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Buffett’s ‘Secret’ Reveals 5 Stocks to Buy

Jonas Elmerraji |Contributor
Wednesday, 10 Oct 2012 | 3:34 PM ET

Warren Buffett’s got a secret. It’s a value investing metric that too many investors ignore today — and it’s spitting out a handful of stocks right now that are worth buying.

The metric? It’s book value growth. Sure, plenty of investors look at book value stats (book value per share and price-to-book are the two most popular), but most use it to measure a company's book value at a specific point in time — now.

Instead, looking at how book value changes over time can tip investors off to firms that are creating the most real fundamental value for shareholders, no matter what’s going on in the stock market.

Book value growth is a metric that’s highly thought of by legendary value investors such as Buffett and Ben Graham — and it’s a stat that Buffett’s own Berkshire Hathaway has embodied. The firm has generated annualized book value growth of 19.8 percent since 1965, besting the S&P 500 by more than double.

Of course we’re not looking at book value growth per share in a vacuum. Other factors favored by Buffett, such as a bargain price-to-earnings ratio, and tenable sales trajectory factored into these names as well.

With that, here’s a look at five other stocks that fit that book value growth mold.

Ford Motor

They love me. They love me not. That’s how Ford Motor must be feeling about investors right now. Ford emerged from the recession as the best in breed among automakers. It was the sole Detroit carmaker that didn’t go bankrupt after the crash, and significant quality improvements sent the firm’s sales rocketing in the years that followed, pushing to record profits last year. Put simply, the stock was a Wall Street darling — but investors can’t seem to stomach Ford now.

The thing is that Ford’s fundamentals are continuing their upward momentum. Management felt like the firm’s success was enough to justify paying shareholders again at the start of 2012 when the firm resumed its dividend, now a 2-percent yield. Quality continues to be a strong point for Ford in the 2013 model year, with positive reviews from automotive journalists across the firm’s full line of vehicles. And with interest rates scraping along historic lows, the costs of getting into a new car have dropped dramatically for many consumers.

To be sure, Europe is a big black cloud over Ford. The firm earns more than a quarter of its sales across the pond, owing to its dominant position in the European car market. But so far, Ford has been able to hold its head above water financially, going so far as to earn an investment grade credit rating for its debt once again.

Ford has been aggressively growing book value per share for the last few years, topping off our list.

Western Digital

Hard drive maker Western Digital is another name that’s turned out impressive book value growth, racking up a 32.3-percent hike in the firm’s book value per share over the course of the last year. Western Digital is now the world’s largest hard drive manufacturer, thanks to the acquisition of Hitachi’s hard drive business that closed in March.

Data storage, hard drives in particular, have been in high demand over the last few years as increasingly connected devices like smart phones hike the amount of data that consumers and companies store in “the cloud.” That positive trend for Western Digital isn’t showing any signs of abating right now. While Western Digital’s bread and butter has been the consumer and office market, the Hitachi acquisition exposes the firm to far more high-end enterprise drives that should help to deliver higher margins once the last integration costs of the acquisition fall of Western Digital’s income statement.

Financially, Western Digital is in good shape in spite of the debt load that the firm took on to fuel the purchase. The firm still boasts more than a billion in net cash, and a new source of cash flows that should help pad those coffers in the years ahead.

Joy Global

Milwaukee-based heavy equipment maker Joy Global is another book value growth name. The firm has pushed its book value per share 32.1 percent higher over the course of the last year. Coupled with a modest dividend payout and a sub-10 (price-to-earnings ratio), Joy Global is a good way for investors to seek value growth, even if the stock has a few headwinds.

The biggest headwind is the mining industry. Joy Global makes equipment like electric shovels and excavators used in surface and underground mines, so it’s enjoyed a large-scale multi-year rally as a result of a similar climb in hard commodity prices. But the potential for slower growth and a pullback in commodity prices has some investors scared right now, scuttling Joy Global’s share price. But central bank money printing is a big upside catalyst for commodity prices right now, and so is growth abroad. Emerging markets still hold a lot of hope for Joy Global in the next few years, particularly in China and India where Joy Global already has a presence.

Joy Global’s hefty cash generation should help to provide protection from any drops in demand for heavy equipment. And at the same time, that padding will help to hike the firm's book value per share, creating a fundamental backstop of sorts for investors.

If you’re looking for unique exposure to basic materials, you could do worse than this name.

Teradyne

Teradyne is the league leader in providing automated test equipment for the semiconductor industry. It’s also a leader in providing book value growth for its investors. In the last year, Teradyne has seen its book value per share climb by 25.5 percent.

Teradyne’s offerings help chipmakers operate. Lately, though, a falling tide has beached all ships in the semi industry, as demand waned and inventories lingered at relative highs. That slowdown in chip manufacturing had a brutal effect on Teradyne’s financial performance in 2008, but the firm took the slowdown as an opportunity to regroup, shoring up its business and consolidating its offerings into a single platform: FLEX. That rework has had stellar effects more recently as profit margins climbed to new highs and the firm’s balance sheet swelled with cash.

Today, Teradyne boasts more than $840 million in cash and investments, easily offsetting a $167 million in debt. In essence that means that around 24 percent of Teradyne’s market capitalization is made up of cold, hard cash. As semiconductors start ramping up production again in late 2012, that’s impressive positioning for a stock with a sub-10 P/E and a track record of book value growth.

Exelon

Last up is Exelon, the $30.5 billion power holding company that owns a mix of regulated and unregulated businesses. Exelon’s book value per share has grown more than 21 percent in the last year, thanks in large part to the firm’s acquisition of Constellation Energy, a deal that dramatically increased the firm’s overall size. The move also makes Exelon the biggest power retailer in the country.

Exelon’s heavy exposure to nuclear power is a big benefit for the firm, especially as prices for energy commodities continue to climb. Nuclear power plants are nightmares to build (both from regulatory standpoints and in terms of capital required), but they produce power more cheaply than almost any other source — and nuclear power makes up around 80 percent of Exelon’s output. And the high barriers to building new plants means that replacement costs exceed the conservative values carried on Exelon’s books.

The power business is capital intense, and Exelon’s balance sheet is no exception. That said, the firm generates enough cash right now to cover its debt obligations and to continue to pay out a huge 5.9 percent dividend yield. While growth in the payout may be a little less likely, Exelon’s book value growth is another source of tangible shareholder value that shouldn’t be ignored.

—By TheStreet.com Contributor Jonas Elmerraji

Additional News: Berkshire to Buy Two Huge Wind Farms

Additional Views: S&P Could Hit 1,575 Year-End: Pro

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Disclosures:

TheStreet’s editorial policy prohibits staff editors, reporters, and analysts from holding positions in any individual stocks. At the time of publication, Jonas Elmerraji had no positions in stocks mentioned.

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