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John Dorfman

John Dorfman: Price-to-book ratio — And you thought this gun wasn't loaded

John Dorfman
| Monday, Nov. 12, 2018, 8:42 p.m.

A gun that everyone believes isn’t loaded can be an especially potent weapon.

In the stock market, the price-to-book ratio is such a weapon. Many people dismiss it as an obsolete stock-picking tool.

Obsolete? Hardly. I have written 17 columns since 1998 recommending stocks with a low price-to-book ratio. The average 12-month gain on these recommendations has been 16.8 percent, which beats the 10 percent average return for the Standard & Poor’s 500 Index by nearly seven points.

Of the 17 columns, 12 have been profitable and 11 have beaten the index.

Bear in mind that my column recommendations are theoretical and don’t reflect actual trades, trading costs or taxes. Their results shouldn’t be confused with the performance of portfolios I manage for clients. And past performance doesn’t predict future results.

Book value is the value of a company’s assets, minus the value of its liabilities. Only about 10 percent of all U.S. stocks are currently selling for less than book value.

For those who want to join me in using this venerable stock-picking tool, here are four stocks I like now that are selling below book value.

Loews Corp.

Loews Corp. (L), which sells for 82 percent of book value, is a conglomerate controlled by the Tisch family. Its composition has changed gradually over the years. Gone are Lorillard Tobacco, Loews movie theatres, CBS television and Bulova watch, among others.

The company’s main business unit today is CNA Financial, a big commercial property & casualty insurer. Of less significance, but still material, are Diamond Offshore Drilling Inc. (53 percent owned), Boardwalk Pipeline Partners LP (100 percent owned, as of this summer) and Loews Hotels.

The hotel unit is showing nice growth, and the two energy companies have great comeback potential if the oil and gas industry shows more than the halfhearted recovery it has so far.

Bank OZK

I’ve lost a bundle of money in Bank OZK shares this year, but I think the stock’s recovery potential is excellent. The bank is based in Little Rock, Ark., and specializes in construction lending. For years, it had higher profitability and a lower percentage of bad loans than its competitors.

It stumbled in the latest quarter, as two loans soured — one for a shopping center and one for an apartment complex, both in the Carolinas. In a conference call, CEO George Gleason said that these were two out of only five loans to go bad in the past 15 years.

Gleason said he doesn’t expect to see many more loans go bad, and I think he has excellent credibility. I have kept the stock in retirement accounts I manage and sold it in taxable accounts for a tax loss, but with the expectation of buying it back. At $25.45, the stock sells for 93 percent of book value.

Ultra Clean

As its name implies, Ultra Clean Holdings Inc. (UCTT) helps to assure pristine conditions in semiconductor manufacturing facilities. It also specializes in gas delivery systems, used in many parts of the chip manufacturing process.

A small-cap stock that is lightly covered by Wall Street, Ultra Clean is currently followed by only four analysts, all of whom recommend it. The stock is very cheap — 85 percent of book value and less than five times recent earnings — because many people fear that the semiconductor business cycle has already peaked.

Maybe it has, but at these prices it might be worth climbing on for a dangerous, but potentially lucrative, ride.

Transocean

Struggling badly is Transocean Ltd. (RIG), an offshore drilling company. Sales are running a third of what they were four years ago, before the oil industry collapsed. Earnings are negative, and analysts think they will stay that way this year and next.

These problems are, I think, adequately reflected in the stock’s price, which is only 41 percent of book. The share price has cascaded downward from about $170 11 years ago to less than $11 a share now.

This one may be untimely, but for bold contrarians with a patience, it could be a big gainer.

Last year

Last year, unfortunately, was a dud. My low price-to-book recommendations from Nov. 14, 2017, posted a 7.2 percent loss through Nov. 9, 2018. In contrast, the S&P 500 returned 9.9 percent. Weis markets Inc. (WMK) was a big gainer, but substantial losses in Tutor Perini Corp. (TPC) and China Yuchai International Ltd. (CYD) dragged down the results.

Disclosure: I own Bank OZK personally and for many of my clients. I own China Yuchai personally and for a few clients. I own Tutor Perini for one client.

John Dorfman is chairman of Dorfman Value Investments LLC in Newton Upper Falls, Mass., and a syndicated columnist. His firm or clients may own or trade securities discussed in this column. He can be reached at jdorfman@dorfmanvalue.com .

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