conditions in early 2003. (For more detail, see the commentary on Chapter 3.)

Ref:  The Intelligent Investor by Benjamin Graham

CHAPTER 20 “Margin of Safety” as the Central Concept of Investment

Also read:

• Margin of Safety Concept in The Business Venture of Buying and Selling Stocks
• Margin of Safety Concept in Conventional and Unconventional Investments
• Margin of Safety Concept in Speculation and Investment
• Margin of Safety Concept in Diversification
• Margin of Safety Concept in Undervalued or Bargain Stockss
• Margin of Safety Concept in Growth Stocks
• Margin of Safety in Good-Quality and Low-Quality Stocks.
• Margin of Safety Concept in Common Stocks
• Margin of Safety Concept in Bonds and Preferred Stocks

Margin of Safety Concept in Bonds and Preferred Stocks (Fixed Value Investments)

In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase, “This too will pass.”  Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY. This is the thread that runs through all the preceding discussion of investment policy—often explicitly, sometimes in a less direct fashion. Let us try now, briefly, to trace that idea in a connected argument.

All experienced investors recognize that the margin-of-safety concept is essential to the choice of sound bonds and preferred stocks. 

For example, a railroad should have earned its total fixed charges better than five times (before income tax), taking a period of years, for its bonds to qualify as investment-grade issues. 

• This past ability to earn in excess of interest requirements constitutes the margin of safety that is counted on to protect the investor against loss or discomfiture in the event of some future decline in net income. 
• (The margin above charges may be stated in other ways — for example, in the percentage by which revenues or profits may decline before the balance after interest disappears—but the underlying idea remains the same.)
• The bond investor does not expect future average earnings to work out the same as in the past; if he were sure of that, the margin demanded might be small. 
• Nor does he rely to any controlling extent on his judgment as to whether future earnings will be materially better or poorer than in the past, if he did that, he would have to measure his margin in terms of a carefully projected income account, instead of emphasizing the margin shown in the past record. 
• Here the function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future. 
• If the margin is a large one, then it is enough to assume that future earnings will not fall far below those of the past in order for an investor to feel sufficiently protected against the vicissitudes of time.

The margin of safety for bonds may be calculated, alternatively, by comparing the total value of the enterprise with the amount of debt. (A similar calculation may be made for a preferred-stock issue.) 

• If the business owes $10 million and is fairly worth $30 million, there is room for a shrinkage of two-thirds in value—at least theoretically—before the bondholders will suffer loss. 
• The amount of this extra value, or “cushion,” above the debt may be approximated by using the average market price of the junior stock issues over a period of years. 
• Since average stock prices are generally related to average earning power, the margin of “enterprise value” over debt and the margin of earnings over charges will in most cases yield similar results.

So much for the margin-of-safety concept as applied to “fixed value investments.” Can it be carried over into the field of common stocks? Yes, but with some necessary modifications.

Ref:  The Intelligent Investor by Benjamin Graham

CHAPTER 20 “Margin of Safety” as the Central Concept of Investment




Also read:

• Margin of Safety Concept in The Business Venture of Buying and Selling Stocks
• Margin of Safety Concept in Conventional and Unconventional Investments
• Margin of Safety Concept in Speculation and Investment
• Margin of Safety Concept in Diversification
• Margin of Safety Concept in Undervalued or Bargain Stockss
• Margin of Safety Concept in Growth Stocks
• Margin of Safety in Good-Quality and Low-Quality Stocks.
• Margin of Safety Concept in Common Stocks
• Margin of Safety Concept in Bonds and Preferred Stocks
• 
  

Invest intelligently by following these three principles of value investing

PRINCIPLES OF OPERATION 

Invest INTELLIGENTLY through adhering to the following three principles of value investing.

First, we think of stocks in the same way that a business person would think of a business.

Second, we do not follow, but instead try to take advantage of the manic depressive Mr. Market.

Third, we always look for a margin of safety.

Margin of Safety

Even after you think you have a good handle on what a stock should be worth, it is important to buy at a discount to this estimated fair value to give an adequate margin of safety.

After all, no projection about the future is foolproof, and protecting yourself from unforeseen events is entirely prudent.

For instance, if a company's new product falls flat and profit growth doesn't materialize, you want to be protected.

It is also important to realise that some companies are riskier and harder to predict than others.  In general, the riskier a company is, the larger the margin of safety should be.

The bottom line is that if you don't use a lot of discipline and conservatism in figuring out the prices you are willing to pay for stocks, you will regret it eventually.  

You might be able to sell some of your overvalued shares to some sucker who is willing to pay an even more inflated price, but in the end, this kind of speculating is the investing equivalent of musical chairs, with the last one holding the stock the loser.  Don't let it be you.

Buy at a price below fair value with an adequate margin of safety and sleep well at night.

Waiting for the Fat Pitch

How do I make sure I don't overpay for something?

The answer:  If the pitcher doesn't throw one right down the middle, you don't have to swing the bat.  Unlike in baseball, there is no penalty for being patient in investing.

You should spend a fair amount of time placing a value on a stock before you even think about buying it, and only buy stocks that you are confident are undervalued.

Learning how to value  a stock takes work, but it can be done.

Price Matters

Price matters in the stock market.

Just like you wouldn't run out and pay $10 a gallon for gasoline, why would you pay 100 times earnings for a company that is growing 15% a year?

Do you think the people who paid $212 for Yahoo YHOO in January 2000 are ever going to get their money back?

Yahoo's a good company, but it may take a very long time for the stock to get back to its old highs.

The same could be said of many other technology stocks and also even those technology companies with moats around them that got clobbered in post 2000.

Remember - the single greatest determinant of a company's return in your portfolio is the price you pay for its shares.

As important as it is to understand the quality of a company - its growth prospects, competitive position, and so forth - it is even more vital that you pay a fair price for the firm's shares.

You'll make a lot more money buying decent firms with low valuations than by paying premium prices for premium companies.  Why?  Because the future is uncertain, and low valuations leave a lot more room for error.

Buying at a Discount to Fair Value

Even though you know about economic moats and have perhaps uncovered a company that has at least one good-sized moat, unfortunately, your work is only half done at this point.  (Quality & Management)

You cannot just go out and pay whatever the market is asking for this stock until you calculate what it's worth (the intrinsic value).  (Valuation)

Otherwise, you might end up having to hold the stock for many, many years to get a decent return on your money.

And in some cases, you might never get one.

VALUE STOCKS IN A WEAK MARKET

In the face of so much blood, why are investors not looking for value shares?  One could argue that market psychology drives the fear of more blood yet to come.  Timid investors wait for the bottom.  Value investors look for opportunities and jump in with an eye towards minimising losses.


----


Value investing takes many different forms, but all approaches aim to achieve the same objective - buying something for less than it is worth.

By Bob Kohut | 19.12.2011

You’ve heard this investing maxim near and dear to the hearts and minds of value investors everywhere – The Time to Buy is when there is blood in the streets.  British Banker Baron Rothschild supposedly made this observation after making a fortune buying in the midst of the panic preceding the Battle of Waterloo.

Today there is certainly blood in the streets, yet trading volumes in share markets everywhere are dwindling as buyers are not stepping in and following Rothschild’s advice.  Just how much blood is enough?

Here is a brief overview of the some recent bloody events:

•    The HSBC flash Chinese PMI (Purchasing Manager Index) for November was 48 – the lowest in 32 months.  The October PMI was 51. Values below 50 indicate contraction in the manufacturing sector.

•    The HSBC Flash China Manufacturing Output Index also hit a 32 month low at 46.7, down from 51.4 in October.

•    Share markets in Europe and the US collapsed as investors learned the catastrophic results of a German government bond auction. 

•    The United States may be headed for another credit downgrade as lawmakers failed to reach agreement on a long term deficit reduction plan.  There is already legislation in preparation to reverse some of the automatic cuts to the defense budget agreed on in the August deal.

•    France looks set to be downgraded this week, which will see its coveted AAA rating.

The inconvenient truth here is there is ample opportunity for more blood to be spilt before this is over.  Australians might take heart that of the three most troublesome areas – China, Europe, and the US – China is still in the best position to continue to deliver economic growth.

The unexpected drop in the HSBC indicators is troubling.  As you know, readings below 50 indicate contraction in economic activity.  The world has been expecting a slowdown in the expansion in China, not a contraction. 

However, other numbers provide a measure of comfort.  The Chinese government has been implementing policies to slow growth to help control what they see as a bigger problem – inflation.  In July of this year inflation reached a three year high of 6.5% but figures released in November show annual inflation fell to 5.5%.  This gives the government room to go back to policies to stimulate growth.

Europe is a catastrophe.  Germany is the Eurozone’s strongest economy and in a recent auction, bond investors responded to the government’s attempts to sell 6 billion Euros in ten year notes with a resounding yawn.  Only 60% of bonds up for auction were sold. It's tough to see a way out in the near future with France set to be downgraded, UK unemployment at a 17-year high, and Spanish house prices tumbling for the 14th consecutive quarter while unemployment soared to 23%.  

Perhaps the greatest concern is the possibility of yet another downgrade to the US credit rating.  The rating agencies have warned of this possibility if the US did not come up with a credible long term deficit reduction plan.  Not only did their politicians not do that, there is growing evidence some of the automatic cuts that were to take place in the event of a failure to reach agreement on a broader plan may be scaled back.  With the concern over China’s contraction and the Eurozone debt crisis, this US threat is still under the radar of many investors.

In the face of so much blood, why are investors not looking for value shares?  One could argue that market psychology drives the fear of more blood yet to come.  Timid investors wait for the bottom.  Value investors look for opportunities and jump in with an eye towards minimising losses.

Value investing takes many different forms, but all approaches aim to achieve the same objective – buying something for less than it is worth.  The difficulty with disciplined value investing is determining the true worth of a company, or its intrinsic value.  Many who consider themselves value investors use some shortcuts, including P/E and P/B ratios, dividend yield, ROE, PE/G, and Debt to Equity (Gearing) rather than the more complex discounted cash flow calculations.  

A P/E less than 10 with a P/EG less than .5 would be a potential value share for any value investing methodology.  The P/EG is a ratio popularised by Peter Lynch that expands on the P/E by using estimated future earnings growth in the denominator.  

We searched the ASX for companies with a minimum market cap of 500 million dollars that met those two criteria along with a minimum dividend yield of 2%.  Here are eight value candidates we found:

Company	Code	P/E	P/EG	ROE	Div Yield	Share Price
Air New Zealand	AIZ	7.96	.11	5.4%	9.1%	$0.67
Boart Longyear	BLY	9.36	.21	8.5%	2.6%	$3.03
Emeco Holdings	EHL	10.14	.46	9.2%	5.7%	$1.00
Fletcher Building	FBU	9.68	.43	9.8%	6.3%	$4.61
Henderson Group	HGG	8.61	.31	20.2%	6.8%	$1.59
Mount Gibson Iron	MGX	4.50	.11	19.8%	4.9%	$1.18
One Steel	OST	5.07	.49	5.3%	10.8%	$0.77
Telecom NZ	TEL	11.46	.64	16.7%	9.7%	$1.56

Where do we begin with this mass of numbers?  Some investors forget that each number is a part of a whole and instead gravitate towards their favorite metric.  Dividend yield is a major attraction of value investing as it provides a cushion in difficult markets.  On that measure alone, one might zero in on OST and TEL.

When you look at the whole forest rather than individual trees OST appears to be the most undervalued.  With a P/E of only 4.57 and a book value of $3.77 per share, it is trading at far below its book value with a share price of a meager $.77.

However, we have yet to look at another critical benchmark for value investing – debt.  While always a concern, we are now faced with the possibility of another global credit crunch which will put companies that rely heavily on short term borrowing and excessive long term debt at significant risk.  So let’s take a look at some debt and liquidity measures for our candidate shares:

	Quick Ratio	Current Ratio	Gearing 2011 - (2010)	Long Term Debt  ($m) 2011 - (2010)
AIZ	.64	.81	83.4% -- (68.6%)	851.5 - (731.2)
BLY	1.12	2.09	23.5% -- (14.5%)	243.5 - (147.7)
EHL	1.4	2.34	48.8% -- (48.8%)	290.5 - (298.9)
FBU	.92	1.78	54.2% -- (40.3%)	1,442 - (920.5)
HGG	.91	1.31	50.5% -- (64.5%)	272 - (325.9)
MGX	.90	3.69	3.9% -- (14.4%)	16.5 - (36.8)
OST	.75	1.89	41.8% -- (23.3%)	1,809 - (715.2)
TEL	.58	.67	90.7% -- (91.2%)	1,312 - (1,736)

   

In better times some value investors might overlook higher debt levels.  Right now that could be a big mistake.  Long term debt is frequently restructured to get better terms.  In the face of a credit freeze, that is not likely to remain a possibility.  High gearing indicates a company is using more of “other people’s money” to operate than its own money.  Liquidity ratios – the quick and the current – represent a company’s ability to convert assets into cash to meet short term liabilities.  Ratios below 1.0 could represent a problem.  If credit availability dries up, liquidity ratios become even more important.

All these indicators must be viewed in the context of the sector in which the company operates.  For example, TEL’s 90.7% gearing seems outrageous until you compare it to Australia’s Telstra, with a gearing ratio of 115.3%.

Another issue with debt and gearing is the trend.  Companies lever up and take on debt for expansion purposes and this is something you need to research.  In our table we showed the year over year difference in gearing and long term debt for each company.  You can see that OST more than doubled its debt and raised it gearing by about 40%.

On other measures, OST seems like it might be a bargain, but the bottom line is they are carrying too much debt.

Now let’s briefly review the other shares and see which ones shake out as potential bargains.

Air New Zealand (AIZ) is the premier air carrier in New Zealand.  Unfortunately, it operates in an industry now dominated by rabid competition and rising fuel costs.  Its debt position is no more than adequate and liquidity ratios under 1.0 could spell trouble.  Compared to some of the other shares in the table, the ROE is nothing to get excited about.  It does have a substantial dividend yield at 9.1%.  Investors interested in AIZ need to check the company’s dividend history and payout ratio.  Remember, yield is based on prior dividends paid with no guarantee of dividends going forward.  In short, there are probably better options.

Boart Longyear (BLY) provides equipment, drilling services, and other consumable products to the mining industry.  As such, they are at risk of a continued drop in commodity prices and a significant slowdown in China which will affect their customers – the miners.  Although their dividend payout ratio is low at 2.8%, dividend payout has been spotty, with no dividend paid for FY2009.  Although they modestly increased debt and gross gearing, they are still low enough to consider their balance sheet as reasonably strong.  BLY is a share that bears watching.

Emeco Holdings (EHL) is another mining services company, specialising in renting heavy earth moving equipment.  They are one of the few companies that actually reduced long term debt year over year although gearing remained the same.  Their 5.7% dividend yield beats most term deposit rates but the most compelling thing about EHL is the share price of $1.02 compared to its book value.  EHL is certainly a candidate for further review.

Fletcher Building (FBU) is a New Zealand based provider of building and construction materials.  Although it has an attractive dividend yield, it has minimal exposure outside New Zealand and Australia.  The company’s dividend payout has been gradually declining since the GFC.  Should the building and construction business deteriorate further, FBU faces significant risk.  There are other shares in our table that appaer to be better candidates.

Henderson Group (HGG) offers investment services in Europe, North America, and Asia.  They are based in London.  This company offers a substantial dividend of 6.8% and a solid ROE of 20%.  Many value investors look for an ROE of 15% minimum to qualify for their consideration.  However, considering the volatility of investment markets and the near certainty (in the opinion of many experts) the volatility will continue, the risks may be too great to look to invest in this company at this time.

Mount Gibson Iron (MGX) is a junior iron ore miner in Western Australia.  Although subject to the same risks from volatile commodity prices and a Chinese slowdown, their numbers are compelling.  The P/E of 4.50 and a P/EG of .11 are substantially better than the sector averages of 11.43 and .53.  An ROE performance of over 19% and a share price very close to book value per share make them a prime bargain bin candidate.  In addition, note they cut their long term debt more than in half and reduced gearing by approximately 70%.  Although the current dividend yield is modest, analysts forecast the dividend to double in FY2012 and FY2013.  MGX deserves a prime spot in the bargain bin.

Telecom NZ (TEL) was once upon a time a state run monopoly offering telecommunication services in New Zealand and parts of Australia.  Although they stand to benefit from the coming broadband explosion, regulatory changes and fierce competition pose significant risks going forward.  Although the dividend yield stands at a stunning 9.7%, dividend payouts have been decreasing over the past few years.  There are better candidates.

Finding value shares is not for the casual investor.  Today more and more investors seem to want someone to “give them a fish”, rather than “learning how to fish.”  Value investing is hard work.  We started with nine shares and boiled down to three – Boart Longyear, Emeco Holdings and Mount Gibson Iron.  Depending on your risk tolerance, you may want to include others.  However, to find real bargains you need to go beyond what we have uncovered here to look deeper into consistency of historical performance of a target share.  The greatest challenge is determining the real or intrinsic value of the company, not just the stated book value per share.  You need to know what goes into the accounting definition of “book.” 

http://www.thebull.com.au/articles/a/25014-value-stocks-in-a-weak-market.html