My Top 8 Undervalued Stocks For February 2024, One Yields More Than 20% (2024)

How many picks to be diversified?

Two investors that I read and follow the philosophies of very closely are Joel Greenblatt and Charlie Munger. Both during their heyday's were very concentrated investors and pointed out that adding more stocks does not always decrease risk. Focusing on a handful of picks that are clearly valued and spread across different sectors could provide all the diversification you need:

Two things should be remembered, after purchasing six or eight stocks in different industries, the benefit of adding even more stocks to your portfolio in an effort to decrease risk is small, and overall market risk will not be eliminated merely by adding more stocks to your portfolio.- Joel Greenblatt

And furthermore from Charlie Munger:

The whole secret of investment is to find places where it's safe and wise to non-diversify. It's just that simple. Diversification is for the know-nothing investor; it's not for the professional. Charlie Munger

While I consider myself a know-something versus know-nothing investor, I do own a wider array of stocks more than 6-8. However, on an annual basis, I usually concentrate on 6-8 stocks of beaten-down names in unloved sectors rather than diversifying widely. While Joel Greenblatt's The Little Book That Beats The Market ultimately created a scoring system of buying 20-30 stocks based on the highest earnings yields and returns on invested capital, the highest marks Greenblatt achieved as a hedge fund manager were when he was running small, concentrated money.

Here are my 8 favorite beaten-down, cheap picks for the first half of 2024:

Occidental Petroleum

Occidental Petroleum (OXY) is a Buffett favorite and has now gained a spot on my leaderboard. The company is a low CAPEX cash machine. A heavily indebted one after the acquisition of Anadarko at that. This one will take time for the patient to realize the stock's full potential. Of the oil majors, it has one of the highest cash yields that you'll find. Using the formula of free cash flow + net interest expense / enterprise value, let's have a look:

All numbers in millions

• TTM free cash flow: $4,830
• Plus TTM net interest expense: $4,830 + $835 = $5,665
• Divided by Enterprise Value: $5,665/ $78,550 = 7.2% cash yield

This compares to Chevron (CVX) at a 6.1% cash yield and Exxon (XOM) at a 5.7% cash yield. I also pitted the group against one another on a comparison of CAPEX expense in a previous article and found the following:

With CAPEX as the lowest percentage of Depreciation and Amortization of these three oil majors, it is seemingly part of the affinity that Berkshire Hathaway (BRK.B)(BRK.A) has for Occidental Petroleum.

Unit Corporation

I have written a couple of articles on this small-cap, Unit Corporation (OTCQX:UNTC) with a very simple thesis, the stock seemed to score at the very top end of the entire stock market when using Joel Greenblatt's Magic Formula screener. Again, this screener hunts for beaten-down stocks with the highest returns on invested capital [ROIC] + the highest earnings yields, or the inverse of the P/E ratio, using E/P.

Using this simple Y-charts mock up would net a total score of 66.62+63.36=129.98. For context, a score of 20 is decent and would reflect a possible combination of a 10% ROIC and a 10% earnings yield.

Fellow Seeking Alpha analyst Kingdom Capital did a great analysis on this and many small and micro-cap stocks. I highly recommend you delve into his pieces for an excellent breakdown of this hidden gem.

A basic storyline for Unit Corporation goes something like this:

The company emerged from Bankruptcy in 2021.

The company was one of the largest Oklahoma Oil and Gas companies that specialized in oil drilling and natural gas production.

They have three segments:

• Oil and Natural Gas Production
• Contact drilling
• Mid-stream gas transportation

The bankruptcy resulted in a downsizing, and shrinking of the asset base and we're now left with a lean mean cash pumping machine that has 14 boss rigs, oil and nat gas reserves, and a balance sheet that many can not believe exists.

Long-term debt has been paid off and shares outstanding have been reduced from 55 million shares pre-reorganization to 9.7 million shares today.

The company re-started its dividend at $10 per annum, or $2.5 per quarter which at today's share price equates to a 25% dividend yield. While this amount is variable depending on oil and gas prices, getting even a well-covered 15% dividend per annum will still float my boat. This company recently had an earnings per share TTM of $25.97 with a share price of $40. The P/E ratio as it stands is around 1.5 X. While this number may deteriorate with lower nat gas prices, remember, they also have no debt.

And lastly, they ended the last quarter with over $170 million in cash on their balance sheet. That's equal to 43% of their $394 million market cap.

Albemarle

Well, I liked Albemarle (ALB) at $184, I guess I better really like it now at $112! I am putting my money where my mouth is and I have been buying frequently. There is a lithium glut with the slowing of EV production and the coming online of supply from many different producers. As this is the largest U.S.-based producer of lithium, I am very comfortable in trusting their accounting practices and would hope to have a better chance than average of management being forthright with investors.

Share price has only risen 88% over the past decade yet we see a 1K+% increase in earnings per share. Revenue has also grown at double the rate of share prices.

I was in this name heavily going into COVID-19 and jettisoned it for a profit when the P/E ratio exceeded 100 for a time. I didn't believe they could compress the multiple through growth after bringing more supply online. They did. And drum roll... now no one wants it.

While earnings look great, this is a CAPEX intensive business with lots of irons in the fire, therefore cash flow tells a different story.

From Seeking Alpha on the cost cutting measures ahead:

The lithium producer said it is looking to reduce costs by ~$95M/year by cutting expenses and its workforce, and expects to realize more than $50M in cost savings this year.

Albemarle said it expects 2024 capital spending to drop to $1.6B-$1.8B from $2.1B in 2023, reflecting "a re-phasing of larger projects in the near term to focus on those that are significantly progressed, near completion and in startup.

This certainly set off alarm bells and sent the stock lower signaling a future demand decrease in an already downtrodden lithium market. I believe lithium is here to stay and this is an opportunity to grab the blue chip of the industry at very cheap prices. I also believe lithium battery technology and charging technology need to improve. Slowly but surely, I think it will and I'm willing to wait.

PayPal

PayPal (PYPL) is still enjoying revenue growth, but is also lacking enough earnings growth forward guidance to appease the street.

Recent earnings were beats, but forward guidance showed negative revisions:

Regardless of the next quarter being estimated lower across the board than the trailing, I am in this one for the long haul versus a short term trade.

Still, 81% off its high and lot of room to grow in digital wallets and transactions, I love it when a company is part of societal verbs, as PayPal is with Venmo.

My valuation was at $89.82/share based on an adjusted operating earnings PEG ratio which can be found in my full article:

• 2018 Adjusted operating income backing out R&D- $4.05 Billion
• 2022 Adjusted operating income backing out R&D- $7.292 Billion
• 5 Year adjusted operating income growth rate backing out R&D CAGR- 12.47%
• TTM adjusted operating income- $7.76 Billion
• Divided by 1,078.1 million shares outstanding = $7.2 Adjusted operating income per share.
• $7.2 X 12.47 to find the price at which the PEG ratio is equivalent to 1= $89.82/ share fair price.

Rolls-Royce

This UK competitor to General Electric (GE), was nearly driven into bankruptcy during Covid as travel came to a halt. The rebound in earnings and cash flow has been amazing.

The company specializes in Aerospace, Defense and Power Plant technology. They are very well known for their commercial aircraft engines.

The company has posted some ambitious free cash flow targets by 2027:

Rolls-Royce (OTCPK:RYCEY) has unveiled a bold transformation plan aiming to significantly boost its financial performance by 2027. The British engineering giant is targeting an operating profit of £2.5 billion to £2.8 billion and free cash flow between £2.8 billion and £3.1 billion.

£3.1 billion is roughly $4 Billion USD in free cash flow on the top end. By 2027, normal discount rates of free cash flow using a basic current risk-free rate plus a point or two would be an intrinsic value in the neighborhood of $50-$72 Billion for the company.

The current market cap is $34 Billion. With 8,362 million shares outstanding, this could be a $8.7 stock on the high end to $6 on the low end. The amount of share buybacks between now and then will also determine the value come that time.

This is a stock I owned during Covid at around $1-$1.5 a share and I regret having sold it. The turnaround story was not as clear then as it is now.

Hershey

Kudos to fellow Seeking Alpha'er Michael Dolen for putting this on my radar, this is a great reversion to the mean play that I had written about earlier here.

The P/E ratio entry here is one of the lower opportunities in recent memory for one of the premier packaged food companies in the U.S.

With Cocoa prices at a near all-time historical high, a reversion to the mean in underlying cocoa prices is all but an inevitability in my opinion which should ratchet down Hershey's (HSY) cost of goods sold and improve gross margins.

This is also an excellent dividend growth stock and is the strongest driver in my purchasing outside of the brand moat and historically low P/E ratio.

With a greater than 10% 5 year dividend CAGR yielding 2.45%, this is one of the better dividend growth stocks I've bumped up against recently all things considered.

The company also sports one of the best returns on invested capital that you will find in consumer staples. This is also being achieved despite the prices of cocoa.

Disney

The Walt Disney Company (DIS) is now one of my largest holdings. Recent earnings had a slew of information to digest. Since my last article on the company, the following has occurred:

• The company re-instituted the dividend
• The company will make a $1.5 Billion investment in Epic Games
• Has new streaming partnerships with Warner Brothers Discovery and Fox

My bullish theses had mostly to do with the top-line growth in revenue after creating Disney Plus to add to the already cash-printing DPEP business. I believe the margins will eventually get to the low teens for DTC DMED like Netflix. The company is close to becoming positive in streaming and has advertisem*nts going live on its platform. I have now used Disney + for three months and have found some impressive features versus Amazon Prime and Netflix (NFLX).

• Disney has subtitles and dubbing in almost all the important international languages whereas Netflix and Amazon do not.
• They can integrate Hulu and ESPN access from within the Disney + app, switching to Hulu from my Disney + was seamless.
• They have an amazing exclusive library that the other streamers would have a hard time competing with even after a decade or more of in-house productions.

I assume the subtitles and dubbing features are mainly due to Disney not needing approval to dub the content because they own it. I find this a competitive advantage in International marketing efforts.

My original price target was based on the following assumptions via my last article:

Building a model, value if a turnaround succeeds

If Disney can successfully merge into full DTC streaming on the media side, achieve Netflix's current margins and grow revenue at 8-9% during the meantime, that would be my bull case. Even disregarding any revenue growth, let's see what that margin mix would look like:

Data courtesy of Seeking Alpha

• Total TTM revenue: $87.8 Billion
• DPEP: 34% of revenue at: $29.85 Billion at 17.7% average pre-Covid margins= $5.28 Billion net income.
• DMED: 66% of revenue at: $57.9 Billion at Netflix margins of 13%= $7.64 Billion net income.
• Total net income based on margin assumption mix of $12.92 Billion

In my bull case price model I will be making the following 2025 future assumptions using a Buffett Owner Earnings Model with TTM numbers bumped up by 10%:

• $13.85 Billion net income based on $94 Billion in revenue (a 10% revenue increase)
• Depreciation and Amortization of $5.75 Billion (a 10% D&A increase)
• CAPEX of $5.217 Billion (a 10% CAPEX increase)
• A risk free discount rate of 5% assuming flat rate trends.

Owner earnings model:

All numbers in millions:

• NI 13,850 + 5,750 D&A = 19,600
• 19,600 - 5,217 CAPEX = 14,383
• 14,383 / 5% RFR = $287,660 market cap
• 287,660 / 1840 assumed shares outstanding at an average .03% increase in float per annum = $156.33/share

I will continue to buy Disney up to $124 / share. This would leave me a 20% margin of safety below what I think is intrinsic value.

Albertsons

Albertsons (ACI) is my favorite special situation stock at the moment. I wrote in detail about the stock here. For those not following the story, Kroger (KR) is attempting to merge with Albertsons to create a grocery juggernaut that should be more competitive with Walmart (WMT). There was a special dividend distributed to Albertsons holders during the outset of this deal which reduced the net to new holders which now stands at $27.25 upon deal closure.

The arbitrage play here stands to net an owner about $5.92 a share in upside from the current price of $21.33, a 27.7% return plus any dividends along the way. If it closes in less than 12 months, the annualized return will be very healthy. This one is slated to close in the first half of the year.

If the deal fails, I have intrinsic value as the following:

All numbers TTM courtesy of Seeking Alpha in millions

Albertsons

• Net income= 1370.7
• Plus D&A= [13707.7+2,387.9]= 3,758.6
• Minus CAPEX= [3,758.6-2,177.5]=1,581.1 owner earnings
• Discounted at 5.5% RFR= $28,747 fair market cap
• Divided by shares outstanding= [$28,747/575.8]= $49.92/share
• Trading at 42.7% of fair value

This is a heads I win, tails I don't lose much situation much in Mohnish Pabrai fashion. Many other M&A deals would worry me if I had to hold onto the target should a deal get blocked.

Risks

Any concentrated portfolio strategy carries risk. I did not divvy up these picks to be diversified across sectors and I never function that way. I look for value and return potential only. This strategy may not be suitable for many investors as all of our risk tolerances are different. If choosing to be more concentrated, I would do what Guy Spier advises and anchor your portfolio to a company like Berkshire Hathaway or one of several index funds to lower your overall volatility.

I am at least 50% anchored to index funds and the other half of my capital is tied to value picks.

Summary

As an author here on Seeking Alpha, I enjoy the community almost as much as I do the analytical toolsets. Some friends help produce new ideas and other authors can help me to reinforce an idea that I already had but hadn't yet crossed certain chasms of information. I always try to do my best to put my money where my mouth is and own virtually every stock I recommend. These are all names I own and am buying.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Brett Ashcroft Green