As the past several years of market turbulence have illustrated, stock prices can definitely swing wildly in the short-term. Even the seemingly strongest companies can suffer serious price declines at times, leaving investors looking with disbelief at the new, drastically reduced value of their holdings.

IN PICTURES: 20 Tools For Building Up Your Portfolio

While it's true some companies have fared better than others over this most recent challenging period, it is too difficult for the individual investor to identify those particular safe haven stocks beforehand. A more realistic strategy for the individual investor is to limit purchase selections for your portfolio to only those stocks that have limited downside risk potential in the first place. That way, on average, your portfolio will probably be safer than the overall market and will be less likely to suffer serious price declines when difficult times inevitably arrive again.

Finding Safety in Book Value
Ben Graham, who is generally regarded as the father of value investing, preferred constructing portfolios with only those stocks that traded at a low price-to-book value multiple. In fact, Graham would only buy a stock if it traded at a price less than two-thirds of its book value. While some of those low priced stocks would truly be losers, Graham reasoned that, on average, the portfolio as a whole was likely to be undervalued, and thus on average end up a winner. (Learn more on book value, in our article Digging Into Book Value.)

While this strategy worked well for Ben Graham, times have changed significantly since his era, and it is typically not feasible for individual investors to construct an entire portfolio of stocks priced well below book value. There are just too many smart people participating in the market for that many bargains to be left lying around for too long Even so, starting with a shortlist of stocks trading at low book values is a great place to begin searching for undervalued stocks. Here are five stocks that may very well turn out to be book value bargains as envisioned by Graham so many years ago:

Company Market Cap Price/Book Value Forward P/E
DryShips (Nasdaq: DRYS) $975 M 0.4 3.1
BP plc (NYSE: BP) $91.2 B 0.9 4.2
Loews (NYSE: L) $14.1 B 0.8 8.3
Sun Healthcare Group (Nasdaq: SUNH) $345 M 0.8 7.9
SUPERVALU Inc. (NYSE: SVU) $2.3 B 0.8 5.7
Data as of market close, July 5, 2010.

BP: Bargain or Bust?
Despite the obvious problems BP is currently facing regarding the gulf oil spill, the cost of which has now eclipsed the $3 billion mark, the company will likely survive. Regardless of your opinion of the environmental consequences of the gulf spill and who is ultimately responsible for it, the fact is that the incident has caused BP shares to plunge, falling from the $60 range in April of this year to currently trade around $31.

While BP's problems are no doubt serious, its halved share price begs the question of whether the entire value of the company's future earnings is really going to be half of what it would have been had this incident not occurred. After all, a company with a market cap north of $90 billion should be able to deal with a $3 billion accident without ruining half of its entire business.

And even if so, the company is already trading at a steep discount to its integrated oil and gas peers. For example, Chevron (NYSE: CVX) currently carries a forward P/E of 6.7, while Exxon Mobil (NYSE: XOM) is priced at 8.2. Even with BP's current conundrum, is its forward P/E ratio of only 4.2 really justified when such similar companies are trading at valuations 1.5 to two times higher?


The Bottom Line

Just as Ben Graham reasoned so many years ago, buying companies trading at low price-to-book valuations is not a surefire way to pick winning stocks. Some will definitely turn out to be losers, but on average, an entire portfolio of stocks purchased at low book values will likely do well. In BP's case, the company has a long history of solid operating performance and long-term growth. Assuming the gulf oil spill does not completely ruin the company, investors who buy into the stock at such a low book value may very well end up seeing Ben Graham's reasoning reflected in their portfolio's returns in the years to come. (For more, see 4 Steps To Picking A Stock.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  2. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  3. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  4. Mutual Funds & ETFs

    ETF Analysis: WisdomTree SmallCap Earnings

    Discover the WisdomTree Small Cap Earnings ETF, a fund with a special focus on small-cap and micro-cap stocks with positive earnings.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares US Regional Banks

    Obtain information and analysis of the iShares US Regional Banks ETF for investors seeking particular exposure to regional bank stocks.
  6. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  7. Technical Indicators

    Key Financial Ratios to Analyze the Mining Industry

    Discover some the most important financial ratios used by investors and analysts to evaluate companies in the metals and mining industry.
  8. Technical Indicators

    Key Financial Ratios to Analyze Retail Banks

    Learn about key financial metrics that investors use to evaluate retail banks, and how the industry is fundamentally different from most other industries.
  9. Technical Indicators

    Key Financial Ratios to Analyze Airline Companies

    Examine some of the most important financial ratios and performance metrics investors use to evaluate companies in the airline industry.
  10. Stock Analysis

    The 5 Biggest Canadian Oil Companies

    Obtain information about some of the largest and most successful major integrated oil corporations that are headquartered in Canada.
RELATED TERMS
  1. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  2. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  3. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  4. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  5. Net Present Value - NPV

    The difference between the present values of cash inflows and ...
  6. Long-Term Debt

    Long-term debt consists of loans and financial obligations lasting ...
RELATED FAQS
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>
  6. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!