I was asked by my editor to write about undervalued stocks. As I scratched my head thinking about an angle to take, I came across an article from 2019 that discussed the Pacer US Cash Cows 100 ETF (NYSEARCA:COWZ). It uses financial metrics such as free cash flow, enterprise value, and FCF yield to find undervalued stocks.
COWZ tracks the performance of the Pacer US Cash Cows 100 Index, an index that’s created by starting with the Russell 1000 Index and selecting the 100 stocks with the highest free cash flow yields, which is defined by free cash flow divided by enterprise value.
These stocks are commonly referred to as “cash cows,” hence the name of the ETF. The holdings are reconstituted and rebalanced quarter on the third Friday in March, June, September, and December. No stock may have a weighting of more than 2% in any given quarter.
These are the 10 best-undervalued stocks to buy from COWZ:
- Altria (NYSE:MO)
- Best Buy (NYSE:BBY)
- CVS Health (NYSE:CVS)
- Discovery (NASDAQ:DISCA)
- Gilead Sciences (NASDAQ:GILD)
- Intel (NASDAQ:INTC)
- Kroger (NYSE:KR)
- Lennar (NYSE:LEN)
- Target (NYSE:TGT)
- Tyson Foods (NYSE:TSN)
Here are my selections based on its holdings as of Oct. 7.
Undervalued Stocks to Buy: Altria (MO)
Free Cash Flow (TTM): $10.1 billion
Enterprise Value: $97.8 billion
FCF Yield: 10.3%
When I’m looking for undervalued stocks to buy, one thing that catches my attention is an FCF yield of 8% or more. While it doesn’t guarantee long-term success, it is an excellent measure of a company’s profitability.
Altria’s stock has had a tough year. Its total return year to date through Oct. 7 is -13.7%, considerably lower than the entire U.S. markets, up 8.2%.
While the company’s investment in Juul has become a nightmare — Altria took a $4.1 billion impairment charge earlier this year to reflect the litigation the e-cigarette company faces — it’s making some interesting moves on the cannabis front.
According to Forbes contributor Chris Roberts, who writes about vices for the publication, Altria has filed two patent applications for vaporizers specifically designed for cannabis. According to Roberts, the vaporizers can control the temperature used to vaporize both THC or CBD.
In December 2018, I said that Altria got a bargain when it acquired a 45% stake in Cronos Group (NASDAQ:CRON), as the long-term prognosis for cannabis was much better than for e-cigarettes. Almost two years on, I’m even more confident it made a smart bet.
The patents suggest cannabis is very much in Altria’s future.
Best Buy (BBY)
Free Cash Flow (TTM): $5 billion
Enterprise Value: $28 billion
FCF Yield: 17.9%
The second stock on this list of undervalued stocks to buy is Best Buy. When I first calculated Best Buy’s free cash flow yield, I thought there had to be a mistake, so I checked out its second-quarter results. Sure enough, the electronics retailer’s operating cash flow in Q2 2020 was $3.8 billion, about six times greater than its operating cash flow a year earlier. At the same time, Best Buy’s additions to property and equipment were actually less than in the same period a year ago.
So, it had $3.4 billion in free cash flow in the second quarter alone. Of course, none of this would come as a surprise to anyone who follows the company. In the second quarter, it had comparable online sales that grew 242.2% in the quarter.
While Best Buy chief executive Corie Barry was extremely complimentary of the entire group of employees and how they performed during the quarter, the company remains cautious of future quarters due to the novel coronavirus.
Sure, the FCF yield is likely to fall into single digits in the quarters ahead. That said, BBY stock remains an excellent play at the intersection of growth and value.
CVS Health (CVS)
Free Cash Flow (TTM): $13.6 billion
Enterprise Value: $150.8 billion
FCF Yield: 9%
From time to time, I like to reach out to some of my InvestorPlace colleagues to get some of their opinions about stocks I’m writing about. On this occasion, Tom Taulli drew the short straw.
Taulli recently included CVS Health in an article about seven cheap stocks to buy for a defensive bargain.
“[T]he company has a diverse set of businesses. Besides its 9,900 brick-and-mortar stores, the company also has a strong position in managed care with its Aetna insurance business, as well as in the pharmacy benefits industry with Caremark. The result is that cash flows have remained robust,” Taulli wrote on Oct. 5.
The reality is that CVS Health’s free cash flow has never been better. Off 21% year to date, Taulli remarked, I’m not sure investors have gotten this good an entry point in quite some time.
Discovery Communications (DISCA)
Free Cash Flow (TTM): $3.1 billion
Enterprise Value: $23.8 billion
FCF Yield: 13%
Earlier in 2020, InvestorPlace’s Mark Hake recommended Discovery stock, suggesting that its earnings power combined with a bevy of in-demand cable channels including HGTV, Food Network, and Animal Planet, made it a very cheap investment.
Since then, DISCA has fallen a couple of dollars and is trading well off its 52-week high of $33.66.
It doesn’t help that JPMorgan cut its target price recently to $25 on concerns that its stable of channels isn’t enough to differentiate itself from all the streaming services that have sprung up in recent years.
In fact, of the 26 analysts that cover Discovery, only eight have it as a buy. Over half the analysts (16) rate it a hold with an average target price of $24.54.
Almost seven years ago, I recommended DISCA because of the job CEO David Zaslav was doing operating its business. In those seven years, Discovery has seriously underperformed the markets as a whole.
Zaslav is still CEO. If he doesn’t do something soon to goose the share price, I suspect he will be put out to pasture. That said, a 13% FCF yield is hard to resist.
Gilead Sciences (GILD)
Free Cash Flow (TTM): $8.5 billion
Enterprise Value: $84 billion
FCF Yield: 10.1%
President Trump’s stay at Walter Reed included receiving remdesivir, the antiviral drug developed by Gilead originally intended to treat the Ebola virus. With Trump’s oxygen levels falling, doctors felt the drug, which is usually reserved for patients whose condition is worsening, was a useful tool in his treatment.
For Gilead shareholders, it was an excellent example of one of its drugs being repurposed to serve a greater good. However, it’s important to note that remdesivir does not lower death rates. It merely helps to reduce one’s stay hospital stay.
On Oct. 8, Gilead announced that it had agreed to sell up to 500,000 treatments of remdesivir to the European Union and other countries not in the EU but in the region. This new agreement replaces a previous agreement that was scheduled to end on Oct. 31.
Many countries in Europe have experienced shortages of the drug, including Spain, which continues to see many Covid-19 hospitalizations.
Gilead stock has delivered a disappointing performance in recent years, so this time in the spotlight could help spur some activity in its share price.
Free Cash Flow (TTM): $21.9 billion
Enterprise Value: $236.5 billion
FCF Yield: 9.3%
Intel definitely deserves a spot on this list of undervalued stocks. Intel might be getting the snot kicked out of it by both Nvidia (NASDAQ:NVDA) and Advanced Micro Devices (NASDAQ:AMD) in 2020 — the two chipmakers are up 137.6% and 89% year to date versus a total return of -10.3% for Intel — but you can’t deny the fact it still can generate significant free cash flow.
In fact, its free cash flow has never been so high. I guess that’s why my InvestorPlace colleague, Ian Bezek, recently said that Intel was a tremendous value at $50.
“What we do know is that Intel stock looks astonishingly cheap for a company that is still growing at a healthy rate,” Bezek stated on Oct. 2.
“Not many times will you see a company with a 9x P/E ratio that has grown earnings 150% in recent years. Investors are also paying just 3x sales and 7x EV/EBITDA, which is incredibly cheap for a tech company.”
I couldn’t agree more. That’s why I said in September that it was an exceptional value play.
“New logo or not, Intel’s still got a few tricks up its sleeve. Patient capital ought to be all over Intel stock at this point,” I wrote on Sept. 8
“I thought it was a buy at $66. It’s definitely a buy at $51 and change.”
A month later and trading around the same price, I continue to believe Intel’s time will come soon enough.
Free Cash Flow (TTM): $3.9 billion
Enterprise Value: $44.2 billion
FCF Yield: 8.8%
Given some of the FCF yields on this list, 8.8% seems almost mediocre, but make no mistake: Kroger is doing better than it has for some time. Its enterprise value is higher than it’s been since 2016. Considering we’re in the middle of a pandemic, and it’s not a tech stock, Kroger has achieved a tremendous performance.
The question is whether it can continue.
In mid-September, Bank of America analysts lowered its rating on KR stock to neutral from buy, with a $2 cut in its target price to $40. Increased competition was its argument.
“We believe Kroger’s plan to integrate third-party marketplace offerings this fall reflects Kroger’s need for a broader general merchandise assortment to compete with omnichannel leaders Walmart and Target,” Bank of America analysts led by Robert Ohmes wrote.
Kroger reported strong second-quarter earnings on Sept. 11 that included a 127% increase in online sales and an overall sales increase of 14.6%. For all of 2020, it expects sales to grow by 13% over last year with adjusted earnings per share growth of at least 45%.
The analysts might think the jig is up for Kroger. I don’t.
Free Cash Flow (TTM): $4 billion
Enterprise Value: $30.7 billion
FCF Yield: 13%
Almost 21 months ago, at the beginning of 2019, I argued that Lennar’s 40% plunge in value the previous year provided investors with a buying opportunity.
“It hasn’t been a good year for housing stocks to buy with all the main players, especially Lennar, getting major haircuts,” I wrote on Jan. 3, 2019.
“Investors just don’t want to own housing stocks at this point. Should interest-rate hikes slow in 2019, that view could change in a real hurry.”
Well, that’s precisely what happened, and lo and behold, LEN stock has almost doubled since the publication of my article.
Now, having doubled in price, I’m back to say Lennar stock is still very cheap for two reasons.
First, its free cash flow generation is insanely good right now. Secondly, the housing market is strong and will likely remain strong into 2021, despite the ongoing pandemic.
When you consider that Lennar’s FCF yield is almost double what it was in early 2019, I think the word “undervalued” aptly describes its share price.
Free Cash Flow (TTM): $6.4 billion
Enterprise Value: $89.7 billion
FCF Yield: 7.1%
As I said previously, when it comes to finding undervalued stocks using FCF yields, I like to go for those companies yielding 8% or more. However, it’s only under my arbitrary floor because TGT stock went on a major tear the past three months, up almost 37%, including dividends.
Target’s been a favorite of mine since the board hired Brian Cornell in July 2014. He’s done a tremendous job refocusing the Minneapolis-based retailer.
A year ago in August, I said that Target stock was bound to hit $200 sooner than most investors expected. Although I thought Target could hit $200 in 2020, I thought it was more likely to happen sometime in 2021.
Regardless of when it hit $200, I continue to believe it’s one of the best retail stocks to hold over the long haul. That’s especially true if Cornell remains in charge.
As I write this, TGT stock needs to appreciate by 24% to hit $200. I’d be shocked if it hasn’t reached this mark by next summer.
Tyson Foods (TSN)
Free Cash Flow (TTM): $2.5 billion
Enterprise Value: $32.1 billion
FCF Yield: 7.8%
The final company on this list of undervalued stocks is Tyson Foods. Through the first nine-and-a-half months of 2020, Tyson has a total return of -34.1%. Over the past five years, its annualized total return is 7.7%, almost half the U.S. markets’ performance as a whole.
Needless to say, it hasn’t delivered for shareholders, which is why the largest U.S. processor of chicken and beef is trying its hand at plant-based and mixed products (beef/meatless combination).
The world is changing, and Tyson can either fall behind or jump on the bandwagon. While it’s too early to tell if its heart is really in the meatless movement, it’s hard to deny that the company has been able to crank up the free cash flow generation in fiscal 2020.
Through the nine months ended June 27, Tyson’s free cash flow was $1.8 billion, 219% higher than in the same period a year ago. And, as it says at the top, it has generated $2.5 billion over the past 12 months, its highest level in the past three years.
Over the past five years, every time TSN stock has fallen below $60; it has managed to scratch and claw its way back to $80 or higher. With a dividend yield close to 3%, it’s an opportunity to get paid by Tyson to wait for it to claw its way back once more.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.