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All Contents © 2020The Kiplinger Washington Editors
By Will Ashworth, Contributing Writer
| May 15, 2020
The last time value stocks were in style, Abraham Lincoln still had a Pennsylvania Avenue address.
OK, it hasn't been quite that long. Still, for years, even the best value stocks have taken a back seat to growth. The Wilshire US Large-Cap Growth Index, for instance, has produced a total return (price plus dividends) of 250.6% between the start of 2007 and May 11, 2020; over the same period, the Wilshire US Large-Cap Value Index managed just 106.7%.
Growth stocks appear to have gotten way ahead of themselves, which at least sets up the possibility that value stocks will return to favor. But there are no guarantees.
"Growth's outperformance will end when it finally crumbles under its own weight, as it finally did in 2000, but I have no idea if it happens next week or in five years," Pekin Hardy Strauss portfolio manager Josh Strauss recently told MarketWatch.
Market timing is a fool's errand, however. Instead, you can do well by simply targeting high-quality value stocks now ... which includes determining just what real "value" is. For instance, is a stock that trades at less than five times earnings a bargain if it's buried in debt? That seems doubtful, especially in this uncharted economic territory brought about by COVID-19.
Here are 10 of the best value stocks to buy right now. For the value component, we're using cash rather than profits, which can be skewed by various accounting adjustments. Also, in this time of uncertainty, it's important for portfolio picks to have healthy balance sheets. So each of these stocks boasts cash positions that are greater than their outstanding debt.
Data is as of May 14. Net cash and price-to-cash flow (P/CF), which refers to operating cash flow, provided by Morningstar.
Market value: $8.9 billion
Net cash: $5.8 billion
Price-to-cash flow: 9.1
Bank stocks aren't having much luck during the pandemic, and their shareholders know it. Year-to-date, the SPDR S&P Bank ETF (KBE) has plunged 43%, dipping harder than the S&P 500 into the bear market and coming off the mat much more slowly.
Out in Silicon Valley, tech- and startup-focused SVB Financial (SIVB, $173.28) reported disappointing first-quarter results on April 23. Profits fell 53% to $2.55 per share, widely missing analysts' expectations for $3.07. On the plus side, it was the first negative earnings surprise in the past four quarters.
Nonetheless, SIVB could be one of the best value stocks in the industry right now.
SVB Financial's shares are off 31% year-to-date. But despite that considerable decline in net income, the bank's net interest margin was 3.12% – only 14 basis points lower than in Q4 2019. By comparison, Wells Fargo's (WFC) net interest margin in the first quarter was 2.58%.
In the company's Q1 2020 letter to stakeholders, CEO Greg Becker highlighted the ways in which the bank is prepared for whatever COVID-19 brings.
"In good markets and bad, we have maintained the strong underwriting standards that have made us so successful over time. In past cycles, we have seen elevated early-stage losses as well as episodic losses in other parts of the portfolio. These have been followed by a rapid return to more normal credit patterns," Becker said. "Our loan portfolio is stronger and more diversified today than in the last crisis."
Meanwhile, SIVB's price-to-cash flow of 9.1 is lower than it has been for most of the past decade.
Market value: $2.9 billion
Net cash: $80.0 million
When you want to develop a new drug or medical device, Medpace Holdings (MEDP, $81.83) provides full-service clinical trial outsourcing, from early Phase 1 clinical trials through pre-FDA approval Phase 3 clinical trials.
Like infrastructure contractors, you can evaluate Medpace's business by its net book-to-bill ratio over a quarterly and trailing-12-month basis. In the first quarter of 2020, Medpace's net new business awards were $246.9 million, or 1.07 times its revenue for the quarter. In the trailing 12 months, its book-to-bill ratio was 1.23, down slightly from 1.28 a year earlier.
During the pandemic, we've all seen how important companies like Medpace are to the healthcare system. Medpace finished the first quarter with a backlog of $1.29 billion, which was 16.8% higher than the year-ago period. Also, MEDP earned $29.0 million during Q1, 50.8% better year-over-year.
Medpace caters to smaller biopharmaceutical companies, which account for 75% of its business, followed by mid-sized biopharmaceutical firms at 16% and large ones at 9%. When investors think of smaller biopharmaceutical companies, they generally think of money-losing operations. Nonetheless, MEDP is profitable, and in Q1 2020, it converted more than 100% of its quarterly income to free cash flow.
Medpace went public in August 2016 at $23 per share and has shot up 256% since then. Yet it still boasts a free cash flow yield of 7.2%; FCF yields of 8% or higher are generally considered value territory. If you're uncomfortable classifying MEDP with other value stocks, consider it growth at a very reasonable price.
Market value: $589.2 billion
Net cash: $50.0 billion
It might seem odd to have Facebook (FB, $206.81) on any list of value stocks. But while Facebook's P/CF is indeed shrug-worthy, what that buys you – a financial fortress – is why it's still a value.
Facebook had $60.3 billion in cash on its balance sheet and $10.3 billion in debt at the end of its first quarter. That works out to $21.02 per share in cash, or a little more than one-tenth its share price. By comparison, Pinterest (PINS) had more as a percentage of its share price ($3.02 per share, so 17%), but Facebook also has generated $23.1 billion in free cash flow over the past 12 months, while Pinterest hasn't generated any.
Facebook's business was indeed affected by the coronavirus outbreak, but it still managed to deliver first-quarter results that were stronger than most. Earnings roughly doubled year-over-year to $4.9 billion, and monthly average users (MAUs) jumped 10% to 2.6 billion – 50 million higher than analyst expectations. Facebook is understandably cautious about the second quarter.
"Outlook is really uncertain. We have a really cautious outlook on how things are going to develop," Facebook CFO David Wehner told CNBC. "We have seen signs of stability reflected in the first three weeks of April, where advertising revenue has been approximately flat compared to the same period a year ago."
Nonetheless, FB stock should be in fine shape. Facebook is the dominant game in town, and many analysts anticipate the coronavirus outbreak will merely accelerate the ongoing trend of advertising dollars shifting to digital.
Market value: $15.6 billion
Net cash: $2.6 billion
Arista Networks (ANET, $205.59) develops cloud networking solutions such as routers and switches for high-performance data centers, cloud service providers and large-scale internet companies.
The company is looking to grab a significant piece of the cloud networking market, which is estimated to be $30 billion by 2024, by using its Extensible Operating System (EOS) to provide a programmable, highly modular, cloud networking platform.
Arista Networks exemplifies the benefits of gender diversity in corporate leadership. Jayshree Ullal has been chief executive since October 2008, long before the company's June 2014 initial public offering. And since pricing at $43 per share, Arista's shareholders have enjoyed a 378% return – very good news for Ullal, who owns 3.7 million shares worth $752 million.
Over the past five years, Arista's revenues have grown 186%, from $837.6 million in 2014 to $2.4 billion in 2019. Operating profits have exploded by 440% over the same period to $805.8 million.
Arista's first-quarter results were better than expected. Revenues of $523 million were $10 million higher than consensus estimates, while adjusted earnings of $2.02 per share beat the Street by 23 cents. Both figures were lower year-over-year, however, and Arista's Q2 revenue estimates were shy of the analyst mark.
However, Arista remains 1% higher year-to-date versus a 12% decline for the S&P 500. While ANET's operations clearly aren't invulnerable to COVID-19, it's still a logical play on the long-term growth of cloud computing. And while it's not quite as cheap as it was in mid-March, it's still trading at a P/CF that's half its five-year average. At current prices, Arista is an intriguing value buy.
Market value: $15.7 billion
Net cash: $3.1 billion
Interactive Brokers (IBKR, $37.68) was founded in 1978 by Thomas Peterffy, the company's current chairman and Florida's wealthiest resident in 2019. The company currently executes more than 1.4 million trades per day around the world.
If you believe company founders are generally better stewards of capital, you might like IBKR, given that Peterffy controls 81% of the company's votes. But the company has had a rocky time of late. As of this time two years ago, IBKR had wildly outperformed the S&P 500 on a total-return basis, 711% to 390%; however, shares have been halved since then, thanks to aggressive competition, lower interest rates and Peterffy's relinquishing of the CEO position.
But things might be perking up for Interactive Brokers. In the first quarter ended March 31, its adjusted net revenues and adjusted income before taxes increased by 24.1% and 22.7%, respectively. IBKR also boasted a healthy 10% sequential increase in total accounts to 760,000, and a 4% increase in net revenue per average account to $3,069.
On a pure P/CF basis, Interactive Brokers is one of the best value stocks you can buy, with a 2.2 multiple that's fathoms below its five-year average of 33.9.
Market value: $14.9 billion
Net cash: $1.8 billion
Video game companies such as Take-Two Interactive (TTWO, $131.53) have been among the most popular "social distancing stocks."
"People are at home, they have nothing to do, they are not commuting," Michael Pachter, an analyst at Wedbush Securities, told the Washington Post. "You have more time and you're bored."
In February, when the company announced earnings for its fiscal third quarter ended December, CEO Strauss Zelnick suggested that Take-Two's future game releases are as strong as they've ever been.
"Take-Two's development pipeline over the coming years is the largest and most diverse in our history," Zelnick said. "Take-Two is exceedingly well positioned to capitalize on the many positive trends in our industry and to generate growth and margin expansion over the long-term."
TTWO finished the third quarter with net cash of $1.8 billion. It expects to release a number of video game titles in fiscal 2021 that will be available on several platforms.
The company isn't just benefiting from people playing more video games – but from an increased interest in watching them, too. ESPN recently announced that it would be airing live NBA 2K League matches in May on ESPN2, the ESPN app and at ESPN.com. NBA 2K is one of Take-Two's most popular video game franchises, and this will mark the NBA-operated league's first live-TV airings in the U.S.
One problem that could slow 2020's surge in gaming is if Microsoft (MSFT) and Sony (SNE) face delays in getting their next-generation gaming consoles launched in time for the holiday season.
Nonetheless, Wall Street is plenty optimistic about the company's prospects. Of the 29 analysts covering TTWO stock, 20 view it as a Strong Buy or Buy, while the rest are merely on the sidelines at Hold. Its P/CF is nothing to scream about, but when you factor in Take-Two's potential, it looks much more like a value.
Market value: $4.1 billion
Net cash: $360.0 million
The original ITT (ITT, $47.38) was called International Telephone & Telegraph. It got its start in 1920 and ultimately became a provider of telephone switching equipment and telecom services. In the 1960s, it went on an acquisition binge, buying more than 350 companies, including Sheraton Hotels, Avis Rent-a-Car, Hartford Insurance and many others. In 17 years, it grew sales from $760 million to $17 billion.
Fast forward to 2011, when ITT split itself into three businesses: Xylem (XYL) a water business, which remains public to this day; Excelis, a defense contractor that, through M&A, is now part of L3 Harris Technologies (LHX); and ITT Corporation, an industrial company manufacturing motion and flow control products. ITT Corporation reorganized as the current ITT Inc. in 2016, separating its operating assets from its liabilities and insurance assets.
Today, ITT has three operating segments: Industrial Processes, Motion Technologies, and Connect and Control Technologies.
ITT's revenues fell by 4.6% to $663.3 million during the first quarter, and profits declined by 12.1% to 80 cents per share. Nonetheless, both results exceeded analyst expectations. Meanwhile, free cash flow in the trailing 12 months increased by 3.3% to $284.7 million; free cash flow margins narrowly improved by 1 basis point to 10.1%.
ITT is one of the most battered value stocks on this list, at 35.6% losses year-to-date. But four of the five analysts who have sounded off on shares over the past month call the stock a Buy, with a $61.40 average price target that implies nearly 30% upside. Meanwhile, its P/CF ratio of 11.2 hasn't been this low since 2012, and its free cash flow yield of 7.7% is on the verge of value territory.
Market value: $2.3 billion
Net cash: $210.0 million
If you've been following the LaCroix sparkling water story, you're probably aware the fizz has gone out of National Beverage's (FIZZ, $49.72) stock in recent years. If you invested five years ago, you have an annual return of 20.6%. If you invested three years ago, that turns into a roughly 14% annual loss.
The cause of the stock's retreat was a combination of increased competition in the sparkling water market from brands such as PepsiCo's (PEP) Bubly as well as a number of public relations nightmares regarding CEO Nick Caporella, who founded National Beverage in 1985.
But sometimes, buying a beaten-down stock during tumultuous times can result in outsized, long-term gains.
National Beverage reported better-than-expected third-quarter results in early March. Sales grew 1% year-over-year to $222.8 million, its first quarter with positive growth in quite awhile. Interestingly, its Shasta and Faygo carbonated soft drink brands had volume growth of 3.2%, more than double the growth from its Power+ brands, which includes LaCroix. Earnings, meanwhile, improved by 7.1% to $26.6 million; on a per-share basis, profits of 57 cents beat the Street by 7 cents per share.
The company's 14.8 P/CF is its lowest multiple since 2010, warranting it space on this list of the market's best value stocks.
Market value: $7.5 billion
Net cash: $730.0 million
If you work in the investment management business, you're likely familiar with SEI Investments (SEIC, $50.64). SEI provides front-, middle- and back-office support to more than 11,300 banks, trust institutions, wealth management organizations, independent investment advisers and other financial organizations. And it has been doing so since 1968.
SEI manages or administers more than $920 billion in hedge funds, private equity, mutual funds, and pooled or separately managed assets. It hasn't done particularly well in 2020, off almost 23% year-to-date. Nor has it done particularly well over the past decade. Its annualized 10-year total return is 9.6%, 210 basis points less than the Morningstar US Market Index over the same period. (A basis point is one one-hundredth of a percentage point.)
The company understandably struggled in the first quarter. The market's sharp correction sent assets under management 14.6% lower year-over-year to $283.4 billion. Assets under management, administration and advisement fell by 2.6%. That resulted in revenues of $414.8 million and profits of 72 cents per share – both below analyst estimates.
So, why buy SEI?
SEIC shares are cheaper by almost every valuation metric, including price-to-cash flow, than it has been over the past five years. Further, it has a very high return on invested capital of 28%. It's also flush with cash and has a sound balance sheet that should get it through this downturn. If it recovers like analysts expect it to in 2021, shares should follow suit.
Net cash: $350.0 million
Five years ago, if you invested in UniFirst (UNF, $156.04), one of North America's largest providers and servicers of work uniforms, you would have generated an annualized total return of 5.9% for yourself, 180 basis points less than the Morningstar US Market Index. You also would have severely underperformed Cintas (CTAS), UniFirst's much bigger competitor.
Value investing often means swimming upstream, going against the crowd. Given its longer-term underperformance and a 22.6% decline year-to-date, UniFirst could hardly be confused with a growth stock. And that's all right.
In the first quarter of 2020, UniFirst's revenue improved 6.2% year-over-year to $464.6 million, while net income jumped 8.2% to $34.7 million. All three operating segments grew their sales during the quarter, including core laundry operations, which account for 89% of overall sales.
CEO Steven Sintros has been blunt, saying the pandemic is likely to hurt its sales and earnings for the remainder of the year. Further, if oil prices stay low and the Canadian dollar continues to weaken, the downside could be even worse than projected.
That said, Unifirst boasts a solid balance sheet with $395 million in cash at the end of March, no long-term debt and just $45 million in operating lease liabilities. And analysts expect profits to rebound in the mid-teens next year. So UNF, which trades at just more than 10 times cash flow, might fly under most investors' radar, but it's worthy of consideration if you're delving into value stocks.