Black Friday and Cyber Monday have passed and you’re still looking for bargains, right? Don’t forget to check out the stock market.
Admittedly, this year’s astonishing rally has left most stocks significantly pricier than they were a year ago at this time. As we’ve discussed recently in this column, large-cap stocks are looking somewhat overvalued these days, especially as measured by the S&P 500 index. That bellwether is trading at nearly 19 times trailing earnings and 16 times what analysts estimate its member companies will earn in the coming 12 months.
If you feel daunted by those valuations, good for you. Whenever the stock market trades above its long-term average (about $15 for every $1 of corporate earnings), it’s time to tread more cautiously. This is not a Buzz Lightyear market, bound for infinity and beyond. At some point, the laws of gravity are likely to kick in. And that’s bearing in mind all the arguments in favor of the stock market rally continuing for some time yet. Once we’re into overvalued territory, the question of whether or not we’re in a bubble, as Nobel laureate Robert Shiller just hinted, is academic.
What’s true of the market as a whole is rarely true of individual stocks, though. In other words, just because the aggregate of all large-cap stocks looks pricey doesn’t mean that there aren’t bargains out there. True, if you’re a firm believer in ultra-efficient markets, you’ll probably never witness such a phenomenon as a bargain. But history has showed us that every market creates opportunities, even if we tend to be much better at recognizing them in hindsight.
Why large cap stocks, in particular – and what’s a bargain, anyway? The first of these questions is considerably easier to answer.
Larger cap stocks, especially those in the S&P 500 index, tend to be very liquid, meaning that it’s easier to get in and out of them without moving the price. There also tends to be more information available about these companies, whether in the form of corporate disclosures or analysts’ reports. That makes the due diligence burden a heck of a lot easier. Besides, if you think the S&P 500 is in overvalued territory, you may want to take a deep breath before looking at small stocks.
When it comes to defining a bargain, I’ve taken a very, very basic approach. After all, deep value stocks trading at single-digit multiples can turn out to be traps: cheap stocks that simply get cheaper with every week that passes. Instead, I’ve taken a look at stocks in the S&P 500, scouring the list for stocks that trade at below-average multiples ($12.50 for every $1 of earnings) and offer above-average rates of earnings growth (10 percent or more). I’ve then divided my bargain-hunting suggestions into two: companies that offer an above-average dividend, and those whose dividends look downright anemic.
Everyone is going to have their own view of value and what makes for a bargain – and these days, there’s no such thing as a bargain-priced stock without a few shadows hanging over its head. So this is just a starting point – but a reminder that digging around for bargains is often more productive than simply tossing one’s arms in the air and walking away.
D.R. Horton (NYSE: DHI)
Forward P/E ratio: 12.27
YOY earnings per share growth: 38 percent
Dividend yield: 3 percent
In spite of all the optimism surrounding the housing market, this homebuilder has lagged the S&P 500 all year. In part, this is because the excitement has surrounded sales of existing homes rather than homebuilders – and then there’s the annoying fact that Horton has reported a rise in the rate of order cancellations. (And that’s not even mentioning the impact that higher interest rates might have on home purchases.)
Nonetheless, demographic trends still favor the housing industry, which in turn has been slow to ramp up the rate of new housing starts. Keep an eye out for future discounting that might eat into profit margins, but here’s one stock that might still be a long-term value.
PNC Financial Services (NYSE: PNC)
Forward P/E ratio: 10.75
YOY earnings per share growth: 11.75 percent
Dividend yield: 2.3 percent
Banks have been one of the big success stories of this year’s market, leading the way higher in both earnings and share price performance. But PNC Financial has been a group laggard, even as it offers a heftier yield than Citigroup (NYSE: C) and a more appealing valuation than Wells Fargo (NYSE: WFC). Regional banks like Regions Financial (NYSE: RF) might be still more appealing, but if you want to add one of the 10 biggest banks to your portfolio right now, this might be a candidate to consider.
Deere & Co. (NYSE: DE)
Forward P/E ratio: 9.5
YOY earnings per share growth: 21 percent
Dividend yield: 2.42 percent
Deere’s earnings are growing at a respectable pace, although investors may be focusing instead on a lack of hefty revenue growth and a "meh" outlook for the farm sector. At some point, however, that emphasis may shift to the company’s ability to deliver robust earnings growth in spite of what’s happening in commodity markets – clearly, the company’s operation discipline is remarkable. Besides, it’s an offbeat way to play the housing industry's relative strength.
Tyson Foods (NYSE: TSN)
Forward P/E ratio: 11.4
YOY earnings per share growth: 32.5 percent
Dividend yield: 0.9 percent
Commodity prices are down, bringing animal feed costs lower, too. That leaves plenty of room for meat producers like Tyson to generate profits. Even though consumers may be skittish about the overall direction of the economy, they’re still willing to buy chicken and beef, it seems – and we’re heading into the peak sports season, when sales of chicken wings soar as football, basketball and hockey all collide on big-screen televisions. Moreover, Tyson has been boosting its dividend.
Jabil Circuit (NYSE: JBL)
Forward P/E ratio: 10
YOY earnings per share growth: 55.8 percent
Dividend yield: 1.5 percent
Earnings growth has been stellar for the contract electronics manufacturer, but it has warned of a bumpy road ahead – and that’s why the stock pops up on the bargain list. If you’re interested, you’d need to reassure yourself that the management team is likely to deliver the right restructuring plan. The good news? Jabil isn’t waiting until the bad news shows up in its financials to take action.
Apache Energy (NYSE: APA)
Forward P/E ratio: 11.3
YOY earnings per share growth: 83 percent
Dividend yield: 0.9 percent
Yes, energy stocks are out of favor. But Apache’s reserves are concentrated in some of the regions in the U.S. with the highest production growth rates and the company is generating a lot of cash from its overseas operations. The stock is trading at a discount in part because its portfolio has been a bit of a mish-mash, making it hard to value, but Apache’s management team is now streamlining that portfolio. Anything trading at a discount to its peers in an out-of-favor sector that doesn’t have an obvious storm cloud overhead is worth a second glance.
In a broadly overvalued market, few relatively inexpensive stocks will be without some kind of question mark, but as long as you’re willing to do a reasonable amount of due diligence and apply your own criteria for what represents a “bargain” in today’s market, these companies offer a starting point for your shopping list.
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