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4 stocks with real value in real estate
Value beat growth in 2004 -- and value stocks with assets did best of all. These companies, all holding lots of property, should continue the trend.
By Jim Jubak
Value beat growth hands down in 2004. And I think this style of investing will come out on top again in 2005. Too bad it's so hard to define what value investing is.
I'm sure not going to put an end to the debate between different schools of value investing in this column. But I will give you my formula for a value investing strategy that will be best of the best in 2005 -- and three new value stocks to add to your portfolio.
Pick pretty much any benchmark you like: Value trounced growth in 2004. Among the Russell indexes, for example, the large-cap Russell 1000 Value Index ($RLV.X) returned 16.5% for the year while the Russell 1000 Growth Index ($RLG.X) returned 6.3%. Go all the way to small-cap stocks at the other end of the size spectrum, and the Russell 2000 Value Index ($RUJ.X) returned 22.3% while the Russell 2000 Growth Index ($RUO.X) returned 14.3%. The results for the Russell 3000 indexes, which include everything from the largest of large caps to the smallest of small caps, are similar: 16.9% return for the Russell 3000 Value Index ($RAV.X ) and just 6.9% for the Russell 3000 Growth Index ($RAG.X).
Value-growth vs. value-asset
But what exactly is a value stock? It's by no means clear. William Miller and Martin Whitman are two legendary value investors in the mutual-fund universe, for example, but they don't define value the same way at all.
Miller owns Amazon.com (AMZN, news, msgs) and eBay (EBAY, news, msgs) in his Legg Mason Value Trust (LMVTX, news, msgs) because he thinks the shares are cheap relative to his estimates of what the stocks will be worth in the future, given their likely earnings-growth rates. I'd call Miller a value-growth investor: His goal is to find stocks that trade at bargain prices because the stock market consensus underestimates that future rate of earnings growth.
Top holdings in Whitman's Third Avenue Value Fund (TAVFX), such as The St. Joe Company (JOE, news, msgs) and Tejon Ranch (TRC, news, msgs), on the other hand, joined his portfolio when they had erratic and relatively small earnings streams. Whitman bought them because the assets each company owned -- in the case of these two companies, primarily land -- were worth, by his calculation, at least 20% more than the market price of the company's stock. I'd call Whitman a value-asset investor: His goal is to find companies with assets that are undervalued by the stock market consensus.
Both approaches work in the long run
In the long run, I think an investor can do just fine following either definition of value: Whitman's 10-year average annual return on his Third Avenue Value fund is 15.6% and Miller's on the Legg Mason Value Trust is 18.6%. Both are home runs in my book.
But in the short term, the characteristics of a specific stock market will reward one strategy of value investing more than another. In 2004, for example, Whitman's fund returned 26.6%, Miller's 12%.
I think I can explain that for 2004. Investors spent much of last year worried about the rate of earnings growth. Earnings growth had been great in 2003. But it looked, at times this year, uncertain for 2004. And projections called for growth rates for earnings on the Standard & Poor's 500 ($INX) to drop from around 20% in 2004 to about 10% in 2005. Investors who worried about that scenario reduced the multiple that they would be willing to pay for current earnings growth to compensate for the risk that future growth would be slower. So even if earnings did rise in 2004, in many cases price-to-earnings ratios contracted enough to result in only a meager gain or even a slight loss.
2004 favored value-asset -- and so will first half of 2005
To be a successful value-growth investor in 2004, you had to put together both the E (growth in earnings) and the PE (growth in the price-earnings multiple). To get a gain in a stock, you had to find a company that could deliver the E in 2004 at a rate above Wall Street expectations. And you had to find a company that could deliver the PE by convincing investors that it could deliver the E again in 2005. Not an impossible task, but certainly a difficult one.
In contrast, Whitman, the value-asset investor, had a number of winds at his back. First, fears of a revival of inflation and of a falling dollar sent investors in search of hard assets that would appreciate in value if inflation rose and the dollar fell. Slow growth rates for revenue and earnings sent management scrambling to realize hidden values on their companies' balance sheets. Value-asset stocks also dodged many of the other worries of 2004: Investors don't have to worry about rising energy costs shrinking margins and crushing share prices if the company's stock isn't valued on earnings at all.
Because I think 2005 will look a lot like 2004, I think value stocks will outperform growth stocks. And because I think the first half of 2005 will look a lot like 2004, I think value-asset stocks will outperform value-growth stocks in the first half of the year.
If earnings projections for the last half of 2005 and 2006 sink low enough, value-growth could take the lead in the second half of 2005. We'll just have to wait and see.
A second look at St. Joe
In the meantime, I think you should add some value-asset stocks to your 2005 portfolio.
Look at the St. Joe Company, for example, which owns about 850,000 acres of Florida land. On the surface there's nothing "value" about this stock. It trades at a price-to-earnings ratio of 53 and a price-to-book-value ratio of close to 10. But that book-value figure is completely misleading, since it is based on the original cost of the land that the St. Joe Company bought to grow timber and not on the current market value of that land. On Dec.16, the company announced that it had sold 93 acres of land in Panama City Beach, Fla., to Simon Property Group for about $286,000 an acre. Of course, not all the land the company owns will be sold and not all of it is as valuable as the land that Simon Property Group just bought, but I still think there's a huge gap between the market cap of this stock and the value of the real estate it owns.
Shares of St. Joe are up 83% since I added them to Jubak's Picks on Oct. 3, 2003. At that point, the market was valuing the 900,000 acres of Florida real estate the company owned at about $2,700 an acre. Now, the stock market is giving that land a value of about $5,400 an acre. I think the St. Joe Company is certainly worth holding, which is why I upped my target price to $84 a share by December 2005 in the days after Christmas. But I've got three value-asset stocks in the same mold that are at better entry points for new money.
Three more picks that hold land
Here are my three new money value-asset buys.
Tejon Ranch has finally started to move, but it's still up 5% since I added it to Jubak's Picks on Oct. 3, 2003. The company owns 270,000 acres that start about 60 miles north of Los Angeles. Development has been held up by fights with regulators and negotiations with environmentalists to protect the most sensitive of these acres. And that has held the stock back. But the land will be developed -- Los Angeles will keep sprawling until it runs out of water, and the Tejon Ranch property is along Interstate 5, a prime transportation corridor. At the Jan. 5 price, shareholders are getting Tejon Ranch's fully developable land for about $3,100 an acre. I'm raising my target price for these shares to $45 by June 2005.
Plum Creek Timber (PCL, news, msgs) has hugely ambitious plans for its real estate. The company figures that about 1.4 million of its 8.1 million acres are better suited for something other than timber. Of those 1.4 million acres, the company has targeted 150,000 acres for current sale for development as home and commercial sites. The current book value per share of $12 clearly undervalues the company's developable land, but there's some danger here in the very ambitiousness of Plum Creek Timber's plans. The company wants to sell off half of those 1.4 million acres by the end of 2007. I just don't think that's possible, and there's a good likelihood that the company will have to scale back its plans, which would hurt the stock on Wall Street in the short run. Of course, in the long run any delay in selling the company's land just means that the company will receive a higher price for the acreage it does sell. To balance the risk of disappointment, investors are getting Plum Creek's land at a price of about $1,000 an acre. I'm going to hold off on adding this one to the portfolio until I see how the company's plans hold up as the year advances. Plum Creek is also a real estate investment trust and pays a dividend yield of 3.8%.
Rayonier (RYN, news, msgs) is still very much a timber company -- which is not a bad business to be in at all with net prices for timber climbing 18% in the Northwest and 12% in the Southeast in 2004. But to grow all those trees, the company owns 2.1 million acres of land that it has started to sell. Some of this -- the land nearest Seattle and the land that runs along the Georgia and Florida coasts -- is worth a lot more as sites for second homes, stores and office buildings than it is as timber. (Which makes the book value of $16 a share a tad understated.) For instance, the company is currently selling 20,000 acres outside Savannah, Ga., and Fernandino Beach, Fla. At current prices, by buying the stock an investor gets the company's land at about $1,150 an acre. The company is due to report earnings on Jan. 25. Rayonier converted to a real estate investment trust in January 2004. The shares pay a dividend yield of 4.7%. I'm adding the shares to Jubak's Picks with a target price of $53 a share by June 2005.
That doesn't end the list of value asset stocks to consider for 2005. But it should be enough to get you started in the right direction.
New developments on past columns
Im insuring my portfolio with land
Tejon Ranch has finally started to move. The shares crossed over their 50-day moving average on Nov. 11, a traditional sign of technical strength. The StockScouter rating for the shares has moved up in the last month from a 7 to an 8, out of a possible 10. If you dug far enough, the Nov. 5 report on third-quarter 2004 earnings contained plenty of good news to keep the shares moving up. The most encouraging number? A 14% climb in real estate expenses from the third quarter of 2003 that helped wipe out most of the earnings growth that might have flowed to the bottom line since revenues almost doubled in the quarter. The rise in real estate expenses, which the company projects to continue for the next few years, is a sign that the company is ramping up marketing and sales efforts to develop the 270,000 acres that it owns about 60 miles north of Los Angeles. At the Jan. 5 price, shareholders are getting Tejon Ranchs fully developable land for about $3,100 an acre. As of Jan. 6, Im raising my target price for these shares to $45 by June 2005. (Full disclosure: I own shares of Tejon Ranch.)
Changes to Jubak's Picks
Buy Rayonier
Rayonier is still very much a timber company, but thats not why Im buying the stock. Not that timber looks like a bad business for 2005. Rayonier got about 36% of its sales from overseas customers. That -- with the aid of the weak dollar -- should give the companys timber sales solid price protection in 2005. In my opinion, for that reason alone the Wall Street consensus (which is based on a decline in timber prices) for 10% earnings growth in 2005 is likely to be low. But its the land that this company owns, 2.1 million acres of it, that makes this stock such a great asset-value play. Some of that land, the acres outside Seattle and along the Georgia and Florida coasts, is a lot more valuable for home sites and commercial development than it is as timberland. But since the land is carried on the companys books at the original purchase price, the value of that land isnt reflected in the valuation of the company. At Jan. 5, 2005, prices, shareholders in Rayonier are paying about $1,150 an acre for all the companys land. As the stock market comes to understand the value of Rayoniers land, the share price will rise. (In the meantime Rayonier, which converted to a real estate investment trust in January 2004, is selling off about 1% to 2% of the acres that it deems best suited to development every year, which certainly supports the current dividend yield of 4.7%.) Im adding the shares to Jubaks Picks with a target price of $53 a share by June 2005. (Full disclosure: I own shares of Rayonier and I will be buying more three days after this column is posted.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Rayonier, The St. Joe Company and Tejon Ranch. He does not own short positions in any stock mentioned in this column.
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