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Buffett Disciples’ Two Value-Stock Picks

Warren Buffett, upon reading Benjamin Graham's Security Analysis, decided he had to attend Columbia Business School to study value investing.

As the story goes, Buffett read the book so many times that when he finally enrolled in Graham's course, he could quote the text from memory. He received his degree in 1951. Columbia, still the educational epicenter of value investing, offers an MBA with a focus on the methodology.

Buffett, who turned 80 this year, announced this week that 39-year-old hedge fund manager Todd Combs will eventually manage the investment portfolio at Berkshire Hathaway , the holding company he built and has run for decades. Combs also attended Columbia Business School.

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In the Columbia Business School newsletter Graham and Doddsville, aspiring Buffetts write-up their stock ideas. Here is a look at two pitches in the fall edition.

CoreLogic sells consumer, financial and property data as well as analytics and services to businesses and government agencies. Its products include appraisals, broker price opinions, data repository solutions, default and REO valuations and other advanced data and services.

CoreLogic was spun off from insurer First American in June. Its stock has dropped 7.9% since, hitting a 52-week low on Aug. 31. But, the shares have rallied 4.3% from the recent trough.

Alex Latushkin makes a compelling argument for CoreLogic, noting that it boasts a leading market share in a niche segment, holds five patents, has a management team that has been working together for 15 years and enjoys a low-cost business model, with more than 50% of its employees working in cheaper overseas markets. Latushkin's bear-case entails a stock price of $14, suggesting 22% downside. His bull case is $37, implying 105% of growth potential.

CoreLogic is scheduled to release third-quarter results Nov. 4. Second-quarter adjusted net income decreased 17% sequentially to $24 million, or 35 cents a share. CoreLogic missed analysts' consensus earnings target by 17%. Its operating margin contracted from 12% to 5.4%. Return on assets touched 4.1% and return on equity came in at 6.6%.

Seven analysts cover CoreLogic. One rates it "buy" and six rank it "hold." None rate it "sell." A median target of $21.75 suggests the stock has roughly 21% of upside. Barclays and KBW expect the shares to command $22, implying a one-year gain of 21%.

Based on peer valuation, CoreLogic is cheap. It trades at a trailing earnings multiple of 17, a forward earnings multiple of 14, a book value multiple of 1.3, a sales multiple of 0.5 and a cash flow multiple of 5.9, reflecting discounts of 17%, 24%, 82%, 84% and 66% discounts to IT services industry averages.

In the latest quarter, institutional investors scooped up shares. Of the stock's 30 largest holders, 17 amplified their bets, four held steady and nine lessened their positions. Fidelity Management is the largest shareholder, with 7% of the float.

U.S. Physical Therapy operates outpatient physical and occupational-therapy clinics. Ostensibly, it appears to be more growth than value. But, as Buffett notes, those that differentiate between growth and value tend to misunderstand his philosophy. U.S. Physical has boosted sales 15% a year, on average, since 2007. It expanded net income 25% a year, on average, over that span, as its stock delivered annualized gains of 8.4%.

Columbia's Ryan Coyle argues that U.S. Physical is a compelling value investment given secular demand growth, free cash flow and the opportunity to acquire in a fragmented marketplace. Citing the Bureau of Labor Statistics, Coyle notes that U.S. demand for physical therapy will grow 4% a year through 2016 as Baby Boomers undergo operations and injury. A demand shift and a shortage of therapists suggest that the therapy market is rife with opportunity for U.S. Physical, which held $7.2 million of cash and $4.3 million of debt in the second quarter.

The company will report third-quarter results Nov. 4. Second-quarter profit grew 23% to $4.5 million, or 38 cents a share, as revenue ascended 4.5%. U.S. Physical beat the earnings consensus by 4.7%, but its stock declined 0.6% on the news. The operating margin rose from 16% to 18%. Return on equity widened from 13% to 14% and return on assets climbed from 9.6% to 10%. U.S. Physical is loved by the sell-side. All six analysts covering the stock rate it "buy." A median target of $21.50 suggests a looming 12-month return of 13%.

Based on peer valuation, U.S. Physical is inexpensive, but not downright cheap. It trades at a trailing earnings multiple of 17, a forward earnings multiple of 14, a book value multiple of 2.3, a sales multiple of 1.1 and a cash flow multiple of 7.7, on par or at slight discounts to health-care-provider industry averages.

Institutional investors tell a different story than brokerages. In the latest quarter, 10 of the stock's 30 largest holders purchased more shares, 17 reduced their positions and two held steady. TheStreet's stock model, which is notably conservative, rates U.S. Physical "buy" with an overall grade of A-minus and a price target of $24.33.