Frothy Market Blues: Consider These 2 Cheap Stocks

Source: Thinkstock

Stocks have been rising relentlessly higher, and this has led many, including myself, to wonder whether valuations have become stretched. Historically, I believe that they have: Stocks typically don’t trade at over 20 times earnings and with dividend yields of under 2 percent without substantial growth, and I don’t think we have that. Nevertheless, if we look at individual stocks, I think there are pockets of value, and investors looking for places to park their money for the long run who don’t want to buy overvalued assets should consider taking positions in the stocks I mention below.

1. Alliance Resource Partners (NASDAQ:ARLP)

This is one of the better-performing stocks in the market for the year, with shares up more than 20 percent. It is a limited partnership, meaning that it gets favorable tax treatment if it pays out a large portion of its profits in the form of dividends.

The company is a coal producer that has been able to buck the trend in this lousy market. Many coal producers have taken huge write downs and have seen negative cash flow because of low coal prices. Punitive legislation threatens to exacerbate these problems. But Alliance Resource Partners has extremely low production and shipping costs thanks to its phenomenal assets and strategic location. Not only has it been making money hand over fist, but it has been raising its dividend every quarter. This seems almost too good to be true, and if this weren’t a coal stock, it would probably be trading at 25 times earnings in this market.

But it is a coal stock, and investors hate coal as a rule, so the stock trades at just 12.5 times trailing earnings. Furthermore, analysts expect the company to grow its earnings going forward despite the weak coal market. If this is true, and if the coal market turns around — after all, despite new EPA regulations, Americans get 70 percent of their electricity from coal – this stock can really fly. Investors will also be pleased to learn that the stock pays an impressive 5.2 percent dividend yield, which is about three times higher than that of the S&P 500. While the shares are near an all-time high and should be bought on a pullback, there is no fundamental reason to wait for one.

2. CF Industries (NYSE:CF)

While CF Industries has had a volatile 2014, this has been one of the best value-creating stocks in the market since it went public in 2005. The stock has gone from $20 per share to over $240 per share, and its dividend has risen from 8 cents share per year to $4 per share per year. Despite this, the shares trade at just 10 times earnings. The reason for this is that its primary product, nitrogen-based fertilizer, has fallen in price while its primary input, natural gas, has risen in price. As a result, the company’s profits are down over the past couple of years. But we have to keep in mind that this profit decline follows incredible profit growth. A couple of years of consolidation makes perfect sense, and I think investors should take the opportunity to accumulate shares now while fertilizer and agriculture are largely out of favor.

CF Industries is a cash flow machine despite these concerns. Furthermore, the company has been a phenomenal value generator over the years. Since the company went public, most fertilizer stocks are higher, but CF Industries has beaten them all because it has been aggressive at the right times, and it has focused on nitrogen-based fertilizers, which comprise the vast majority of fertilizer demand.

Going forward, the global demand for food is going to rise as the population rises and as people in developing economies want a higher standard of living. This will generate demand for products that make food production more efficient, including fertilizer. So while CF Industries may be in an earnings slump, I suspect that this will be temporary, given that it supplies such a crucial product to the marketplace.

Disclosure: Ben Kramer-Miller is long CF Industries and Alliance Resource Partners.

More From Wall St. Cheat Sheet: