Valuation Matters: 3 Undervalued Stocks For January 2023

Hey everyone,

I believe that the strategies I employ in my portfolio are applicable to the broader context, and to most people looking for conservative growth, mixed with appealing income.

This mix of income and growth is based on finding companies that, at the time of purchase, fulfill the following criteria:

• Fundamentally sound (Credit rating, balance sheet, management)
• Paying a well-covered dividend that’s likely to grow.
• Attractively valued, with potential for at least 8.5-9% annual CAGR on a conservative basis, including company dividends.

If a company fulfills these basic requirements, it can be a “BUY” for me – and I use a mix of such companies to construct an attractive investment portfolio – both for the longer, shorter and medium term.

My strategy entails using such investments, but not being a B&H-forever investor. While there are companies that I would hold for a very long time, no company is, or (in my view) should be immune to trimming or selling as a result of overvaluation.

Time and time again, it’s been clearly shown that the market has a tendency not only to overreact, but to do so violently, and to be able to do so extensive periods of time.

Therefore, my strategy consists of buying quality companies when they’re cheap, and trimming/selling them off when they’re reaching excessive levels, reinvesting the now-profit-induced proceeds into cheaper companies to repeat the cycle anew.

A fairly simple strategy that I believe can be understood by anyone.

Of course, it’s tricky to know either when a company is cheap, or when it is expensive. Mistakes can be made.

Cheapness can be misinterpreted, and even if you buy it cheap, things can happen that end up making the company even cheaper. An insurance company taking a huge writedown. A utility losing a rate case, influencing profits as well as dividends. A global event causes the entire supply chain as well as the manufacturing base of a previously-thought “safe” company to crumble, leading to long periods of significant undervaluation even well below what we saw when we bought it at what we thought was a “cheap” price.

Things can happen – and they do happen.

Because I don’t invest in growth-type stocks, It doesn’t/hasn’t happened as often that I’ve misinterpreted overvaluation. Oh, sure – sometimes a company can keep climbing a bit more. I sold a few dollars too early in trimming some investments – but not to any degree that I “missed out” on a large profit – at least not until now.

This would be different if I invested in companies earlier in their stage of development or growth. When it comes to such investments, it becomes important not to trim when you “think” it has reached it’s high – because your entire thesis may be based upon that company rising 10,000%.

But that is not how I invest – at least not at this time.

What I do is use a combination of common stock investments, dividends, and the selling of cash-secured/covered options to garner returns in the double digits on an annual basis.

It’s not the type of strategy that will turn your $10,000 into $1,000 000 quickly – not without you investing a substantial amount. It’s the sort of strategy that I view as very advantageous when you already have a decent-sized portfolio that you want to grow in a safer manner. Or, as most of my readers, you’re not yet “rich”, but you’re looking to grow safely and not go left field.

Safe growth takes time – but it’s just that. It’s safe.

Some considerations for January 2023

We’ve started the year out with a bang. I’m up almost double digits already in my portfolio, owing to a mix of very positive EU development with solid incoming dividends from companies similar to the ones I’m going to be presenting you with today.

However, all this should be viewed as potentially temporary. My concern is that I, generally speaking, and over the longer term, outperform broader indices because if I don’t, I might as well put my money in an index fund and spend my free time doing something else.

Because I do exactly that though, and because I beat broader indices by 32-40% last year (by not having an FY22 loss, above all), owing to exactly the dividends and undervaluation I spoke about, that means that part of my own free time is best spent managing my own investments.

Despite the positive development we’ve seen, I fully expect, and actually hope that we see a decline in the shorter term again, to allow me to load up more on qualitative stocks (like the ones I’m going to be presenting here).

January has brought us some positive news in the form of inflation normalization, albeit a slow one, in most EU/NA territories, with countries that have lagged their interest rates like Sweden seeing not seeing inflation going down just yet.

The inflation/recession fears, as well as the geopolitical play with Ukraine/Russia, is what currently form the basis of my continual investment thesis, and how I allocate my incoming capital overall.

And as it stands, there’s plenty of capital to allocate – although I still maintain a large cash position (for my standards) at around 5.7%.

So the core of my message for January here is to stay careful and conservative – I would not give into the instinct to perhaps invest more as the market rises – not more than you would otherwise, at any time.

The signals we’re currently seeing only indicate that the negative trends are slowing down – not that they’ve stopped.

So, without more chatter, here are the three companies I would consider among the better to invest in at this time.

As always, the companies I present to you are:

• At least BBB-rated
• At least 3% yield, preferably 3.5-5%
• Fundamentally sound with an upside of over 8% annually on a conservative basis
• I already own at least 0.5% of my portfolio in the company’s I present, or plan to buy as much within 24-48 hours of publishing.

The companies for January 2023

1. Essex Property Trust (ESS)

First on this list is a REIT that, despite not having seen a single negative cent of forward FFO, has lost every bit of premium and is now trading at close to 15x P/FFO.

On a high level, Essex seems really like the perfect sort of Residential REIT. You have a BBB+ credit rating, a yield of 4%+ that’s more than covered by a superb FFO, and stable underlying operations. Essex has a market cap, following the decline, of around $14B.

The REITs assets cater to the middle and upper middle class, typically a group more resilient to changes in economy and inflation, and this is reflected in the continual low rates of impaired rents and nonpayment.

The company’s driving characteristic is that it’s primarily a west-coast exposed residential REIT. This, of course, comes with its share of issues in the current macro and geopolitical climate as well as market trends. However, the way that the market is treating the company because of this is excessive, to say the least.

The REIT, furthermore, has a strong tradition of offering one of the highest overall total RoR of all Public REITS since its IPO back in -94, and it’s a dividend aristocrat with a 28-year history.

That dividend isn’t going anywhere, as I see it.

The company’s current conservative upside begins at 8.5% annually for essentially a flat development without any reversal to normalcy. However, any reversal to the 20x P/FFO will bring with it annual rates of return closer to 20% annually here until 2025 or a total of almost 70% – by investing in a BBB+ rated REIT that rents out something people need no matter what – living space.

This is the sort of investment I love investing in. It’s safe, the upside is clear, the risk for more downside seems limited, and even if a downside does occur, the fundamentals are so solid that Essex will be able to weather most downturns with a smile unless it’s something truly fundamental.

But hey – that’s why I target no more than 2-4% in any one company.

So, Essex is a “BUY”-rated REIT with a yield of over 4% here. It’s my first choice to present you with for this month.

I presently own 2.2% in ESS, my rating is “Buy” and I’m buying more.

2. Citigroup (C)

Okay, so you might have missed out on some of the very early opportunities here – we alerted Citigroup weeks ago on iREIT on Alpha, but the upside for this bank is still very significant. I love investing in finance – all aspects of it. I invest in insurance, reinsurance, banks, brokers as well as some niche finance businesses.

Citigroup’s appeal here isn’t necessarily a stellar business that always has been solid – but a stellar/fundamentally sound business with BBB+ rating that’s massively underappreciated.

Citi is the third-largest banking institution in the US, and it’s one of the “big four”. After the crisis in -08, I’ve been following most bigger banks and their efforts to increase their safety and capitalization. Citi is no different there, and they have managed to do this quite well.

I would generally say that solid banks, no matter where they are as long as they’re in what we would consider the “west”, which also includes Southern Europe, deserve a P/E multiple of 8-11x. That’s where I usually accept “Most” banks. If some are higher, I may accept this based on their fundamentals. If some are lower, this may be a decent justification if the bank doesn’t have the “best” fundamentals or upside.

Citi, like Essex, trades at a 4%+ yield that’s very well-covered. The bank currently trades at around 7x P/E which by itself implies a bit of undervaluation here.

Things become even better when we look at historical and forecasts.

Citi is estimated to see negative RoR for its EPS in 2022 and 2023 – but follow this by a reversal in 2024 and 2025, which should see normalization go up into double digits. Even if we only assume a flat development, with these forecasts and the bank’s fundamentals in mind, we find ourselves with an upside of 13% annually, or 46% in 3 years.

The company has an upside as high as 27% per year, or over 100% in 3 years, if we see full normalization on par of the company’s valuation to a 10x P/E – only 10x, no more than that.

I do not view this as an unrealistic prospect in the least. So why am I not yet more invested in Citigroup?

A few reasons. The company is in a downward trend due to EPS. That means that generally speaking, the stock won’t rise too far (going by history of other stocks in the same situation). I believe we’ll have opportunities to buy cheap, or even cheaper, in the next 12 months or so. So I’m tiering my investments here.

But Citi is a “BUY” here.

I presently own 0.63% of C in my portfolio, my rating is “Buy” and I’m buying more.

3. BASF (OTCQX:BASFY)

BASF has been growing a fair deal since it’s low below €45 native, and I’ve been continually loading up on the stock. Yes, the company is expected to see significant profit impacts not just for 2022 but for 2023. However, think back to around half a year when many investors were forecasting catastrophe for the company. There was talk about shutting down Ludwigshafen, and that BASF would not survive the natgas shortage.

Well, I forecasted this not to be as fundamental an issue as some – and I turned out right. Ludwigshafen did not shut down. Top-line growth is strong. I’ve been reporting on and calling BASF, among others, to be one of the better plays available in the EU for the past half-year or so. the company might not have looked the part, given everything that’s going on. However, in the recent bout of market reversal, things might have indeed been starting to take a different tune.

Remember, I’ve impaired and discounted my overall targets for BASF several times, accounting for Wintershall DEA, energy troubles, for other issues several times now. An analyst-wide PT of €90+ turned into one of around €55-€60/share, and it was justified.

All of this led to my current, 5.6% position in BASF yielding well over 6.8% on my current cost basis – and that’s from the largest chemical company on earth. The reason it’s so large is that I bought more when it was cheap – and now that the company is rising, and due to positive FX and my native SEK currency, we’re seeing substantially positive RoR and good trends.

Despite massive inflation, and energy prices, China was restricted by COVID during most of 2022 and restrained macro, and increased interest rates, top-line production grew by 2% in 3Q22, and BASF recorded a moderate demand growth in key customer areas. This especially came from logistics and agro, while infrastructure was predictably down.

On a before-special items level, the company achieved very solid EBIT despite massive input headwinds and energy pricing issues. Highlights came in, especially from downstream segments, which managed to push prices.

The question that analysts seem preoccupied with is just how deep and how long the trough will be before BASF gets back to normal-level earnings, and how this could not be impacting the dividend.

My answer to that is the following.

Valuation-wise, we’re seeing very good trends despite the company climbing back up above €50/share. In the case of full normalization, which for the world’s largest chemical company with an A rating is something I view as valid, the upside is still close to triple digits.

Here are some of the impairments I’ve made to my forecast model.

• A GDP Slowdown

• €4-€5B impairment on Wintershall DEA, based on its 50-62% dependence on Russia, and the 72.7% BASF Stake, due to dividend postponements, Nordstream 2 financing, no additional Russian projects/transactions

• Increased energy cost for all of the company’s segments, though primarily for the operations in the EU, lowering my top-line long-term growth rate by 100 bps.

• Significantly changed NAV/SOTP valuation multiples for the company’s oil/gas business (Wintershall). The value of the reserves is unchanged.

• It’s also conceivable that finance costs/debt spreads might increase slightly due to the postponed IPO, which nullifies the expected cash injection and may necessitate the green debt market with a somewhat higher debt cost.

• I’m risk-adjusting my valuation for the segment and cutting it to less than €4B in valuation for the entire BASF stake. For the remaining segments, I use EBITDA multiples ranging from 4.5X (chemicals) to 13.5X (agri). The adjusted NAV comes to around €59B on a net basis, which comes to a treasury-adjusted NAV/share of €66-€67 on a per-share basis, down from the mid-70s.

I continue to give BASF a PT of €70 – which is almost €14 above the current S&P average, and my target is for the long-term, beyond this current crisis. I do not mind holding BASF for a long time as this upside materializes – similar as with other companies.

I presently own 5.6% of BASF in my portfolio, my rating is “Buy”, but I don’t buy more due to having reached my allocation limit.

Wrapping up

So, these are my buying “tips” for January of 2023. My aim is to be able to provide you with at least 3 such names that combine these qualities and which I also own, or invest in, every single month.

It’s my fondest hope that by doing this, more readers understand and “fall in love” with value investing, which continues to be the guiding principle of my investment ambitions.

If you have any questions about this approach, or my current picks presented here, feel free to ask them and I will make sure to get back to you and answer them as best I can.

But for now, these are my “quick picks” for the time being, and for the month of January – even if we’re in mid-January here.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.