A bargain is often in the eye of the beholder, but some blue chips look just too good to pass up these days.
That’s because like pretty much everything else in investing, valuation has a way of reverting to the mean. So, when you find a quality stock trading at a sizable discount to it’s own historical earnings multiple, it’s often a good long-term bet.
True, you need to exercise a little patience in order to enjoy those healthy returns. It can take a while, but eventually the market will go back to valuing the stock the way it has in the past — and will probably even overshoot to where it looks too pricey.
And, of course, sometimes stocks are cheap for a reason. They sport a low earnings multiple not because they’re bargain-busting buys, but because something is seriously wrong with their growth prospects.
But when it comes to the bluest of blue chips, we found a number of cheap, high-quality stocks with ample prospective returns.
We combed through the Dow Jones Industrial Average looking for stocks trading at significant discounts to their own five-year averages on a forward earnings basis. They also had to have high returns on equity (ROE), a measure of quality. Additionally, they had to offer double-digit prospective total returns in the next 12 months or so, based on a large sample of Wall Street estimates.
That left us with five blue chips that look like bargain-busting buys:
Shares in Boeing (NYSE:BA), the aerospace giant, have had a turbulent 2012. The stock’s been volatile, with little price appreciation to show for it, even after it delivered a big-time beat-and-raise second-quarter report.
The stock offers nearly a 10% discount to its own five-year average, according to data from Thomson Reuters, and ROE stands at a mind-boggling 80% (the highest of any Dow component).
Meanwhile, analysts’ median price target stands at $88. Add in the 2.5% yield on the dividend, and the implied upside comes to more than 20% in the next 12 months or so.
With shares off more than 2% so far this year, Caterpillar (NYSE:CAT) isn’t looking so hot as one of InvestorPlace’s 10 Best Stocks for 2012. But the thesis and valuation remain the same, especially in light of CAT’s record earnings and outlook. Eventually the market is going to pay up for those profits.
If it was a bargain before, it’s a steal now. Shares trade at about a 50% discount to their own five-year average. And ROE is an enviable 40%.
Wall Street’s median price target is $110. Including the 2.4% yield on the dividend, CAT has an implied upside of nearly 27% in the next year or so.
There’s no doubt that the global slowdown and stronger dollar are weighing on chemical giant DuPont’s (NYSE:DD) business, but results and the outlook have been more resilient than the market is baking in.
The stock is trading 17% below its own five-year average on a forward earnings basis, while ROE is a very shareholder friendly 30%.
With a $56 median price target and a 3.4% yield on the dividend, DuPont has an implied return of more than 15% in the next 12 months or so.
A lot’s riding on Microsoft’s (NASDAQ:MSFT) upcoming launch of its new operating system, not to mention its Surface tablet. If the new OS flops like Vista or the entry into the tablet wars goes as well as the Zune music player did against Apple’s (NASDAQ:AAPL) iPod, well, all bets are off.
The stock is certainly priced for disappointment — or worse. With a forward price-to-earnings (P/E) ratio of 9, MSFT offers a 27% discount to its own five year average. And yet, with an ROE of 38%, this is a high-quality stock. It’s also one of InvestorPlace’s 10 Best Stocks for 2012, and is outperforming the market by a wide margin so far this year.
Wall Street’s median price target stands at $36, and the dividend is yielding 2.6%. That makes the implied upside nearly 23%.
It sometimes feels as if United Technologies (NYSE:UTX) is fighting wars on too many fronts. From defense spending to the construction market, this industrial conglomerate has to worry about selling everything from aircraft engines to elevators.
But UTX delivered a big upside surprise in the second quarter, and shares still look undervalued. The stock’s trading at more than a 12% discount to its own five-year average by forward earnings, and with an ROE of 24%, it offers quality, too.
A 2.8% yield on the dividend and a $91 median price target give UTX an implied return of 17% in the next 12 months or so.
As of this writing, Dan Burrows held none of the securities mentioned here.