The past few months have been simply awful for value hunters. The S&P 500 trades for around 25 times earnings, versus a historical mean of just 16! Value stocks, then, are a precious commodity right now.
Heck, finding any attractive stocks to buy right now is difficult.
So, what are value stocks, anyway? Trick question: Everyone has a different definition. Still, for me, value stocks typically begin with price/earnings-to-growth ratio, an important value metric that every investor should keep an eye on.
I start with the price-to-diluted-earnings-per-share ratio. Then I divide that number by the growth rate of diluted EPS. The general rule is that if the PEG ratio is less than 1, it belongs in the “value stocks” category, and if it’s above 1, it’s overbought. However, if earnings are growing at 15% or higher per year, I’ll actually permit a PEG ratio of up to 2, and I consider it a “growth at a reasonable price” (GARP) stock.
I also give a 10% premium each for companies with large cash holdings, significant free cash flow and a world-class brand name.
That’s the starting point for more research. But if you want to see where my research has already led me, here’s a look at seven value stocks to buy or put on your wish list.
Rare Value Stocks to Buy: HD Supply (HDS)
HD Supply Holdings Inc (NASDAQ:HDS) is an unfamiliar name to many, but it has very familiar origins. HDS is the professional services division of Home Depot Inc (NYSE:HD), and it’s one of the newest stocks on my value radar.
HD Supply distributes tons of different kinds of equipment to about half a million customers across maintenance, infrastructure, construction and other industries. The website’s partial list includes just about everything you’d find in a home improvement store.
Distribution can be a fabulous business if you have the infrastructure and footprint, and HDS seems to have both. Moreover, it has very little capex to worry about, so it’s a free cash flow machine.
HD Supply’s earnings outlook doesn’t scream value — it screams growth. Earnings are set to explode by 56% this year before slowing to “just” 18%. The five-year outlook is about 19% in annual profit growth on average … yet the stock trades at just 11 times next year’s earnings. Price/earnings-to-growth is a measly 0.5!
The only black mark I feel is worth mentioning is that debt is about 10% per annum, but that’s manageable. And it’s certainly not enough to drown out all of HDS’ other virtues.
Rare Value Stocks to Buy: Southwest Airlines (LUV)
Southwest Airlines Co (NYSE:LUV) currently has a PEG of around 0.7, but for what it’s worth, PEG isn’t always the greatest measure for Southwest. In fact, a few different stocks can be classified with that guideline. Airline stocks, for instance, tend to have heavily fluctuating net income, so it’s hard to get a bead on where they really are.
Instead, I just look at the general state of airlines’ finances — net income, balance sheets and the like — as well as price relative to bottoms that the stock has touched in recent years.
Southwest has $3.4 billion in cash and short-term investments versus $2.5 billion in long-term debt. Earnings are solid, and the company has pushed out about $1.1 billion in free cash flow last year.
LUV stock trades around $36.60 as I write this, and it reached lows of $32 just last year. If Southwest drops below $35, I’d say that presents an opportunity.
Rare Value Stocks to Buy: Magna International (MGA)
Auto parts are hot, hot, hot!
Carl Icahn is all over them, and Magna International Inc. (USA) (NYSE:MGA) is a Canadian provider that I like for its value prospects right now.
Magna International is a $16 billion company that, depending on the year, is the industry’s largest player. Its parts can be found across the Detroit Big Three, higher-end cars like those from BMW and even Tesla Motors Inc (NASDAQ:TSLA).
MGA made roughly $2 billion in net income last year, and trades at less than 8 times those earnings. That figure drops to 7 on forward estimates. Overall, the company is projected to grow earnings by 13% annually over the next five years, and it has a 0.7 PEG ratio.
The company finally did reach into its cash hoard to make a $2.5 billion acquisition of German transmission maker Getrag that closed early this year, so its actual cash-to-debt situation isn’t great. But the company’s cash flow is healthy, at almost $730 million last year.
Rare Value Stocks to Buy: Nike (NKE)
Nike Inc (NYSE:NKE) sits at a PEG ratio well north of 1, so it’s certainly not a true “value stock.”
That’s where GARP comes in.
Analysts begin by providing 15% annualized EPS growth estimates. Nike definitely gets a 10% premium for having more cash than debt ($5.4 billion to $2 billion), 10% for having great free cash flow and 10% for its brand name. That alone means I’m willing to pay about 20 times earnings. Next year’s earnings are pegged at $3.72 billion, meaning NKE stock trades at 26 times earnings, or a PEG ratio of 1.3.
That number wouldn’t work with most stocks, but for an innovative world-class company like Nike, it’s fine by me.
Rare Value Stocks to Buy: Ford (F)
I’m not 100% sold on Ford Motor Company (NYSE:F), but I am looking at it right now.
Ford is solidly profitable, at $8.5 billion in the trailing 12 months, and it has substantial free cash flow.
The problem with auto manufacturing stocks is their bottom lines can fluctuate wildly. It’s difficult to ascertain if they are truly value stocks. Ford at the moment has a PEG ratio of 0.6, so it technically qualifies, and by quite a bit. What does bother me is that sales haven’t been growing all that much.
Still, there’s not too much downside here. A double bottom at $8 in 2012 is Ford’s most recent low. Meanwhile, a nearly 5% dividend yield isn’t just going to provide something of a floor — it’s a great enticement to buy.
Rare Value Stocks to Buy: Enova International (ENVA)
Enova International (NASDAQ:ENVA) is an online lender that distinguishes itself from its loser peers — like On Deck Capital Inc (NYSE:ONDK) and LendingClub Corp (NYSE:LC) — in that it has a business model that actually makes money.
And it will make a lot more.
Enova has the best analytics of any online lender that I know of. It is expanding its near-prime consumer credit product, as well as its installment lending business and its U.K. consumer products.
ENVA is a $20 stock that’s trading at $9. A large part of that has been sparked by fears over a crackdown by the U.S. Consumer Financial Protection Bureau on various lenders. Those fears aren’t unfounded, either, as Enova itself announced in June that an assessment over proposed rules on small-dollar loans could affect the revenue stream.
That said, the rules “didn’t contain any big surprises,” CEO David Fisher said at the time. But Enova is pivoting. While net income will finish significantly lower this year, earnings are expected to rebound by 27% next fiscal year as Enova expands the rollout of new products.
Rare Value Stocks to Buy: Signet Jewelers (SIG)
Signet Jewelers Ltd. (NYSE:SIG) is a name I frankly didn’t expect to see show up while I was digging for value stocks.
Yes, SIG stock is battered, which typically is one way that a value is crafted. Shares are off 22% in the past year, and 35% from their late 2015 peak.
The market just isn’t fond of Signet … which is too bad, because the financials are actually pretty good.
Net income has improved in each of the past four years, including a 23% bump last year. That growth isn’t stopping. Earnings are expected to grow another 20% to $8.22 per share this year, then another 15% next year. Long-term EPS growth is slated at 17%. Free cash flow is about $300 million in the trailing 12 months.
And yet SIG stock is trading at just 10 times next year’s earnings, plus it boasts a skinflint 0.7 price/earnings-to-growth ratio.
I love Signet as a value here, but there’s a little short-term gunpowder, too. About 13% of SIG’s stock is sold short, which could prompt a short squeeze on any good news. That good news could come on Thursday, Aug. 24, when Signet reports earnings. If SIG pops, it still might be worth chasing. And if drops on anything other than a completely new and uber-bearish outlook, that’ll just make the value proposition even better.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. He can be reached at TheLibertyPortfolio@gmail.com. As of this writing, he was long ENVA.
