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All Contents © 2017The Kiplinger Washington Editors
By Dana Blankenhorn
| February 2017
What makes value stocks … well, values? When is a cheap stock actually inexpensive … and when is it just plain ol’ cheap?
When a company has size and real earnings, and when its area of business is just out of fashion, even a great company’s stock can get tossed into the bargain bin. That is where you want to pick it up.
One of the most basic metrics of value stocks is the price-to-earnings ratio. The lower a stock’s P/E, the faster the price of your investment will be covered by earnings. Fast-growing stocks have very high P/E ratios and appeal to investors seeking growth. Slow-growing stocks have lower P/E ratios but may either pay dividends or be poised for a turnaround.
However, a lot of investors make mistakes when picking out cheap stocks. They assume the market will quickly discover its mistake and bid a low-priced stock up quickly. But that’s not how it works. Industrial fashions change slowly. A reputation, once lost, is very hard to regain. When an operating company breaks down, it can also be very hard to repair.
Still, there are ways to make money in cheap stocks. Another, more highly valued company could buy another one out. Undervalued companies may grow their way out of trouble. Hedge funds and private equity companies are always looking for undervalued assets they can buy, break up, and squeeze profit from.
These 7 ultra-cheap value stocks to buy all sell at single-digit P/Es, but also feature market caps of over $10 billion. They’re solid companies with real profits. Some even pay dividends.
There are reasons these companies are in the bargain bin, and there are bears in all these issues. Still, we want to look at the merchandise — pick it up, shake it and examine it from every angle.
One man’s trash is another man’s treasure, after all.
Prices and data are from the original InvestorPlace story published on February 21, 2017. Click on ticker-symbol links in each slide for current prices and more.
This slide show is from InvestorPlace, not the Kiplinger editorial staff.
GM P/E: 6.3
Mention an interest in General Motors Company (GM) and get ready for the pushback.
GM is a slow-growth company that can only deliver 2% of revenue to the net income line in good years, and which took a government bailout to save less than a decade ago. The “car buying cycle” is always said to have just peaked, and 2015 does remain its best year, with U.S. sales of 3.085 million vehicles.
But this is not just an American company. In 2015, GM sold a total of 9.8 million cars, and China is its biggest market, not the U.S.
Even near its highs for the year, GM stock yields 4% and trades at around 6 times earnings. General Motors covered that dividend three times with earnings last year, meaning it looks safe, and just one-quarter of its assets are subject to long-term debt. Operating cash flow has been rising for three years straight, and came in at $16.545 billion last year.
The best argument against GM is that auto sales are unsustainable. But the 264 million cars on U.S. roads today average 11.6 years old, a record. Some 17.5 million cars were sold in 2015, while 11 million were scrapped.
Cars are getting better, and many believe that the rise of autonomous cars will kill most of the current car makers. But will it? You can make an argument that GM is best-positioned to take advantage of this trend, and Maven, its car-sharing company, is already working with Uber. General Motors also has a $500 million investment in Uber’s competitor, Lyft.
Bulls argue that as cars become a service, rather than a product, General Motors should benefit, with service revenues and younger fleets. The auto market is changing rapidly, but do you believe that GM, with a market cap of nearly $53 billion, can no longer compete?
I believe it can.
Lin Cheong via Flickr
eBay P/E: 5.4
Some value stocks become cheap because investors believe that a competitor is about to eat (or already is eating) its lunch.
For eBay Inc. (EBAY) — the auction site that was one of the first true e-commerce success stories — that competitor is Amazon.com, Inc. (AMZN). The assumption that eBay is always about to be trampled by Amazon is a big reason why shares are trading at less than 6 times earnings while the market continues to set new records.
However, Christmas of 2016 was very, very good for eBay, with earnings of $601 million on revenues of $2.4 billion. The site consistently delivers operating margins of 25%, and its $7.5 billion in long-term debt is nearly equaled by the $7.13 billion of cash and short-term securities on its books at the end of 2016.
eBay is no longer just an online garage sale. It includes StubHub, the ticketing site, a host of local classified ad sites and an open source platform that lets merchants access its application program interfaces directly. The company continues to open new markets, like wine, and the stock has advanced 13% since the start of 2017.
The success of eBay continues to create successful businesses like eDropOff, a consignment shop founded in 2004. Conscious that not all eBay sellers are honest, the company has launched an authentication program for luxury goods.
I don’t think eBay is going to be a high-flyer again, but neither do I think Amazon is about to kill it, if only because the risks of dealing with, and accounting for, fraud are costs a company like Amazon is just not interested in facing.
If you believe in the second-hand market, then, you can buy eBay with some confidence. It’s a tech stock that should do well when the next recession hits. And given that the current recovery is now 8 years old, wise investors should be ready for a recession.
Equity Residential P/E: 5.3
Real estate investment trusts (REITs) are billed as income investments, not value plays, yet EQR firmly belongs in this list of cheap stocks to buy now.
Equity Residential (EQR), which has properties in some of the country’s hottest rental markets, like New York, San Francisco and Seattle, certainly looks like a value play with a listed price earnings ratio of around 5. That’s despite paying around 3.2% in dividends — not great for a REIT, but better than a 30-year U.S. bond.
What’s going on?
For one, a big asset sale has temporarily skewed Equit’s P/E. Equity closed on the sale of over 23,000 apartments to Starwood Capital Group early last year. It was a good deal, over $230,000 per apartment, and had been announced the previous October, but when those profits hit the books — $3.59 billion when revenue from rents was $619 million — it meant big earnings on a low stock price. Take out the sale, which comes off the next time Equity reports earnings in April, and the P/E returns to a more natural 24. But don’t walk away from the opportunity.
Even without asset sales, Equity does very well most quarters. For the December quarter, for instance, it earned $276.9 million on revenue of $605.5 billion. Nearly 50 cents of every dollar coming in turns into net income. The only operating company I know which does that is Facebook Inc. (FB).
Then there is Equity’s secret weapon. EQR is an investment vehicle for Sam Zell, a pioneer of the modern real estate industry who is personally worth $4.8 billion. Zell has turned out to be a master of the real estate game because he knows when to sell, not just when to buy. He sold his Equity Office Properties Trust for $36 billion, in a leveraged buyout by the Blackstone Group LP (BX) in 2006, shortly before the real estate market peaked.
The strategy for EQR now is to move away from the suburbs and toward properties in central cities. This makes good sense given the larger economic trends of research and computing driving progress, and of people preferring shorter commutes. There is also the possibility Zell could sell the whole company, with analysts believing its real estate, less debt, is worth 20% more than the stock’s current price.
Bottom line: If you can get Sam Zell on sale, it’s a bargain.
Gilead Sciences P/E: 6.9
Gilead Sciences, Inc. (GILD) is the company that made Hepatitis C a treatable condition, and it has been richly rewarded for that. But the shares peaked in 2015 and have since lost more than 40% of their value.
That’s despite operating margins of more than 50% and a 3% dividend that’s downright rare in the biotech space.
GILD began falling in mid-2015 after investors came to doubt whether the company has an encore, and knowledge that sales of its Hep C compound, sold as Sovaldi and Harvoni, will decline as Western customers are cured. (The compound is sold for much less in developing markets like India.) Earnings are churning, but the stock trades at less than 7 times earnings.
Sales have been slowly falling, from $8.5 billion in the fourth quarter of 2015 to $7.3 billion in Q4 2016. But the slope has been gradual, and the company’s dividend is covered almost five times by earnings.
The best reason to buy Gilead is its balance sheet. There is now no debt, and $32 billion in cash on the books. That balance sheet could be used to fund a major acquisition, or a new drug discovery. A candidate drug against HIV called Descovy could be that great discovery. Gilead already has a $10 billion per year HIV franchise so it can get a winning drug to market quickly, and Phase 3 studies for Descovy are already underway.
So far, Gilead management is more interested in making rather than buying new cures. If it were to go on a buying spree, it might look at $23 billion cancer-drugmaker Incyte Corporation (INCY). Or it might pick up BioMarin Pharmaceutical Inc. (BMRN), a $16 billion outfit working on rare genetic conditions among children. It even has the size to do a merger of equals with Bristol-Myers Squibb Co (BMY), an $88 billion company with 2016 sales of more than $19 billion.
All that is speculative, but the clock is ticking. Maybe an activist investor like Carl Icahn can force management to make a move.
But it’s certainly among value stocks worth speculating on. GILD is cash and potential on the cheap.
Delta P/E: 8.8
If industry analysts distrust any industry more than autos, it’s airlines.
Nearly all major carriers went through some form of bankruptcy during the last decade, victims of vicious price wars. Delta Air Lines, Inc. (DAL) was among them. It bought Northwest Airlines a year after leaving bankruptcy in 2007, and many believe it was Northwest’s corporate culture that is responsible for Delta’s later success.
Regardless of who is responsible, Delta is now the world’s biggest airline and its stock has come roaring back.
DAL brings 10% or more of revenue to the bottom line. Debt has been reduced to 15% of assets. The company even instituted a dividend in 2013 that yields a modest 1.6%. If you bought Delta shares at the time of the merger, your stock is worth five times more than it was — and you have a dividend that has tripled.
So how is it possible that even after a spectacular run-up of 40% in the past six months that you can buy DAL for less than 9 times earnings?
Because airlines are a cyclical business, rising and falling with the economy, and the cycle now looks to be peaking. Airlines have high fixed costs, and it’s only after the costs of flying are paid that money starts gushing to the bottom line. Jet fuel prices, a major cost component, are rising. Competition, especially on international routes, is increasing from national flag airlines in the Middle East and Asia. Delta’s size seems to have topped out at $40 billion of revenue each year, and profit margins have been declining steadily.
For growth, Delta is looking south, offering to buy almost half of Grupo AeroMexico SAB de CV (GRPAF), the bid being raised recently to compensate for the falling value of the Mexican peso. The deal would give AeroMexico some of Delta’s expertise, and give Delta a new hub in Mexico City.
Analysts like Delta, with most calling it an outright buy. They see protectionism as a fad, and Delta the best-priced among the airlines. Bernstein recently upgraded the airline to “Outperform,” expecting a 28% gain over the next 12 months.
Among these cheap stocks, Delta might have the most to love.
Corning P/E: 8.6
Corning Incorporated (GLW) is the cheapest technology stock around. Cheaper than Apple Inc. (AAPL). Cheaper than International Business Machines Corp. (IBM). Cheaper, even, than HP Inc. (HPQ).
Yes, Corning is a tech stock.
Look at your mobile phone. That’s probably Corning Gorilla Glass covering the screen, glass that resists breaking even when you’re clumsy. Corning says it is engaged in “materials science technology and innovation,” and that has been its focus since 1851. Over the years it has gone from headlights and telescope lenses to optical fiber cable and now, materials like Willow Glass, which makes solar panels flexible enough to roll into a tube.
Corning’s heavy investments in glass technology have helped it to profit margins of 25%, and it regularly delivers $3 billion in operating cash flow each year.
But the stock still sells for just less than 9 times earnings, even at 10-year highs. Investors who bought and held the stock since the bottom of the last crash have seen their dividends triple to 16 cents. GLW recently broke above its 2008 peak and is cruising even higher.
Corning just closed one of its most profitable years ever, earning $3.597 billion on revenues of $9.39 billion. Profits can be choppy, quarter to quarter, as its development cycle and its customers’ products cycles don’t always coincide. Corning reported a loss of $392 million, 36 cents per share, as recently as last March. But look at the year-to-year numbers, and those variations smooth out.
Why GLW is always in the realm of value stocks has been a mystery to me for years. It’s a stock for patient investors, and the stock price is prone to collapses, as in 2008, 2011, and 2015 — collapses that caused analysts to wonder whether the company would ever succeed again. But it can, because it regularly deploys $750 million on research, because it sticks to its knitting, because it is inherently stable. CEO Wendell Weeks will have been in place for 10 years this April, and he’s a lifer, having joined the company in 1983.
Corning is simply one of those investments you seldom see anymore: a steady loyal outfit (it has kept its base in Corning, New York since 1868) that sticks to its knitting, that does its job, and that manages to keep up with a changing world.
Altria P/E: 9.9
You may know Altria Group Inc. (MO) by its former name, the American tobacco giant Philip Morris. Its best-known brand is Marlboro.
Altria has always been a tobacco company. It still buys other tobacco companies, most recently privately held Sherman Group Holdings LLC, and makes money off them.
What investors need to know is Altria makes a lot of money, and it has been doing so for many years.
As with other tobacco stocks, Altria was en vogue during the last decade, but shares have slowly recovered from the 2008 crash and are only now approaching those old highs. Even now, though, you can get a yield of 3.4% on the shares.
Even Altria management knows there is a limited life span in selling cigarettes, and it made a big investment in SABMiller plc, the giant brewery company, that paid off handsomely last quarter after SABMiller merged into Anheuser Busch Inbev NV (BUD). Altria got cash, 10.5% of the new company, plus two seats on the board. When those extraordinary gains come off the books, Altria’s P/E will look like less of a bargain.
Absent the gain, Altria recorded earnings of 68 cents per share, about $1.2 billion, again beating the dividend payout as well as analyst estimates. Net revenue, exclusive of taxes, came in a little short of estimates at $4.7 billion, but investors liked what they saw and bid the stock up after the report came out.
Altria also offers the risk of product recalls, as with a recent recall of smokeless tobacco made in Illinois. More recently the company suggested the problem — metal shards in cans of Copenhagen and other brands — may have been deliberate sabotage.
The biggest red flag analysts can find on Altria’s books is its debt, which stood at $13.9 billion at the end of 2016. That could prove troublesome as interest rates rise, if Altria must refinance at higher rates. But the company also has $4.6 billion of cash on its books and the debt now represents less than one-third of its asset value. Management seems to be on top of things.
A lot of people hold a moral objection to owning cigarette stocks. I am among them. But Altria is a $140 billion company — one of the largest cheap stocks on the market — making regular profits with a dividend yielding over 3% every year. Management is clever, and since their products are addictive, the market abides even if the customers do not.
If that is your brand of success, go for it.
This article is by Dana Blankenhorn of InvestorPlace. As of this writing, he was long AAPL and AMZN.
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