Bottom Fishing with 3 Companies

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

I'm a contrarian at heart. There is nothing I like better than betting on a company that everyone doubts and seeing the stock flourish in spite of what people think. The Motley Fool CAPS Screener offers me a perfect way to try and find companies that could outperform using my contrarian's bent. Each company in the CAPS universe is assigned a star ranking depending on what the overall investment community thinks about the company. Stocks that are expected to underperform are assigned 1 star, and companies that are expected to outperform get a perfect 5 stars. Periodically I like to try to bottom fish with the 1 star ranked companies. I recently ran a screen looking for companies that not only had a 1 star ranking, but that also had at least a 2% yield, and showed 10% or better earnings growth in the last few years. Three companies in the same industry caught my eye.

What stuck out about these companies is they are all involved in something to do with property management and development. While AvalonBay Communities (NYSE: AVB) is a multifamily community developer, Boston Properties (NYSE: BXP) specializes in office properties, and Simon Property Group (NYSE: SPG) operates malls, they are all tied to real estate. It's not hard to understand why the CAPS community might bet against companies tied to real estate. Everyone knows the challenges in real estate over the last few years, and this worry I'm sure is part of these company's low 1 star ratings. There are two questions I want to answer. First, which of these companies is the best of the three? Second, is this “winner” a potential investment idea that could lead to profits in the future?

To begin, let's separate the wheat from the chaff; many investors start with a company's PEG ratio. This gives you an idea of the relative value of a stock in comparing its P/E ratio to its expected earnings growth. Take a look at how these three companies fare side by side:

<table> <tbody> <tr> <td> <p><strong>Name</strong></p> </td> <td> <p><strong>P/E on '12 Earnings</strong></p> </td> <td> <p><strong>Growth Expected</strong></p> </td> <td> <p><strong>PEG</strong></p> </td> </tr> <tr> <td> <p>AvalonBay Communities</p> </td> <td> <p>24.67</p> </td> <td> <p>11.40%</p> </td> <td> <p>2.16</p> </td> </tr> <tr> <td> <p>Boston Properties</p> </td> <td> <p>22.43</p> </td> <td> <p>6.30%</p> </td> <td> <p>3.56</p> </td> </tr> <tr> <td> <p>Simon Property Group</p> </td> <td> <p>19.75</p> </td> <td> <p>6.27%</p> </td> <td> <p>3.15 </p> </td> </tr> </tbody> </table>

You can tell that either they are going through a cyclical low point, or the market seems to be overvaluing the stocks with all of their PEG ratios above 2. Though companies can operate for years with a high PEG ratio, I prefer to stick to something that Peter Lynch once said. He made the comment that a company's P/E ratio and growth rate should move in line with each other. He further said that when the P gets too far ahead of the E that something has to give. Either the stock has to “take a rest to let the earnings catch up,” or of course the “stock price could come down” to a more reasonable level. That being said, we are trying to determine the best investment and, relatively speaking, the lowest PEG ratio represents the best value. (Avalon – 3, Boston – 1, Simon – 2)

Another way to compare these companies is by looking at their past performance when it comes to net income and cash flow. While history might not predict future results, it can serve as a guide. Companies that do well in the past, don't normally hit a wall and stop. If anything, they might see slower growth, but that's understood. In the last three years, Simon Property Group shows the best overall performance, with net income up a total of 231% and operating cash flow up 16.59%. AvalonBay comes in second with net income up 186% and operating cash flow up 14%, which leaves Boston Properties last showing net income up, but cash flow down. (Avalon – 2, Boston – 1, Simon – 3)

Since one of the reasons I picked these companies was yield, it makes sense to look at their dividends and payout ratios. Simon Property Group comes out the winner here as well with a 2.74% yield, and it has the only free cash flow payout ratio less than 100%, at 81.6% in the most recent quarter. While AvalonBay has a slightly higher yield at 2.88%, the company's payout ratio is negative. This puts Boston Properties in the middle with a 2.01% yield, but a relatively more reasonable 150% payout ratio. (Avalon – 1, Boston – 2, Simon – 3)

Last but not least, each company's balance sheet is of particular concern, since real estate companies have to use leverage in most cases to generate returns. AvalonBay comes out the winner here with the lowest debt-to-equity ratio at 0.74. Boston Properties is second at 1.73, and Simon Property has the most leverage at 3.78. (Avalon – 3, Boston – 2, Simon – 1)

The final score is AvalonBay – 9, Boston Properties – 6, and Simon Property – 9. We have a tie. The tiebreaker in this case is each company's revenue growth. AvalonBay is expected to see 9.8% revenue growth next year versus Simon Property's expected growth of 5.8%. This makes AvalonBay our overall winner. If you want to do some bottom fishing, the numbers suggest this is the company.

With over 45,000 apartment homes in 10 states, 14 communities under construction, and the rights to develop 27 more, the company certainly owns its share of assets. If the economy continues to recover, this could be a good way to play this improvement. Though the company's dividend payout ratio is negative in the most recent quarter, the company has been fairly consistent, raising its dividend since 1994. Aside from times in 2002-2004 and 2010-2011 where the dividend stayed flat, annual increases have been the norm. With a 2.88% yield, and 11.4% expected EPS growth, investors get a potential total return of over 14%. The fact the company has the highest revenue and least leverage of the bunch doesn't hurt either. Use this information as a starting point for your research and see if this community developer deserves a spot in your portfolio.


MHenage has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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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