What do Warren Buffett, Peter Lynch, and Benjamin Graham have in common? In addition to posting stellar, market-beating performances over decades-long periods, each of these famous investors weighed business strengths along with financial metrics to uncover stocks that were priced below their intrinsic value.
The value-investing toolbox is still helping people pick winners today and, with the stock market flying high, it could pay to take some strategy cues from some of history's most successful investors and go the value route. Read on to learn why Kinder Morgan (KMI -0.46%), Morgan Stanley (MS -3.45%), and IBM (IBM -1.54%) could be smart value plays that deserve a spot in your portfolio.
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This cash flow machine is dirt cheap right now
Matt DiLallo (Kinder Morgan): Energy infrastructure giant Kinder Morgan's stock is down nearly 7% since the start of the year. Because of that, it now trades at a mere 9.7 times free cash flow. That's quite a discount for a stock that routinely sold for nearly 20 times free cash flow before the oil market downturn, and was in the low teens as recently as late last year. What's truly bizarre about the company's valuation drop is that it came despite the fact that cash flow has only slipped 7.4% from its peak in 2015, which shows the tremendous stability of its business during the current oil market turbulence.
There's no reason for the stock to be getting cheaper. Kinder Morgan's recent first-quarter earnings report certainly didn't have any bad news, since results came in a bit better than expectations. Meanwhile, the company continued to make progress on its strategic initiatives this year, including partnering on its Elba Island project and recently launching an IPO in Canada to help finance its Trans Mountain Pipeline expansion. Because of this progress, the company remains on pace to restart dividend growth later this year.
Investors, however, currently value Kinder Morgan as a no-growth stock, which is absurd since the company has several high-return expansion projects in the pipeline. For example, the $10.3 billion of fee-based projects the company has in development should deliver $1.5 billion of annualized adjusted EBITDA by 2020, which represents quite a boost to the $7.2 billion in adjusted EBITDA it should generate this year. The first wave of this growth should start flowing to the bottom line next year.
With all that growth on the horizon, smart investors have a chance to buy Kinder Morgan for dirt cheap prices these days. Doing so puts them in the position to cash in when the rest of the market catches on and revalues the company for the growth that's just over the horizon.
Profit from Wall Street's rebound
Dan Caplinger (Morgan Stanley): The financial industry still has plenty of bargains, even though the entire sector has bounced back dramatically since the financial crisis. In particular, investment banking specialists like Morgan Stanley have started to see a solid uptick in the number of mergers, acquisitions, and other strategic deals going on, and that presents opportunities for growth in a lucrative fee-producing area of the market.
Yet the real opportunity for Morgan Stanley could come from regulatory reform. Investors have been excited about the Trump administration's call for less stringent regulation on the financial industry, and although large Wall Street companies haven't always been the president's favorite companies, an ability to conduct business more freely would help the investment banking specialist. In addition, a more favorable interest rate environment could be beneficial for the bank, and Morgan Stanley's recent efforts to cut back on expenses could also bolster profits.
Morgan Stanley stock currently trades at less than 13 times trailing earnings, and when you incorporate future earnings expectations, the stock's forward multiple weighs in at less than 11. There's some uncertainty about whether changes in the regulatory environment will happen quickly, but regardless of what happens there, increasingly favorable conditions for mergers and acquisitions should help bolster Morgan Stanley's existing business.
Big Blue offers big value
Keith Noonan (IBM): Shares of information technology company International Business Machines have dipped roughly 13% since the start of April, erasing nearly all the gains that the stock had made over the last year and bringing the company's forward price-to-earnings ratio down to roughly 11. Big Blue faces considerable challenges as it carries out its transformation away from hardware sales toward a model that sees it leaning more heavily on emerging categories like cloud services, security, and artificial intelligence, but with a low earnings multiple and an attractive returned income component, it looks like a strong play for value investors.
Lagging sales performance for the company's hardware and operating systems software means that investors should be prepared for the company's 20-consecutive-quarter streak of declining revenue to be extended, but there appears to be relief in sight. The company's strategic imperatives segment recently posted 12% growth over the prior-year quarter, bringing trailing segment revenue to $33.6 billion -- or roughly 42% of sales over the last 12-month reporting period. IBM anticipates that strategic imperatives revenue will reach $40 billion in fiscal 2018 -- indicating growth that could reverse its negative sales and earnings trends.
For those looking for returned income, the company's dividend profile is the real deal. IBM sports a chunky 3.9% yield, a cost of distributing its payout that comes in below 44% of trailing earnings and 49% of trailing free cash flow, and a 22-year history of annual payout increases. With its inexpensive valuation combined with that level of income generation, buying into IBM's turnaround story looks like a prudent move.
