Editor’s Note: Related tickers: American Railcar Industries, Inc. (NASDAQ:ARII), Ford Motor Company (NYSE:F), General Motors Company (NYSE:GM), Herbalife Ltd. (NYSE:HLF), Textainer Group Holdings Limited (NYSE:TGH), Aircastle Limited (NYSE:AYR)
John Neff was an investing genius who viewed himself as “a low price-to-earnings investor.” During his 31-year tenure at Vanguard’s Windsor Fund, Neff was producing annual total returns of 13.7%, on average, easily outperforming the market’s returns over the same time horizon. He followed an investment approach of picking undervalued stocks with reasonable earnings growth that were trading at earnings multiples between 40% and 60% below the valuation of the broader market. His investments were stocks that traded at low valuation multiples relative to their total returns as measured by the sum of forecasted earnings growth and dividend yield. Neff pursued stocks with a strong fundamental case for investment, earnings growth above 7%, and above-market total returns in relation to P/E ratios (i.e. the above-market GYP ratio).
What is the GYP ratio?
Today, the number of stocks that meet Neff’s strict selection criteria is small, just like many strategies with market-beating potential. Based on our adaptation of the total return ratio, the GYP ratio (forward earnings growth rate plus forward dividend yield, divided by forward P/E), below is a closer look at five stocks that seem undervalued relative to their total return potential when compared to the GYP ratio of the overall market. Neff’s paying attention to dividends stemmed from his belief that dividends were often overlooked as a component of total return that can help investors outperform the market.
American Railcar
American Railcar Industries, Inc. (NASDAQ:ARII), a leading North American manufacturer of hopper and tank railcars, has a GYP ratio of 2.5, a result of a forward (2014) EPS growth rate of 17.4%, forward dividend yield of 2.9%, and forward P/E of 8.1x. The company’s long-term EPS CAGR is 15.0%. American Railcar Industries, Inc. (NASDAQ:ARII)’s GYP ratio is 2.7 times higher than the comparable ratio for the S&P 500. The company’s payout ratio is 29% of the current-year EPS estimate.
We like American Railcar Industries, Inc. (NASDAQ:ARII)’s exposure to the booming energy sector and the long-term investment in railroad transportation as the most cost-efficient transportation means, particularly in the periods of rising energy prices. American Railcar Industries, Inc. (NASDAQ:ARII) is in a growth phase, coming out of 2012 as its best earnings year in history, which prompted the company to reinstate its dividend in Q4 2012, after a pause of more than three years. Its total revenues for 2012 were up 37%, driven by an increase in manufacturing segment revenues, while railcar shipments were up 51%. Revenue and EBITDA growth has continued into this year, driven by both manufacturing and leasing segment sales. Operating margins are improving year-over-year (holding up at 16%), partly as a result of cost reduction initiatives from prior years. The company’s business model of a vertically integrated supply chain is resulting in savings.
We also like American Railcar Industries, Inc. (NASDAQ:ARII)’s long-term operational environment. The long-term replacement demand and growth will be driving demand for freight cars, both of which have favorable trend characteristics. The average age of covered hoppers is 20 years and the average age of tank railcars is 16 years. Tank car deliveries are expected to grow through 2014, and will average 15,300 units annually over the next five years, about the same, on average, as the number of covered hopper deliveries. The company’s leasing operations are performing well and have a potential for notable growth in the future. American Railcar Industries, Inc. (NASDAQ:ARII)’s international expansion in India, and potentially in Russia, Saudi Arabia and Australia, could also boost financial performance in the future.
Ford
Ford Motor Company (NYSE:F), the second biggest U.S. automaker by market share, has a GYP ratio of 2.49, given its forward (2014) EPS growth rate of 18.6%, forward dividend yield of 2.7%, and forward P/E of 8.9x. The company has a long-term EPS CAGR of 11%. Ford’s GYP ratio is thus 2.7 times higher than the comparable ratio for the S&P 500. While Ford Motor Company (NYSE:F)’s long-term EPS CAGR is lower than that of its archrival General Motors Company (NYSE:GM) and its forward P/E higher than GM’s, Ford differentiates itself from its main peers by an attractive dividend. The carmaker’s dividend payout ratio is 29% of the current-year EPS estimate.
We like Ford Motor Company (NYSE:F)’s long-term growth potential, despite near-term challenges in Europe and South America. Ford’s vehicle sales have been robust this year—rising 18% in April from the prior year, with the best April tally for pickup trucks since 2005. The U.S. energy sector boom, recovering construction markets, and the housing market growth have supported strong sales. In the longer term, a pent-up replacement demand in the U.S. amidst a record-high average age of the passenger fleet will help drive U.S. vehicle sales for several years. The automaker is increasing its U.S. market share, but it is still suffering losses in Europe, where it will likely return to break-even within two years, following its aggressive restructuring plan. We like Ford Motor Company (NYSE:F)’s push to gain a competitive edge by shortening the length of its product cycle (to a three-year period) and introducing new models faster than competitors.
Herbalife
Herbalife Ltd. (NYSE:HLF), a multilevel marketer of nutritional supplements and fitness products, has a GYP ratio of 1.98, which is a result of a forward (2014) EPS growth rate of 14.5%, forward dividend yield of 2.7%, and forward P/E of 8.7x. HLF’s long-term EPS CAGR is 15.1%. The company’s GYP ratio is 2.1 times higher than the comparable ratio for the S&P 500. HLF’s dividend payout ratio is 25% of the company’s current-year EPS estimate.
This stock has been a focus of a contentious debate between hedge fund manager Bill Ackman of Pershing Square—who called Herbalife Ltd. (NYSE:HLF) a pyramid scheme, initiating a large short position in the stock—and financier Carl Icahn, who has built a respectable stake in the stock and has said that HLF may become “the mother of all short squeezes.” (He also thinks Herbalife is “a great company to take private.”) Many investors are still short the stock, which does not instill confidence in the good long-term prospects of Herbalife Ltd. (NYSE:HLF). However, despite all the headwinds and accusations, the company has shown robust financial performance so far this year, reporting a year-over-year growth in net sales of 17%, 24% growth in adjusted EBITDA, 44% increase in adjusted EPS, and an adjusted operating margin expansion by 120 basis points to 17.2%. The company’s sales numbers showing growth across all geographical regions dismiss concerns that Herbalife’s main growth driver is the expansion in new markets.
Aside from the robust growth, the stock currently offers attractive valuation. However, given that the stock is at the epicenter of the clash of the hedge fund titans and a subject of highly speculative positions, it is better to wait until there is more clarity about the uncertainties surrounding Herbalife Ltd. (NYSE:HLF)’s business model.
Textainer
Textainer Group Holdings Limited (NYSE:TGH), the world’s largest lessor of intermodal containers based on fleet size, has a GYP ratio of 1.88, which is a result of a forward (2014) EPS growth rate of 11.7%, forward dividend yield of 4.8%, and forward P/E of 8.8x. Textainer Group Holdings Limited (NYSE:TGH)’s long-term EPS CAGR is 9.7%. The company’s GYP ratio is 2.1 times higher than the comparable ratio for the S&P 500. TGH’s dividend payout ratio is 48% of the company’s current-year EPS estimate.
The company controls 18% of the container leasing market. It has been profitable for 27 consecutive years and has paid dividends for 24 years in a row. As an income stock, Textainer Group Holdings Limited (NYSE:TGH) is attractive as its long-term leases provide secured and predictable revenue and cash flow streams. In fact, about 81% of its fleet is contracted on long-term and finance leases. Its financial performance is strong, with a revenue CAGR of 17% and EBITDA CAGR of 24% since 2008. A remarkable sign of TGH’s financial resilience is its ability to sustain profitability during deep recessions—with a strong example of the Great Recession in 2009, when the company’s operating margin dipped but was still high at close to 35%. Since then, Textainer Group Holdings Limited (NYSE:TGH)’s operating margin has climbed to above 50%. The fundamentals are strong as demand for leased containers remains firm, average lease utilization is close to record levels at 95%, and residual values are attractive. The impending acceleration in global economic growth will lead to a further improvement in the company’s fundamentals.
Aircastle
Aircastle Limited (NYSE:AYR), a company that acquires, leases and sells high-utility commercial jets, has a GYP ratio of 1.72, a result of a calculation based on a forward (2014) EPS growth rate of 11%, forward dividend yield of 4.2%, and forward P/E of 8.8x. Aircastle Limited (NYSE:AYR)’s long-term EPS CAGR is 24.4%. The company’s GYP ratio is nearly twice the GYP ratio for the S&P 500. Aircastle’s dividend payout ratio is 40% of the company’s current-year EPS estimate. The company has declared dividends for 28 consecutive quarters.
Aircastle Limited (NYSE:AYR)’s aircraft portfolio consists of some 159 aircraft on lease with 69 customers in 36 countries. The company is in a growth industry, and is projecting a total investment of $850 million or more to capture that growth. In fact, the company is planning to double plane leasing assets to $10 billion over the next five years, according to a Bloomberg article.
We like the fact that the long-term jet leasing market outlook is bullish, as Airbus forecasts a 4.7% CAGR in passenger traffic and a 4.9% CAGR in freight traffic over the next 20 years, above the pace of GDP growth. Especially robust will be growth in Asia-Pacific region. Also positive is the fact that the company has a strong portfolio that is consistently almost fully utilized—portfolio utilization was 98%-to-99% and rental yield was 14% over the past six years (in the first quarter, fleet utilization was 97% and rental yield was 13.6%). The company beat revenue and EPS estimates for the Q1 2013. It reported lease rental and financial lease revenues up 5%, reflecting benefits from new aircraft acquisitions, and adjusted EBITDA up 11%. Aircastle Limited (NYSE:AYR)’s valuation also impresses, as the stock is trading at a 20% discount to book value.
Final thoughts
There are many metrics out there that have beaten the market historically—see another one here—but the GYP ratio is underrated. Aircastle Limited (NYSE:AYR), Textainer Group Holdings Limited (NYSE:TGH), Herbalife Ltd. (NYSE:HLF), Ford Motor Company (NYSE:F) and American Railcar Industries, Inc. (NASDAQ:ARII) may not have much in common from an operational standpoint, but their presence on John Neff’s screen makes them worth watching for the remainder of 2013 and beyond.
Disclosure: none
