When investing, it is important not to be fooled by low valuations. That is to say, just because a stock has a cheap valuation relative to the market or its peers, that doesn’t mean that the stock is a good buy. Instead, a cheap valuation is often reflective of weak fundamentals. If the fundamentals stay weak forever, then the stock can likewise stay weak forever, too.
As such, blindly buying all single-digit P/E stocks is not a good investment strategy. Most stocks with low valuations simply aren’t worth the risk.
Having said that, there are a handful of low P/E stocks that are worth the risk. These are the class of cheaply valued stocks that have an opportunity meaningful improve operations over the next several quarters or years, and as such, will rise sharply as favorable fundamentals converge on a discounted valuation.
Which stocks belong in this category? Not many. But, here’s a list of seven such single-digit P/E stocks that have visibility for big upside potential in the foreseeable future.
LGI Homes (LGIH)
Forward P/E Multiple: 8.4
First on this list is LGI Homes (NYSE:LGIH), a really beaten-up housing stock that should rise sharply in 2019 as fundamentals stabilize and improve within the U.S. housing market.
LGIH stock dropped sharply in 2018 on signs that the housing market was slowing. The Fed was tightening, so mortgage rates were rising. The economy was slowing, so housing starts were dropping. Inventory was big relative to demand. Home prices were starting to flatten out.
All those headwinds are reversing course in 2019. The Fed isn’t tightening anymore. Mortgage rates are falling, while wage growth is at a decade-high, unemployment levels are at record lows, and home ownership rates are way off their highs. The economy is stabilizing, and housing starts are jumping back. Inventory is falling. Demand is coming back. Home prices are showing signs of rising again.
If these housing market improvements persist throughout 2019, then LGIH stock should rally in a big way as those fundamental improvements converge on an anemic 8.4 forward multiple.
Forward P/E Multiple: 8.5
Next up: AT&T (NYSE:T). The telecom giant has been hammered on debt concerns in today’s slowing economy and rising rate environment.
Long story short, AT&T acquired Time Warner in 2018, and in doing so, amassed the world’s biggest debt load ever seen. Shortly thereafter, rates started moving sharply higher, and economic growth started materially slowing. That combination put significant pressure on AT&T’s huge new debt load, and weighed on AT&T stock.
Those headwinds are turning around. Rates aren’t moving higher anymore. They are actually moving lower. Economic growth is slowing. But, recession fears were overblown, and now the consensus seems to be stable and slower going forward. As such, all that pressure on AT&T’s balance sheet should ease in 2019. As it does, T stock should rise.
It also helps that AT&T will get big help from the roll-out of 5G coverage in 2019, while streaming operations should get a nice boost from Time Warner’s content assets. That double tailwind, plus favorable macroeconomic trends and a 8.5 forward multiple, should lead to gains for T stock in 2019.
Forward P/E Multiple: 5.3
One of the more hated stocks on Wall Street right now is chipmaker Micron (NASDAQ:MU). For the past several months, the stock has traded at a single-digit forward multiple. Yet, during that stretch, MU stock has broadly gone lower, not higher.
Why? The valuation is already pricing in peak earnings. In a nutshell, Micron goes as the memory market goes, and the memory market goes based on on supply-demand fundamentals. Those supply-demand fundamentals are notoriously cyclical. Eras of high supply and low demand, are followed by eras of low supply and high demand, and vice versa.
Right now, we are going from an era of low supply and high demand (good for Micron), to an era of higher supply and lower demand (bad for Micron). During those transitions, profits drop. But, the magnitude of the drop is an unknown. Investors don’t like unknowns. So, they sell MU stock, and prepare for the worst.
The worst may not happen this time around. Demand drivers in the memory market are very robust, thanks to things like the cloud, IoT, data, and AI, and should provide cushion for earnings erosion during this down-cycle. If that does happen, and earnings don’t fall by that much, then MU stock could soar from today’s 5.3 forward earnings base.
Forward P/E Multiple: 7.2
The big bear thesis in Ford (NYSE:F) stock – which has dragged the stock from $16 to $8 over the past 5 years – has merit. Namely, car ownership rates are dropping in the sharing economy, and project to fall further as the sharing economy grows in popularity. Also, Ford is losing market share to new EV players, like Tesla (NASDAQ:TSLA), and this dynamic should continue for the foreseeable future, too.
But, this bear thesis is already fully priced into Ford stock. In the big picture, Ford will be just fine. Sure, the auto market is shrinking and Ford is taking home less share. But, the auto market isn’t disappearing, nor will it ever disappear, and Ford will forever remain an important player in that market. As such, sales and profits should remain stable going forward, with potential gains from an EV pivot.
At just 7.2-times forward earnings, Ford stock isn’t priced for stability, let alone any upside. But, in the long run, investors will get stability, and potentially even some upside. As such, Ford stock could rally big from here in a multi-year window.
Signet Jewelers (SIG)
Forward P/E Multiple: 8.4
Haven’t you heard? Millennials are pushing back big life events, like marriage, and consequently, just aren’t buying wedding rings. That’s largely why Signet Jewelers (NYSE:SIG) has struggled dramatically over the past several years.
But, there’s more at play here. Young consumers aren’t just pushing back big life events. They are valuing experiences over products, and choosing to spend their paycheck on travel, not jewelry. Why? Because an exotic beach is much more “Instagrammable” than a new necklace or ring.
This trend isn’t reversing course soon. But, consumer demand for jewelry has been alive and well for 2,000-plus years. It isn’t going away anytime soon because of Instagram. Regardless of how the IG trend plays out, the jewelry industry will be just fine, supported by healthy and secular demand drivers that are far more enduring than pretty much any other trend out there.
Because of this, it’s only a matter of time before Signet’s numbers stabilize. Once they do, SIG stock — which trades at just 8.4 forward earnings versus a five-year average forward multiple of 14 — will roar higher.
Forward P/E Multiple: 7.7
By now, everyone knows the retail apocalypse isn’t happening. E-commerce and brick-and-mortar commerce need to exist together, because there is demand and need for both. As the market has realized this over the past year-plus, traditional retail stocks have bounced off their retail apocalypse lows.
Macy’s (NYSE:M), though, has had a tough time holding onto those gains. The numbers at Macy’s have been disappointingly weak, especially relative to department store peers on a comparable sales and margin basis. As such, investors have been unwilling to buy into the Macy’s rebound story, and Macy’s stock has dropped over the past few quarters.
This is all just near term noise. In the big picture, Macy’s has created a sustainable niche for itself in the apparel retail world as the happy medium between quality and price. It isn’t Walmart (NYSE:WMT), where quality is questionable and prices are great. Nor is it Nordstrom (NYSE:JWN), where quality is great and prices sometimes required a double check. Instead, it’s right in the middle of the two, with passable quality at reasonable prices.
That niche has long term staying power since a majority of consumers find themselves in that middle-income band (52% of Americans live in the middle class). To be sure, that doesn’t mean the numbers will ever be great again. There’s a little company called Amazon (NASDAQ:AMZN) that is also fighting for that middle class. But, the numbers will stabilize, and stability is enough to create a big rally in Macy’s stock from today’s 7.7-times forward earnings base.
International Business Machines (IBM)
Forward P/E Multiple: 9.9
International Business Machines (NYSE:IBM) has had a tough run over the past several years as new and upcoming tech companies have passed up Old Big Blue in critical growth markets, like cloud and AI. As this has happened, IBM’s growth rates have fallen flat. Margins, too. And IBM stock has crashed.
But, not all hope is lost. IBM’s cloud business is turning the corner, and its business will continue to turn the corner in 2019 as the company integrates high-growth Red Hat hybrid cloud operations into its ecosystem. As this happens, IBM’s growth rates will improve. Margins will improve, too. Analysts will upgrade the stock. Investors will get excited.
All of those positive catalysts will attract more buyers to the stock. How many more buyers? Quite a few. At under 10-forward earnings, IBM stock is by far the cheapest way to play the cloud revolution. Thus, so long as IBM gets its act together on the cloud front, this stock has plenty of runway ahead through multiple expansion.
As of this writing, Luke Lango was long LGIH, T, TSLA, SIG, M and AMZN.