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Smaller undervalued stocks have greater potential to return multiples of your investment.
The difference between smaller undervalued cheap stocks and mega-caps are that the latter have already enjoyed the bulk of their long-term gains. They can only get so big. Plus, at one time, they were also small stocks.The smallcap and midcap sectors thus offer the biggest selection of stocks that could return multiples of your investment. They have room to grow. If you choose the right undervalued cheap stock and stick with it, that’s how fortunes are made.
There’s one other criteria to this undervalued cheap stock approach that I often employ. While I love growth stocks and they have a lot of potential for multi-bagger gains, I look carefully at undervalued stocks. These are stocks the market often hasn’t rewarded yet for any number of reasons.
I performed a screen for undervalued stocks between $2 billion and $10 billion in market cap, with a PEG ratio under 1.0 (indicating its P/E ratio is less than its EPS growth rate), and that cost less than $15 per share. I evaluated the list and came up with three candidates that I think could double in share price.
Undervalued Stock #1: International Game Technology (NYSE:IGT)
International Game Technology (NYSE:IGT) came as a real surprise. International Game Technology had long been the premier name in the world of gambling infrastructure, providing the most interesting slot machines and other computerized games to the gaming industry. What happened? Well, I lost track of the company years ago and things have changed.
The big change: competition. There have always been several players in the sector – names like Bally Technologies (NYSE: BYI) — but each began stealing market share from International Game Technology, and pricing pressure started to cut into earnings for everyone in the sector.
Still, International Game Technology is an undervalued cheap stock that remains a very viable business. It has a solid balance sheet with $828 million of cash on hand, and $1.35 billion in debt – although that debt is taking a real toll on net income to the tune of $123 million annually. That’s almost 25% of operating income. Still, it throws off well over $300 million of free cash flow each year.
International Game Technology is an undervalued cheap stock here at $14.40, with long-term EPS set to grow 19% long term. On next year’s EPS of $1.27, that puts fair value around $24 for next year, and $28.80 the year after – a 100% return from here.
Undervalued Stock #2: Och-Ziff Capital Management Company (NYSE:OZM)
Och-Ziff Capital Management Company (NYSE:OZM) is a controversial name these days, and that’s why it’s been unreasonably discounted. Och-Ziff is an undervalued stock that provides investment advisory services, invests in equity markets, real estate, loans, operating companies, cell towers, parking, golf, debt and senior housing.
The firm is under scrutiny by the SEC and DOJ because of investments it made in a Democratic Republic of Congo diamond mine and in certain transactions in Libya. I think these investigations are fishing expeditions, and that Och-Ziff is not likely to risk its existence on illegal deals. The stock sold off from $16 to $13.
Analysts project 20% long term EPS growth, which on FY14 EPS of $1.25 implies a fair value of $25 this year, and on FY15 EPS of $1.73 suggests fair value of $34. That’s more than 100% upside. It also pays a 7% yield.
Undervalued Stock #3: Fortress Investment Group (NYSE:FIG)
Fortress Investment Group (NYSE:FIG) is a legendary investment firm that offers investment managing services to virtually every kind of business that requires such services: pension and profit sharing plans, corporations, institutions, banks, charities, and municipalities. It runs hedge funds, private equity funds, trades currencies and commodities…you name it.
Fortress is an undervalued stock that makes its money by charging fees for its services and making money on its own investments. It has an amazing balance sheet with no debt and $1.55 billion in cash. It had repurchased almost 12% of its shares.
Here’s the kicker – the company has $7 per share in cash and the stock trades at $7.89. That means the market values its investments and fee services at zero. That’s crazy and that’s why the stock is going to double from here, at least.
Lawrence Meyers does not own shares in any company mentioned.
A crushing blow to Honda and Toyota
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