7 Good Stocks That Hold Hidden Value
In the stock market, value often is in the eye of the beholder.
In the stock market, value often is in the eye of the beholder. At a time when many stocks seem overpriced in light of a tepid global economy and anemic growth in revenues and profits, we went hunting for businesses that offer value in ways that may not be evident from their price-earnings ratios.
To make the initial cut, companies had to show higher operating earnings in the first quarter of the calendar year than in the same period in 2015—a sign that the basic business was improving despite the disappointing economy. Next, we looked for potential catalysts to drive the company, and stock, forward over the next few years. Those might be new sources of revenue, for example, or the prospect that the market would better appreciate existing lines of business. A commitment to returning capital to shareholders, such as via dividends, was also a plus.
We found seven companies, all of which are leaders in their industries. There's no guarantee that these firms will thrive, of course. But they're all compelling ideas that would become even more attractive should their stocks get cheaper amid a broad market swoon.
Share prices and related data are as of May 17. Except for Coach, earnings per share are actual figures for 2015 and estimated figures are for 2016 and 2017. For Coach, the actual figure is for the fiscal year that ended June 2015; estimates are for the years that end June 2016 and June 2017.
- Share price: $37.88
Market capitalization: $10.5 billion
52-week range: $27.22-$42.13
Earnings per share: previous year: $1.92; current year, $2.12; next year: $2.18
Price-earnings ratio: 18
Value traits: High dividend yield, turnaround potential
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Leather goods maker Coach (symbol COH) has tried richer and tried poorer, and it decided that richer is better. That may signal an opportunity in its battered stock. The popularity of Coach’s luxury handbags soared from 2006 to 2013. Then, as sales slowed, Coach adopted what would be a disastrous strategy: It began to emphasize price discounting. That ruined the name's cache with some shoppers and drove sales off a cliff. Total revenue dived from a peak of $5.1 billion in the fiscal year that ended in June 2013 to $4.0 billion in fiscal 2015, while operating earnings per share sank from $3.61 to $1.92. Although Coach was profitable, the trend in sales sent investors fleeing. The stock plummeted from close to $80 in 2012 to a low of just above $27 last September.
To fix the business, Coach reversed itself on discounting, pushing up prices for its goods. The company also boosted its product lineup and ramped up remodeling of its retail stores. It's early, but the turnaround plan seems to be working: In the quarter that ended March 26, Coach sales rose 11% from the same period a year earlier, and net income before merger and restructuring costs surged 22%. The stock has rebounded somewhat, and on a price-earnings basis no longer is dirt cheap, selling for 18 times estimated year-ahead earnings. But bulls, including Nomura Securities, believe that Coach's turnaround will stick and that the brand's quality will attract a much larger following abroad. "The most significant luxury opportunity remains Asia, specifically China," Nomura says. In the latest quarter, Coach stores in mainland China posted double-digit-percentage sales growth despite the country's slowing economy. Meanwhile, Coach's investors are being paid for their patience: The stock's dividend yield is a rich 3.6%.
- Share price: $28.31
Market capitalization: $9.5 billion
52-week range: $22.74-$39.00
Earnings per share: previous year: $2.05; current year, $2.35; next year: $2.52
Price-earnings ratio: 12
Value traits: Reasonable P/E, declining earnings volatility
Commercial real estate continues to boom in much of the U.S., but eventually the market will peak. When that will happen, no one knows. One potentially less risky way to play the commercial market over the long haul is to buy shares of CBRE Group (CBG). As the world's largest commercial real estate-services firm, CBRE provides property management, appraisals, development advice and other services from more than 400 offices worldwide.
One of the company’s key goals has been to make earnings less vulnerable to development boom and bust cycles by boosting revenue from long-term service contracts. In the first quarter, recurring fees accounted for 46% of CBRE's total revenue, up from 39% a year earlier. Morningstar expects that ongoing shift to make CBRE "more resilient, especially as market activity comes off historical highs."
Brokerage William Blair says CBRE also has sought to attract and keep more clients by continuing to add services via acquisitions, with a goal of providing one-stop shopping. That strategy helped CBRE's revenue double from 2010 to 2015, to $10.9 billion. In a major deal last year, CBRE acquired property management firm Global Workplace Solutions, which will add $3 billion to CBRE's annual revenue, much of it overseas. One of GWS's specialties: efficient building energy management.
Despite a 14% increase in first-quarter operating earnings, many investors remain jittery. The stock is about one-third below its 2015 high, and it trades for just 12 times estimated year-ahead earnings—far cheaper than the overall stock market’s P/E of 17. That’s a green light for value hunters to take a look.
DaVita HealthCare Partners
- Share price: $76.76
Market capitalization: $15.9 billion
52-week range: $61.36-$84.40
Earnings per share: previous year: $3.83; current year, $4.03; next year: $4.41
Price-earnings ratio: 19
Value traits: Stable dialysis business, growth potential in managed health care
- DaVita (DVA) is best known as a major operator of kidney dialysis centers, serving more than 190,000 patients from about 2,200 U.S. clinics. That business brought in the bulk of the company's 2015 revenue of $13.8 billion. But with DaVita reliant on Medicare and Medicaid payments for most of its patients, it's also at the mercy of Uncle Sam's efforts to drive costs down.
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To diversify, DaVita in 2012 paid $4.4 billion for HealthCare Partners, a doctors' group that manages all of the health needs of its client-patients. But like DaVita's dialysis business—and like many other managed-care businesses—HealthCare Partners has struggled with government efforts under Medicare and Obamacare to squeeze medical costs. In 2015, DaVita's managed-care business generated operating income of just $34 million, or a mere 3% of the company's total.
Despite the drag from the managed-care unit, DaVita's operating earnings before one-time charges hit a record $3.83 per share last year, and they are expected to edge up to $4.03 in 2016. With the nation facing obesity and diabetes crises, the business of keeping kidneys functioning has proved to be a stable source of earnings growth even in the face of government cutbacks. That kept DaVita's stock flying through early 2015, when it hit a record high of $85. The broad decline in health care stocks that began last summer drove DaVita under $62 by February. It's now back to $77, or about 19 times estimated year-ahead profits.
Brokerage Robert W. Baird thinks the stock is a relative bargain for two reasons: first, expectations of continued solid growth of DaVita's dialysis business, including overseas; and second, the potential in the managed-care business, for which, Baird says, "expectations are incredibly low." So far, one major DaVita investor is sitting tight: Warren Buffett's Berkshire Hathaway began buying shares in 2011 and now owns 38.6 million, or nearly 19% of the total company.
- Share price: $213.60
Market capitalization: $38.4 billion
52-week range: $152.31-$218.84
Earnings per share: previous year: $10.39; current year, $10.62; next year: $11.98
Price-earnings ratio: 20
Value traits: Rising earnings outlook, growing dividends and share buybacks
Major defense stocks have been among the market's hottest issues since 2011, thanks mostly to the same basic script: The companies have used much of the cash they've generated to sharply boost their dividend payments and buy back huge chunks of shares outstanding.
For Northrop Grumman (NOC), the strategy has worked so well that the stock has been lifted well above traditional "value" parameters. Northrop shares now are priced at 20 times estimated year-ahead earnings, compared with 17 for Standard & Poor's 500-stock index. By contrast, Northrop's P/E averaged less than 9 in 2011, compared with almost 14 for the S&P (both figures are based on earnings for the previous 12 months).
But investment bank Goldman Sachs argues that the stock is just catching up to the company's strong future earnings prospects—and in that sense it is still undervalued. Analysts project that Northrop will earn $10.62 per share this year on sales of $23.8 billion. The company has long been a big player in manned and unmanned aircraft, radar, surveillance technology and cybersecurity systems.
Now a huge new project is on the horizon: In October, Northrop was picked to build the new Long Range Strike Bomber, an $80 billion program. Goldman figures that Northrop's earnings will reach $15.02 per share in 2018 on sales of $28 billon. As one stop along the way, the stock should hit $235 within 12 months, Goldman says. "We continue to believe Northrop is the best-positioned defense company we cover and is set to substantially outgrow peers over the next several years," Goldman says. The question is whether the stock already fully reflects that growth. Goldman is betting the good news isn't yet all baked in.
- Share price: $29.27
Market capitalization: $24.5 billion
52-week range: $23.74-$36.40
Earnings per share: previous year: $2.65; current year, $2.88; next year: $3.08
Price-earnings ratio: 10
Value traits: Reasonable P/E, likely dividend initiation
- Synchrony (SYF) was born in 2014 as part of General Electric's decision to jettison much of its financial-services empire. Formerly known as General Electric Capital Retail Finance, Synchrony is the nation's biggest provider of private-label credit cards for merchants, including Amazon.com (AMZN), Wal-Mart (WMT) and Lowe's (LOW). Its card accounts total 68 million. For merchants, a key attraction of Synchrony's private cards is that the company shares some of the cards’ profits with them. Meanwhile, consumers like the cards for the rewards programs they offer.
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Besides credit cards, Synchrony operates other lending businesses, including CareCredit, which finances consumer health care procedures that typically aren't covered by insurance. Although GE took a beating in some of its financial operations in the 2008 market meltdown, the business that makes up Synchrony stayed profitable. As an independent company, Synchrony last year earned $2.65 per share on revenue of $9.7 billion. In the first quarter of this year, earnings rose 6.1% on a 13% jump in revenue.
Thanks in part to the above-average interest rates consumers pay on many of Synchrony's private-label credit cards, the business generates high returns on shareholder capital, says Morningstar. The research firm calculates that the stock’s "fair value" is $40, or about one-third greater than the current price. Moreover, Synchrony trades for a modest 10 times estimated year-ahead earnings.
The big concern about Synchrony is that the economy could weaken, which could pare consumer spending and drive up credit card losses if more of Synchrony's dicier borrowers suddenly can't pay their debts. Investors who are willing to bear that risk, however, may find Synchrony a compelling value. Another potential attraction: Synchrony could start paying dividends this year if the Federal Reserve gives its okay.
Thermo Fisher Scientific
- Share price: $148.82
Market capitalization: $58.5 billion
52-week range: $117.10-$150.95
Earnings per share: previous year: $7.39; current year, $8.35; next year: $8.97
Price-earnings ratio: 18
Value traits: Reasonable P/E, prospects in developing nations
Many investors like to bet on companies that are engaged in scientific research, such as biotech firms. Thermo Fisher (TMO) is another way to play scientific discovery: It supplies tools to the researchers. The company calls itself "the world leader in serving science" and backs that up with a huge lineup of scientific and lab equipment—from high-end instruments to lab chemicals to microscope slides. To build itself into the Home Depot for scientists, Thermo Fisher has been on an acquisition binge over the past 10 years or so. Total sales reached $17 billion last year, up from $10.8 billion in 2010. In that same period, net income nearly doubled, to $2.0 billion, and the stock has more than doubled, reaching record highs this spring. (Note that the company's debt load also has grown sharply to pay for those acquisitions.)
At its current price, Thermo Fisher is valued at 18 times estimated year-ahead earnings. Bulls on the stock, including KeyBanc Capital Markets and research firm Cowen & Co., say that's still a reasonable valuation given the company's growth prospects. They note that, stripping out the sales boost from a recent acquisition, revenue from Thermo Fisher's core business was up 10% in the first quarter from a year earlier—compared with the paltry 1.2% average revenue growth reported so far by companies (excluding energy firms) in the S&P 500. One potential growth kicker for the future: The company is pushing to sell more equipment in developing countries whose governments are emphasizing scientific research to boost economic growth. If emerging-markets economies pull out of their recent funk, Thermo Fisher could get a boost.
- Share price: $68.64
Market capitalization: $7.6 billion
52-week range: $60.59-$87.78
Earnings per share: previous year: $5.11; current year, $5.79; next year: $6.30
Price-earnings ratio: 12
Value traits: Reasonable P/E, strong cash flow to fund stock buybacks and dividends
Wyndham Worldwide (WYN) is the world's largest hotel company, with 678,000 rooms, mostly under economy brands such as Howard Johnson, Ramada and Super 8. Wyndham will lose that distinction if the planned merger of Marriott International (MAR) and Starwood Hotels & Resorts Worldwide (HOT) goes through.
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But Wyndham shareholders know that the main driver of the company's success hasn't been hotels; rather, it has been the company’s time-share resorts and time-share exchange business. The latter counts 3.8 million members worldwide. The fees Wyndham collects from its time-share empire have helped drive steady growth in revenue, to a record $5.5 billion last year. Net income also hit a record, at $612 million, or $5.11 per share. But even as Wyndham and other lodging companies posted strong years in 2015, their stocks were hammered by investors' fears that an economic downturn was imminent. Wyndham shares plunged from $93 in early 2015 to less than $61 early this year. They have since bounced back a bit.
To be sure, the hotel and time-share businesses face rising competition from Airbnb, the rent-your-home website. But that hasn't stopped Wyndham's growth. What's more, the size of Wyndham's time-share network—including 112,000 vacation properties worldwide—attracts users because of the breadth of choice. In turn, having 3.8 million users in its exchange (the most of any exchange) encourages more property owners to join. Goldman Sachs says Wyndham’s first-quarter results showed that "time-share trends remain healthy." Wyndham also gets high marks for returning capital to shareholders via stock buybacks and dividend hikes; the company boosted the payout rate by 19% in January. One other vote of confidence: Three Wyndham insiders, including CEO Stephen Holmes, bought shares in the open market in February for about $65 per share—the first insider buys in at least four years.