4 Buffett and Graham buys

For double the value, these stocks meet the investment criteria of two legendary value investors.

By TheStockAdvisors Apr 12, 2013 10:05AM

Financial Stock Chart Kick Images Photodisc Getty ImagesBy J. Royden Ward, Cabot Benjamin Graham Value Letter


Benjamin Graham has been recognized for decades as the father of value investing. Warren Buffett was a student of Ben Graham at Columbia University and later worked for Mr. Graham for several years.


For this Special Report, I combine Warren Buffett's and Ben Graham's criteria for choosing stocks. During the past eight years, I have featured Graham-Buffett Stocks on 16 occasions. Over that period, these stocks have increased 77.% vs. 28.8% for the S&P 500.


To find new investment opportunities for you, I looked for stocks with:


1. Free cash flow more than $20 million.

2. Net profit margin more than 15%.
3. Return on equity more than 15%.
4. Discounted cash flow value higher than current price.
5. Market capitalization more than $1 billion.
6. Standard & Poor's rating of B+ or better.
7. Positive earnings growth during the past five years with no deficits.
8. Dividends currently paid.


They sell at sensible prices, offer reasonable appreciation potential and provide solid dividends. I am confident these high-quality stocks will fare very well during the next six months.


Aflac

Aflac (AFL) is the world's largest supplemental cancer insurance provider, deriving 75% of its business from Japan. Aflac's focus on new products, such as hybrid whole life insurance products, and its successful promotions in Japan are producing outstanding performance.


Sales increased 12%, and earnings per share soared 39% in 2012. Insurance policy sales in Japan are growing more rapidly than expected.


Growth should continue at a rapid pace in 2013, too. Japan's new prime minister has announced several worth-while programs to bring Japan's economy out of the doldrums, which will help Aflac's sales. In addition, sales in the U.S. have improved noticeably.


AFL shares sell at 8.7 times 2012 earnings per share, which is well below Aflac's 10-year average price-to-earnings ratio of 10.6. AFL shares are medium risk and sell at a significant discount to S&P's discounted cash flow value of $58.00. The 2.8% dividend yield adds significant value.


American Express

Established in 1850, American Express (AXP) is a leading global payments and travel services company. Sales and earnings declined in 2008 and 2009, but rebounded to record levels in 2011 and 2012.


American Express's strong balance sheet and low customer defaults helped the company weather the recent recession. I forecast sales growth of 6% and earnings per share growth of 11% in 2013, compared to slower growth in 2012.


The company's new technologies in digital and mobile payments will help produce solid growth during the next several years. A stronger or more stable global economy could spur more spending by businesses and consumers, thereby boosting revenues.


AXP shares are undervalued at 14.8 times latest earnings per share. The stock sells at a sizeable markdown to S&P's discounted cash flow value of $76.00. The shares are low risk and offer a dividend yield of 1.2%. Warren Buffett's Berkshire Hathaway owns 13% of AXP.


PetSmart

PetSmart (PETM) provides top-quality pet products and services in North America. In 2012, PetSmart's 1,278 stores produced an industry-leading $6.8 billion in revenue.


Virtually all PetSmart stores offer complete pet training services and high-quality grooming services. In addition, PetSmart offers full-service veterinary hospitals in 799 of its stores. PetSmart operates 196 PetsHotels within retail stores, and expects to expand this concept.


Sales advanced 10% during the past 12 months, while earnings per share jumped 25%. Management expects slower growth; the announcement of this caused PETM's stock price to drop to a more reasonable price. I expect sales to increase 6% and earnings per share to rise 14%.


PETM shares are reasonably valued at 17.5 times current earnings per share with a dividend yield of 1.1%. Shares currently sell at a substantial markdown from S&P's discounted cash flow value of $80.00. The company operates in a recession-resistant industry and will therefore produce steady growth in future years.


UnitedHealth Group

UnitedHealth Group (UNH) provides a broad range of health care benefits and services, including health maintenance organizations (HMOs), point of service (POS) plans, preferred provider organizations (PPOs) and managed fee for service programs.


Gains from the rising Medicare population will be offset by future rate cuts in Medicaid and Medicare during the next several years. Although details in the Affordable Care Act are lacking, the increased Medicare population will likely more than offset rate cuts.


In July 2012, the U.S. Defense Department awarded its Tri-Care contract to UnitedHealth. The five-year contract will provide a noticeable boost to sales and earnings.


In addition, the recent acquisition of XLHealth, which serves seniors with special needs, will add to sales and earnings in 2013 and beyond.


UnitedHealth is gaining market share by lowering costs and increasing services to customers. I forecast revenue and earnings per share growth of 9% in 2013.


At 10.3 times latest earnings per share, UNH shares are undervalued. UNH shares sell well below S&P's discounted cash flow value of $65.00. The 1.6% dividend yield and very low risk rating make UNH an excellent investment choice.


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