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2 compelling stocks for the value investor

“We don’t get paid for activity, just for being right. As to how long we’ll wait, we’ll wait indefinitely.” – Warren Buffett

It’s not every day that you find a share worth buying. But value investors, unlike technical traders, (should) spend a lot of time trying to value companies so they can pounce on value opportunities when they arrive. Here are two stocks that currently offer decent value and may well prove to be an excellent opportunity if they become cheaper or if results are positive. Mr Market is not expecting too much of these two stocks…

The first is Vision Eye Institute Ltd (ASX: VEI) the owner of various ophthalmology practices. The company’s main services are consultations, laser eye surgery and surgical services (for example, treatment of cataracts and macular degeneration). Macular degeneration, for example, is more prevalent in an older population that is more overweight than ever.

More generally the Australian population is ageing and we are facing an obesity epidemic, so I’m making the prediction that demand for ophthalmological surgical services will only increase in the years to come. However, the problem with this is that the eye doctors already hold too much bargaining power, and can profit at the expense of shareholders by demanding ever better terms of engagement.

This problem could be diminished if Vision Eye Institute were taken over by Primary Healthcare Limited (ASX: PRY), because Primary Healthcare also manages general medical practices and diagnostic practices. Therefore, Primary Healthcare could add more value to ophthalmologists by utilising its existing network to grow referrals, and it could also use its existing managerial expertise to reduce costs. In my view, Vision Eye Institute is worth more to Primary Healthcare than it is as a standalone business, but even as a standalone business, it looks cheap at current prices of under 80c, assuming its second half results show some incremental improvements.

A little over a week ago I wrote that Vision Eye Institute is undervalued at 70c based on an assumption of no growth in the second half of 2014. Furthermore, in my view the company would be worth significantly more than $1 per share to Primary Healthcare, which already owns over 20%. The recent share price plunge – resulting from the fact that the founder is suing the company – was probably a buying opportunity. It may pay to keep an eye out for the results: if gross margins have actually improved, I would be increasing my valuation accordingly.

An even more attractive option might be SDI Limited  (ASX: SDI), a company that manufactures and sells dental equipment and material such as amalgams (for fillings) and tooth whitening systems. The company exports about 90% of its products, and has predicted it will earn $5.7 – $6.2 million in FY 2014. Although this equates to a likely 2014 P/E ratio of slightly above 12, there seems to be a decent likelihood that profits will continue to grow into FY 2015.

The company’s founder is chairman Jeffery Cheetham. The Cheethams effectively control the company, and various family members occupy key roles. Whether this is a good thing or a bad thing depends entirely on the way the controlling family treat retail shareholders. There is a huge difference for example, between the way that Murdoch runs “his” company and the laudable leadership of the Moufarrige family at Servcorp Limited (ASX: SRV).

Although the share price is up over 10% since I first covered the company, an increased dividend plus profit of $6.1 million or above would suggest that SDI is still a good value opportunity, even at 60c per share.

However, SDI Limited does not have a great history of paying huge dividends and the company has not generated strong returns for shareholders in the last decade. Nonetheless, I think profits will grow over the next couple of years because new products should boost sales, the company benefits from a weaker Australian dollar, and the price of silver (a major input cost for the company) has come down. It also helps the buy thesis that directors were buying shares on market quite recently.

SDI limited is NOT the only undervalued stock that has seen director buying at around the current share price, and there are other companies available to buy with much stronger track records.

This little gem of a company has grown earnings per share for five years in a row, pays a strong dividend and better yet, 2 directors bought shares on market, not very long ago. 

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Motley Fool contributor Claude Walker (@claudedwalker) owns shares in SDI Limited.

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