MW 5 cheap stocks that value manager Bill Nygren likes in this overpriced market
By Michael Brush
Is the stock market expensive? Not if you know where to look.
Skeptics tell us it's tough to find stocks to buy given the U.S. market's historically rich valuation right now. The S&P 500 SPX, for example, trades at a level rarely seen in the past two decades.
But the real problem might be that the naysayers are not looking hard enough. Go beyond the 25 largest stocks in the S&P 500 - mostly high-growth tech companies - and there are plenty of bargains to be found. That's the view of a veteran value-stock investor with a solid long-term performance record.
"The big story is not what you think about the S&P 500 or how the handful of dominant companies will perform," said Bill Nygren, who manages the $23 billion Oakmark Fund OAKMX.
"What's more interesting is how wide the spread is between [stocks with high and low price-to-earnings ratios] in the S&P 500," added. "Lots of companies across various industries are available at single-digit P/E multiplies. For investors, that is more important than whether or not the S&P 500 is attractive."
A negative explanation might be that the quality differential between high P/E and low P/E stocks is larger than it has been historically. That would justify the spread. "We don't see any evidence of that in earnings growth or the sustainability of the return on capital," says Nygren. As for the 500 investment candidates in the S&P 500, Nygren adds, "the 475 [other] stocks are the more interesting place to look."
Many of these businesses may be more mundane in terms of revenue growth - or what they do - compared with the "Magnificent Seven" stocks and other shooting stars in tech. But these steady Eddies regularly boost earnings per share by using cash for buybacks. They are also returning cash to shareholders via dividends. "They're not as exciting as the companies leading the market, but they are selling for a third of the market multiple and they are the better investments."
Nygren is worth listening to because his mutual fund has done consistently well. Oakmark Fund has outperformed both its Morningstar benchmark index and value-fund category by four to five percentage points annualized over the past five years.
Here are five stocks he's bullish on now:
1. General Motors: Once the iconic symbol of the U.S. economy, General Motors $(GM)$ recently traded at a paltry forward P/E of just 5.5. That's a 76% discount to the forward P/E of the S&P 500. True, car sales won't grow as fast as the sales of high-end computer chips, but GM has other levers it can pull, Nygren says.
With its stock so cheap, the company has moved from using cash to invest in the car business to buying back stock. At a 5.5 P/E, this produces a 20% return on invested capital. "This year they bought back 25% of their share base and they said if the market does not react by giving them a higher stock price they will do it again next year," Nygren says.
This decision produces tremendous earnings-per-share growth. Buying back 20% of its stock produces net income growth of 25% for GM. That's higher than the growth rate of many of the richly valued S&P 500 stocks. "GM can buy back 20% of its shares annually without taking on debt because it is priced so cheap," Nygren says.
Moreover, traditional car sales might pick up because consumers are coming to grips with the shortcomings of EVs.
2. Alphabet: Alphabet $(GOOGL)$ $(GOOG)$ has a forward P/E of 20, which does not look cheap. But if you put a multiple on its cloud-services revenue that's similar to the multiples of other companies in the space, back out $12 a share in cash and put venture-capital spending on the balance sheet instead of the income statement, where it depresses reported earnings, Alphabet has a P/E of around 13.
"It is hard to argue that search is so bad a business that it should be valued at 60% of the market multiple," Nygren says. True, investors worry that competitors may turn to AI to enhance search. Alphabet has been slower to use AI in search but will catch up, Nygren predicts. Another fear is that U.S. antitrust regulators will break up the company. But even if that did happen, it would force the market to recognize the true value of various Alphabet divisions, benefiting shareholders.
3. Citibank: Citibank's stock recently traded at a forward P/E of 9.4, or 59% of the S&P 500 multiple. An ongoing restructuring could elevate both earnings per share and return on equity enough to give Citi a multiple more in line with higher-quality Bank of America $(BAC.SI)$, which recently traded at 12 times forward earnings. "You have to believe that after so many years of being mismanaged, Citibank is finally well-managed," Nygren says. He obviously believes, because Citi was Oakmark Fund's fourth-largest holding as of the end of September.
4. APA: Recently trading at just 6.8 times earnings, shares of this energy company look cheap, Nygren says, especially considering the value of the offshore oil assets it owns near the South American country Suriname. APA $(APA)$ is developing the site with France's TotalEnergies $(TTE)$ (FR:TTE). Nygren says the value of this asset alone could be equal to APA's current market cap.
Even without the Suriname project, APA's stock looks attractive. The stock price is around the same level it was at three years ago. But in the interim APA has purchased Callon Petroleum without adding debt, bought back a lot of stock and paid down debt by about 30%. Production is up 40%, and cash flow has advanced 75%.
Deere: This agricultural-equipment company recently traded at a P/E of 16.4 times expected earnings of $25 per share. But Nygren assumes that depressed corn and soybean prices will normalize, boosting Deere's (DE) earnings per share to around $30, lowering that forward p/e to a more reasonable 13.7 times.
Michael Brush is a columnist for MarketWatch. At the time of publication, he owned GOOGL and APA. Brush has suggested GOOGL, C and APA in his stock newsletter, Brush Up on Stocks. Follow him on X @mbrushstocks.
-Michael Brush
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(END) Dow Jones Newswires
November 06, 2024 09:20 ET (14:20 GMT)
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