2 Value Investment Picks

Anmol is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

What do Warren Buffet, Ben Graham and David Dodd have in common? They were all value investors.

Value investing has taken many forms since it was first introduced by Ben Graham and popularized by Warren Buffet. This approach seeks to invest in undervalued companies that have been ignored by the general market. The time frame is usually for the long run, but the potential rewards are higher since the perceived future fair value for the stock is higher.      

In this article I want to being to your attention two companies that I believe have a higher intrinsic value than realized, and when the market realizes their potential, they value should jump. 

LeapFrog Enterprises (NYSE: LF)

It makes children's educational toys, including the LeapPad. The first version, LeapPad1, was one of the top ten gifts of 2011. It looks like the latest version, the LeapPad2, will repeat that feat as it is already showing up on "top toy" lists.

The LeapPad is a tablet designed especially for children. Parents like it because you cannot connect to the Internet through it except to LeapFrog's own site. It is also designed to be kid-friendly and is loaded with educational aps.

On Nov. 5, the company reported third quarter results that beat consensus. Earnings were 51 cents compared to the consensus of 41 cents. Revenue jumped 28% due to strong sales of the LeapPad2 and LeapsterGS. Sales of the LeapPad2 were double the sales that LeapPad1 did in the third quarter last year.

This should be good news going into the holiday season, right? Not so fast. The company was very conservative with guidance given the big third quarter beat. It said it was being cautious because sales depended on the economy to a large degree. The analysts thought some of the sales growth was possibly pulled forward from the fourth quarter.

Despite the big beat, shares sold off hard. But that means it has created an even more attractive opportunity for we value investors.

The University of Michigan preliminary sentiment for November jumped to a 5 year high. The consumer feels good right now. It doesn't get better than that for the retailers going into the holiday season.

Where's the Value?

LeapFrog has attractive valuations. It has a forward P/E of just 9.8, which is well under the average of the S&P 500 at 13.6x. Its price-to-book is at 1.8. A P/B under 3.0 usually indicates value. It also has a great price-to-sales ratio of only 0.9. A P/S under 1.0 can mean a company is undervalued.

Earnings are supposed to skyrocket by 174% this year. But analysts are more cautious about 2013 given the competition in the tablet market even from the adult tablets like the iPad mini. They are expecting earnings growth of just 3.4%. I think LeapFrog is in a unique position, with its strong brand and educational focus, to appeal to parents. I'm more optimistic than the analysts about how it will fare in competition from the Kindle, the iPad and any other tablet already on the market for adults.

This is a small cap so it's going to be more volatile. Prepare yourself. However, you will be rewarded handsomely if you have the stomach for it.

 CVS Caremark (NYSE: CVS) is one of the largest drug store chains in the United States and offers pharmacy services.

 The company reported third quarter results on Nov 6 and surprised the consensus by a penny. The company also raised full year guidance to account for the stronger-than-expected third quarter.

The analysts were surprised at the strength in the report. Retail sales were up 5.5% year over year. CVS also continues to steal new pharmacy customers from Walgreen due to an unresolved contract dispute there. And it's apparently retaining a good number of them.

 The analysts concede that the comps will get more difficult in 2013 given the high bar of 2012. But they believe CVS has a strong management team that can navigate it.

 Where's the Value?

CVS has a forward P/E of 13.8 which makes it just a little more expensive than the average of the S&P 500 at 13.6. But it has a price-to-book ratio of just 1.6, which is lower than the S&P average of 1.9. It also has a price-to-sales ratio of 0.5 which indicates there's a lot of value in the shares.

Earnings are expected to grow 20.5% in 2012, but 2013 still looks good too with another 11.6% growth.

This is a large cap, with a market cap of $59 billion. It pays a dividend yielding 1.4%. It should be less volatile than the overall markets and shouldn't have sharp swings. As one analyst put it recently it is a "steady ship in stormy seas."

Hopefully in this article, You got a brief introduction to value investing and perhaps might consider value investing as your style of investing. These two stocks might be a perfect foundation to start your watch list or portfolio from and I highly encourage you to look into these stocks further. The Motley Fool offers some great services to get you started as well.

Anmolsc has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend LeapFrog Enterprises. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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