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3 Magnificent Stocks With P/E Ratios Under 15, As Warren Buffett's Mentor Prefers

Motley Fool - Sun Oct 8, 2023

Warren Buffett is a classic value investor. The Oracle of Omaha has built his enormous wealth by paying a fair price for a great business, then holding that top-quality stock for decades.

He studied under value investing mastermind Benjamin Graham at Columbia University, and often praises his mentor's book, The Intelligent Investor, as "by far the best book on investing ever written."

In that book, Graham recommends sticking to your investing philosophy while ignoring the noise of day-to-day price changes. He also notes that buying stocks with a robust margin of safety is the key to building life-changing wealth.

The Intelligent Investor offers many supporting strategies for finding great companies with undervalued stocks. For example, Chapter 14 centers on this nugget: "Current price should not be more than 15 times average earnings of the past 3 years."

This way, you should always end up with a solid margin of safety. You won't lose sleep over the price movements of a deeply discounted value stock -- especially if you know that the company runs a smart business plan under competent management.

On that note, we asked three of The Motley Fool's top tech sector analysts to share their best ideas under Benjamin Graham's guiding principle of a low price-to-earnings ratio. Read on to see why they selected lithium producer Albemarle(NYSE: ALB), semiconductor designer Microchip(NASDAQ: MCHP), and digital payments expert PagSeguro Digital(NYSE: PAGS).

PagSeguro: A high-growth bargain amid economic revival

Anders Bylund (PagSeguro): The Brazilian financial services veteran PagSeguro has found itself in Wall Street's bargain bin lately. The stock has fallen 45% over the last year and currently trades at the very modest ratio of 9.3 times trailing earnings. Measured from a different angle, PagSeguro can be yours for a mere 4.7 times free cash flow.

That's a tremendous bargain, normally reserved for struggling businesses on the brink of -- or knee-deep in -- a major crisis. That doesn't sound like a Buffett-and-Graham stock at all.

But that's not where PagSeguro stands. The company has been solidly profitable since joining the public stock market in 2018. And if you want cash profits, PagSeguro has a mottled history with several years of negative cash flows -- but that chart has turned positive and kept rising over the last year and a half. These days, PagSeguro's free cash flows outshine its after-tax net income by a wide margin:

PAGS Net Income (TTM) Chart

PAGS Net Income (TTM) data by YCharts

This is actually a high-octane growth stock, even though its stock trades at bargain-bin prices. PagSeguro's year-over-year revenue growth has averaged 24% over the last five years, more than tripling the annualized revenue stream from $677 million to $1.7 billion.

And I could go on. PagSeguro's target market is the deeply suppressed but rapidly improving Latin American area. For example, Mexico's inflation crisis is fading out and the country's gross domestic product (GDP) is rising by a healthy 2.6% this year. E-commerce is only getting started in many of these nations, presenting tons of untapped greenfield opportunity for an online payments expert like PagSeguro.

So PagSeguro's stock gives you a high-growth financial services business in a stabilizing corner of the world economy -- all at a bargain-bin share price.

What's not to love?

This commodity looks dirt (lithium) cheap

Nicholas Rossolillo (Albemarle): Warren Buffett's search for quality businesses on the cheap hasn't steered him clear of the wild world of basic commodities and materials. After all, Berkshire Hathaway has dumped ample amounts of money into utilities and oil companies in recent years, owing to their ability to crank out massive amounts of cash. The trade-off, though, is often a very volatile stock price.

Lithium stocks have been just that: volatile. Lithium and the batteries that need the element have sometimes been referred to as "the new oil," a term even Tesla(NASDAQ: TSLA) CEO Elon Musk has used. But economic worries have mounted this year, dragging down share prices even of top lithium miner and refiner Albemarle.

Two primary issues have cropped up. First, lithium prices themselves have fallen dramatically in 2023 from all-time highs reached in late 2022, mostly because of concerns over China's sluggish economy -- the world's largest market for electric vehicles, and thus a top lithium consumer to make all those batteries needed for EVs. And second, a plethora of new lithium mining projects are gearing up for production, threatening to bring new supply to market and further limit the upside for lithium pricing down the road.

Albemarle has been just fine. It foresaw ballooning demand for lithium years ago, and started developing mining sites with low cost of production. As a result, even with commodity prices plunging from their peaks, Albemarle is highly profitable and able to continue its pace of expansion. It even has had the financial strength to bid for one of those newer mining operations that are gunning for a piece of the lithium pie. Albemarle currently has a bid in to acquire Australia's Liontown Resources.

Even in a "bad year," there's a lot to like about a company like Albemarle. The company's operating profit margin is just over 30% over the last reported 12-month stretch, and lithium output and revenue have been chugging higher despite lithium prices falling. After nearly half of the stock's value getting wiped out in the last year, Albemarle now trades for a meager five times trailing 12-month earnings -- what could be considered cheap even for a big no-growth mining operation.

In the years ahead, I believe Albemarle will gradually transform into a dividend-paying machine as it gobbles up lithium market share and cranks out lots of cash. For investors that like to emulate Buffett's value stock-picking methodology, Albemarle deserves a fresh look right now.

This bargain-priced chip stock is ramping up dividends and buybacks

Billy Duberstein(Microchip): Microcontroller, analog, and FPGA chipmaker Microchip meets Buffett's criteria for an attractive stock in several ways.

First, Microchip trades at just 12.5 times earnings estimates for the current fiscal year ending in March 2024. That's certainly a cheap Buffett-like valuation.

In addition, Microchip has other attributes Buffett likes. It's a highly cash-generative business, high with adjusted operating margins coming in at 48.1% last quarter and a sky-high return on equity of 37.5% over the past 12 months.

Margins and efficiency like that imply a competitive advantage, which Microchip has built up over the course of 30 years improving results and operations. Under Chairman and former CEO Steve Sanghi, Microchip was one of the first companies to innovate programmable microcontrollers used in a wide variety of machines, from planes and cars to other industrial and consumer appliances.

Starting around 2008 and lasting through 2018, Microchip embarked on an acquisition strategy, in which it acquired all the types of chips that go around microcontrollers in a system, allowing Microchip to sell its customers, "total systems solutions," rather than just individual chips. Management has also proven excellent at wringing out synergies from those acquisitions, steadily increasing growth and margins over the years to its current all-star numbers.

Of course, those acquisitions didn't come cheap, so Microchip has been using a lot of its free cash flow to pay down debt since its largest-ever acquisition of Microsemi in 2018. But five years on, the company finally hit a leverage target it's comfortable with last year. Since hitting its debt paydown goals, Microchip has been gradually growing its dividend and ramping up share repurchases, until it envisions returning 100% of cash flow to shareholders by March of 2025. So its current 2% dividend should continue to rise steadily.

Investors are currently worrying about an industrial chip slowdown in the near term, but Microchip's industrial end-markets should grow over time as machines use more and more semiconductor content over time. Long-term investors should therefore take advantage of the current discount.

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Anders Bylund has positions in Tesla. Billy Duberstein has positions in Microchip Technology. His clients may own shares of the companies mentioned. Nicholas Rossolillo has positions in Albemarle and Tesla. The Motley Fool has positions in and recommends PagSeguro Digital and Tesla. The Motley Fool has a disclosure policy.

Paid Post: Content produced by Motley Fool. The Globe and Mail was not involved, and material was not reviewed prior to publication.

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