1100 13th Street, NW, Suite 750Washington, DC 20005202.887.6400Customer Service: 800.544.0155
All Contents © 2019The Kiplinger Washington Editors
By Vince Martin
| July 26, 2017
One of the hardest aspects of value investing is determining which stocks look cheap — and which stocks are actually cheap enough to be worthwhile stocks to buy.
Cheap stocks aren’t hard to find, even in this market. Many retail stocks are trading for around 10 times their earnings. Ford Motor Company (F) and General Motors Company (GM) have even lower earnings multiples. Other industries with secular challenges, like office supplies or even oil and gas, offer several stocks with fundamentals that make them look cheap.
But often cheap stocks are cheap for a reason — or several reasons. Earlier this month we highlighted 10 of those value traps as stocks to avoid. Yet sometimes a cheap price simply means the market isn’t paying quite enough attention — or is overreacting to future threats that may not materialize. Here are 10 stocks to buy that look cheap and ARE cheap.
Prices and data are from the original InvestorPlace story published on July 24, 2017. Click on ticker-symbol links in each slide for current prices and more.
It’s not just Ford and GM stock that look cheap. Auto parts suppliers across the board are trading at multiples that imply earnings will decline — and significantly so.
Goodyear Tire & Rubber Co. (GT) is one of those stocks, trading at just over 7x 2017 analyst earnings-per-share estimates. And there might be a case that GT stock is a value trap, not a value play. “Peak auto” concerns suggest U.S. auto sales will decline. That in turn would suggest lower sales of Goodyear tires — and lower earnings for Goodyear stock. Additional competition from foreign — and lower-cost — manufacturers is another concern.
But Goodyear has exposure to growing overseas markets as well, which generate over 40% of segment-level profit. The company has fixed pension concerns and is generating substantial amounts of free cash flow. And at 7x earnings, even a modest decline in the U.S. auto market, combined with international growth, probably suggests upside for GT stock.
There aren’t many stocks to buy in the auto space, but Goodyear looks like one of them.
The upheaval in U.S. media markets amidst “cord-cutting” and other trends has added volatility to most stocks in the space. But in terms of companies that own local network affiliates, consolidation seems to be on the horizon.
Nexstar Media Group Inc. (NXST) kicked off that process with a $4.6 billion acquisition of Media General. But sector M&A seems likely to pick up again. A “quiet period” around an FCC spectrum auction has ended. The return of the “UHF discount” rule should make mergers easier. That in turn should open more opportunities for Nexstar — either as a buyer or a seller.
Even without M&A, Nexstar has opportunities in front of it. A recent debt refinancing will save the company millions of dollars a year. Using substantial free cash flow to further pay down debt will add more interest savings – and create even higher cash flow.
With NXST trading at just 10x 2018 EPS, investors are pricing in all of the industry risk — and none of Nexstar’s opportunities. That seems far too conservative.
Bank stocks including Bank of America Corp (BAC) sold off last week after financial sector earnings didn’t do quite enough to get investors excited. But that simply extends the buying opportunity in BAC stock, one I’ve recommended for most of the year.
Second-quarter numbers were excellent, with earnings per share rising 12% year-over-year. BofA CEO Brian Moynihan called the quarter “one of the strongest quarters in our history” — and he’s not wrong. Charge-offs dropped 8%, and provisions for credit losses declined a whopping 26%. Book value per share rose to nearly $25.
And yet BAC now trades below $24 – a discount to its book value, and just 13x this year’s projected earnings. Both are cheap multiples – and both remain simply too cheap. BofA is a leading consumer banking franchise that is operating well, has minimized risk, and is growing profits. At a price below book value, BAC is one of the best stocks to buy in the entire market– not just among ‘cheap’ stocks.
Airline stocks like Alaska Air Group, Inc. (ALK) have come back into favor over the past few years. No less an investor than Warren Buffett — who once called the industry a “death trap” for investors — has taken stakes in majors American Airlines Group Inc. (AAL), Delta Air Lines, Inc. (DAL), and United Continental Holdings Inc. (UAL).
But the pick in the space is ALK, which doesn’t yet have the scale of those majors. ALK is growing, both through increased demand in its key Pacific Northwest markets and with the benefits of its acquisition of Virgin America last year. And it has more room to expand domestically — and to outgrow its larger rivals.
Meanwhile, ALK stock looks cheap, trading right at 10x 2018 analyst estimates. That’s actually above most peers — investors still don’t fully trust the cyclical industry — but Alaska Air’s growth prospects are better. Fuel prices may still come down in a “lower for longer” oil scenario, and it’s possible that the industry could again look to consolidate, with Alaska Air a potentially intriguing target down the line. At 10x, that’s more than enough to be bullish on ALK.
IT resellers like Insight Enterprises, Inc. (NSIT) generally look cheap, simply because of how tough the reselling business is. Margins are razor-thin — often below 3% on an operating basis. Overall IT spend has been stagnant, and moves to lower-cost cloud solutions imply potential deflation in that spend — and another headwind to profits for resellers.
From that standpoint, NSIT’s ~12x forward P/E multiple might not be as attractive as it appears at first glance. But there’s reason to think NSIT can outperform even in a difficult industry. The company’s acquisition of cloud-focused Datalink closed in January, and the company still has an estimated ~$20 million in synergies to capture from that deal. The purchase should help margins and improve Insight’s capabilities in the key cloud space.
Meanwhile, Insight is performing well, with four straight earnings beats. And consolidation may be on the horizon in the sector, perhaps jump-started by the acquisition by Tech Data Corp (TECD) of the Technology Solutions business of Avnet, Inc. (AVT). With a roughly $1.5 billion market cap, NSIT could be an interesting target for larger players like Tech Data or CDW Corp (CDW).
Again, reselling is a tough space. But reseller stocks quietly have been very solid performers over the past few years. NSIT seems likely to keep that performance going – particularly with its earnings multiples pricing in basically zero growth going forward.
There’s one big risk hanging over Synaptics, Incorporated (SYNA). Investors are increasingly concerned that the company will lose its spot in the Apple Inc. (AAPL) iPhone.
Being an Apple supplier can be risky, as InvestorPlace contributor Brad Moon detailed in April. Earlier this year, British chipmaker Imagination Technologies (IGNMF) saw its stock plunge when Apple decided to develop graphics chips in-house. Clearly, there’s a risk that Synaptics’ display and sensing chips could be replaced in upcoming generations of the iPhone.
But Apple only drives about 15% of Synaptics’ revenue, and the company has a growing business in Android products. Meanwhile, the company has $3 per share in net cash, and that aside, trades at less than 10x FY18 EPS estimates. Even if Synaptics loses Apple as a customer — and that’s a big ‘if’ — the stock still would look cheap. And that seems to make SYNA worth the risk at these levels.
Even after a big Q2 earnings beat, United Rentals, Inc. (URI) still trades at a rather low multiple. URI stock trades for just about 12x 2017 EPS estimates, and about 11x the company’s guidance for adjusted free cash flow this year.
That’s simply too low for the largest equipment rental company in the world. There are cyclical concerns here, but machine manufacturers like Caterpillar Inc. (CAT) and Deere & Company (DE) are seeing their multiples expand, not contract.
URI still has room to grow earnings for several years — yet investors are acting as if those profits are at or near a peak. With URI a clear Donald Trump stock, any political movement could add further tailwinds. With all that’s going right here, low-double-digit earnings and cash flow multiples don’t seem close to high enough.
The overhang at Owens-Illinois Inc. (OI) is related to its liability for asbestos manufactured by a former business unit back in the 1950’s. But even with that overhang, OI stock looks a bit too cheap at this point.
Owens-Illinois now is the world’s largest manufacturer of glass containers. It’s not a high-growth business, to be sure, but it has been a good one for the company, whose roots date back to the beginning of the 20th century. 2016 revenue was flat excluding acquisitions, but cost controls allowed adjusted EPS to rise 15%. OI is guiding for another 4%-8% growth this year — yet the stock is valued at just 10x the midpoint of that guidance.
Given international reach, market share dominance and likely steady, if slow, growth, that multiple looks just too low. It does appear that the asbestos liability is closer to the end than to the beginning, even if the company itself admits it can’t estimate that liability with 100% certainty. OI has doubled since early 2016, but still sits well below early decade highs of $35. And it doesn’t take much in the way of optimism — and accompanying multiple expansion — to get OI from below $25 to $30, at least.
At this point, Kroger Co. (KR) probably is more of a contrarian stock than a value stock — even if KR stock is cheap, and getting cheaper. KR stock has fallen 35% just since December, including 26% in just two sessions last month.
The June collapse came from a one-two punch. First, Kroger pulled down full-year earnings guidance, citing industry-wide deflation. The next day, Amazon.com, Inc. (AMZN) announced its acquisition of Whole Foods Market, Inc. (WFM), sending shockwaves through the grocery industry. And with Kroger already facing new competition from European discounter Lidl, there’s an obvious fear that margins are only going to get thinner.
But an 11x forward EPS multiple for KR stock looks a bit too cheap. For all the hype about the Amazon-Whole Foods tieup, Amazon is only picking up 3% market share. And Amazon has failed many, many times before in efforts to expand its realm. Deflation in the industry is bound to reverse at some point (even if that point isn’t coming soon). And Lidl seems a bigger threat to smaller, less-scaled players than to Kroger.
It will take some nerves to buy KR stock here. And there’s probably good reason why Kroger stock should be somewhat cheap. But 11x-12x earnings seems a bit too cheap at this point.
KLX Inc. (KLXI) was spun off by B/E Aerospace Inc. in late 2014. KLX acts as a distributor of parts, consumables, and logistics services to aerospace companies worldwide.
The company also made an entry into the energy space — at precisely the wrong time. That effort, combined with common post-spinoff selling, pushed KLXI shares below $30 early last year.
But they’ve since recovered — and likely have more room to run. Distributor stocks like W W Grainger Inc. (GWW) have been pressured of late, with the threat of Amazon Business often cited as the cause. But the technical nature of KLX’s markets and its deep relationships across the space make its business far less likely to face competitive threats.
In the meantime, KLX is throwing off impressive amounts of cash, yet isn’t valued at that highly. Already-raised 2017 guidance suggests a forward multiple of just 13x, and analysts are expecting 20%+ growth in 2018. If KLX can get anywhere near those targets, it has more upside. And if the energy business improves at all, and KLXI no longer becomes “cheap,” a more normal 18x-20x EPS multiple could suggest huge gains for KLXI, even after recent strength.
This article is from Vince Martin of InvestorPlace. As of this writing, Vince Martin has a small bearish position in CAT options, and may initiate a position in BAC stock soon.
More From InvestorPlace
The Top 10 Vanguard Funds on the Market
7 Safe High-Yield Dividend Stocks to Buy
7 Stocks to Buy That Wall Street Analysts Hate