By Jacob Sonenshine
In the age of soaring stocks and expensive valuations, some investors may turn to the cheapest ones to find bargains. There's a way to do that -- and a few stocks stand out.
Large U.S. technology companies have seen their stocks soar over the past couple of years, sending the S&P 500 up 28% this year. The index now trades at its highest valuation level since 2020, at about 22.5 times expected earnings for the coming 12 months. It's too frothy for some investors to keep buying megacap stocks, and it has made smaller, cheaper names look particularly appealing.
Cheap stocks are alluring, in a sense. A stock's price-to-earnings, or P/E, multiple is unlikely to move much lower unless the company is truly in financial trouble or on a path to bankruptcy. Meanwhile, better-than-expected earnings can send shares soaring.
But these stocks are sometimes a value trap: Those whose valuations fall below six times earnings often struggle to perform well thereafter, according to Trivariate Research's Adam Parker. However, his research shows those that drop to 10 times earnings or below -- but remain above six times -- are more promising,
Parker screened for stocks that have recently dipped below 10 times earnings for the first time at least five years, but remain above six times. Within this broader grouping, the screen identified companies that are on the mend and are basically financially healthy. Specifically, historical data show that the best names are firms that analysts expect to report higher sales growth versus compared with the past 12 months and whose net debt equals no more than half of their market values.
The screen turned up five stocks, but two of them have already posted large total returns since their multiples had declined to such low levels. That's why we are highlighting the three that haven't rallied much yet, so there's still time for optimistic investors to get in.
They include the $21 billion by market cap solar panel maker First Solar, which is expected to see sales grow 31% in 2025 from 26% this year, has more cash than debt, and is generating more than $1 billion in annual earnings. The stock's P/E ratio first fell below 10 times in late October this year, and the shares have only edged up 3% since that point.
FMC Corporation is a $7.3 billion chemical manufacturer. Analysts expect sales to grow 4% in 2025 after having dropped this year. It has net debt of about $3.3 billion. FMC's stock valuation first dropped to below 10 times earnings in late September of 2023, and the stock price is still down since then.
Lastly, Royalty Pharma is a $15.4 billion pharmaceutical finance company with $6.7 billion of net debt. Analysts expect revenue to jump about 13% next year after having dropped this year. The stock is about flat since mid November, 2023, when its multiple first dropped below 10 times.
Give these stocks a look. They're the ones that may turn out to be undervalued.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
December 05, 2024 14:40 ET (19:40 GMT)
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