Let’s take a look at some of the top value stocks right now, ones that should be seen as potential investments for August. Some of these have upcoming earnings reports. I expect that each of these companies will show good earnings and strong free cash flow (FCF) growth and margins for the second quarter. As many of you know, I tend to focus on FCF as a measure of a company’s financial health, especially for value stocks. That helps set their target values fairly easily.
And by the way, what is a value stock? I define value stocks as those with a good bargain element in relation to some easily defined measure of their value. Notice that I did not say that it is cheap on an absolute basis. I am not limiting my view of the value stocks to just low price-to-earnings (P/E) or price-to-book-value (P/BV) stocks.
Note also that I want the value to be easily defined or viewed. So, for example, a company that has a high EV-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) but is seriously bleeding cash flow is not a value stock.
The value should be readily apparent. For example, it could be a sum-of-the-parts (SOTP) basis, a reasonable FCF yield situation, or a major catalyst like a spin-off coming up that the market is ignoring.
One more thing. The purpose of this list is to make you money. These seven value stocks have very high expected returns with lower-than-average risks over the next year.
Here are the seven value stocks that investors should consider for August:
- Microsoft (NASDAQ:MSFT)
- AT&T (NYSE:T)
- Oracle (NYSE:ORCL)
- IBM (NYSE:IBM)
- Square (NYSE:SQ)
- ViacomCBS (NASDAQ:VIAC)
- Ault Global Holdings (NYSEAMERICAN:DPW)
Let’s dive in.
Value Stocks: Microsoft (MSFT)
Market Cap: $2,155 billion
Microsoft could reach $400 per share with a $3 trillion market capitalization, up from its present $2.155 trillion market cap and $286.14 share price at the close on July 22. This would happen if the software company produces excellent free cash flow (FCF) and FCF margins for Q2. Microsoft releases earnings for its fiscal Q4 ending June 30 on July 27.
Last quarter, its revenue rose 19% year-over-year (YoY) and operating income rose 31% to $17 billion. But FCF rose 24% in the past year to $17.09 billion. This represents a huge 41% of its quarterly $41.7 billion in revenue for the March quarter. So we can use this to value MSFT stock.
For example, sales for the year ended June 2022 will reach $185.75 billion. Using its 41% FCF margin, we can estimate FCF will hit $76.1 billion by June 2022.
Now, in the trailing 12 months through March, Microsoft produced $53.08 billion in FCF. Dividing this by the $2.155 trillion market cap gives it an FCF yield of 2.5%. So, using this for the 2022 estimate we can derive the target market value.
This is done by dividing the $76.1 billion in forecast FCF by 2.5%, producing a target market value of $3.044 trillion. That is 41% over today’s market value. This implies that MSFT stock should trade at 41% higher than today’s price of $286.14. That gives us a target market price of $404 per share.
Market Cap: $200 billion
AT&T is an interesting stock. On the one hand, it has a huge 7.4% dividend yield with its $2.08 dividend, as of the close July 22. On the other hand, the company plans to spin off its TV and media assets into a new public company. As a result, it will cut its dividend by “nearly 50%.”
But keep in mind that is for the “remainco” company, i.e., the telecom AT&T. The new media spin0ff company is expected to also pay a dividend. But the problem is we don’t know what the ratio for the spin-off shares is, as well as the dividend payment for the new spin-co. All we know is that “AT&T’s shareholders would receive stock representing 71% of the new company” from the original press release. In AT&T’s July 22 quarterly earnings release, the company said that the merger will occur in the “next few weeks.”
Theoretically, the dividend payment between the two companies could still add up to $2.08 as it stands now, in terms of dollar value. But we can’t quite expect that to happen.
As a result, you can expect that T stock will get cheaper. But I have sort of changed my mind since my last article on this. I used to think that AT&T stock could fall to as low as $22 if the new remainco stock had a dividend of $1.10 and the market gives it a 5% dividend yield (i.e., $1.10 / 0.05 = $22).
But now I think that even if the dividend is at $1.10 and there is a 4% yield (i.e., $1.10/.04 = $27.50), it won’t matter as much as it might be otherwise. That is because it is clear that the spin-co will also pay a dividend and shareholders could make up a good portion of the difference paid out before.
Either way, it now looks like AT&T stock looks like good value. For one, you get to enjoy at least three more quarters with a high yield. And second, after the spin-off, I suspect that the media company assets will move up quickly or have a higher value than they otherwise would have had as part of the conglomerate.
Value Stocks: Oracle (ORCL)
Market Cap: $253.2 billion
There is no question that Oracle is a powerful free-cash-flow-generating software company. On June 15, its fiscal Q4 and full-year earnings statement for the period ending May 31 showed this. Revenue grew 8%, mainly from its cloud services and licenses. And net income grew 11% on a non-GAAP basis for the fiscal year.
But FCF rose 18.8% from $11.575 billion the year before to $13.752 billion. This was much faster than its revenue and net income growth.
FCF is my preferred financial measure simply because it cuts through all the GAAP accounting nonsense which is getting more complicated. Free cash flow shows the actual cash generated by the business during the period, after taking out major expenses, including some not in the income statement.
Moreover, its FCF margin was 34% of its $40.479 billion in total revenue for the year ending May 31. Using this margin I estimate that FCF will hit $14.348 billion next year, based on analysts’ forecasts of $42.2 billion in sales. This will be useful to determine the value of ORCL stock.
For example, using a 4% FCF yield, we can derive its target market value of $358.7 billion. This is seen by dividing the $14.348 billion 2022 FCF estimate by 4%. It also represents a potential gain of 41.67% over today’s market value of $253.2 billion. It also produces a price target for ORCL stock of $128.48, or 41.67% over Thursday’s closing price of $90.69 per share.
Market Cap: $125.7 billion
On July 19, IBM produced excellent results given its new focus on cloud services business. Its cloud business revenue over the trailing 12 months grew 15% to $27 billion (actually 13% adjusting for currency).
Moreover, its adjusted free cash flow over the trailing 12 months was $11 billion. This implies that IBM stock is very cheap. If we divide the company’s FCF by its market value, the resulting FCF yield is 8.75%.
This is very cheap, and its FCF yield is much higher than its peers in the industry. Microsoft’s FCF yield is under 3%, while both ORCL and CSCO stock have a 5.9% FCF yield.
Therefore, we can estimate IBM’s comp value by using a 6% FCF yield, just to be conservative. That puts its target market value at $183.3 billion. This is 45.8% over its market value today of $125.7 billion. It also implies that IBM stock should have a target price of $205.15, or 45.8% over its price on July 22 of $140.71.
Moreover, given that analysts forecast that sales will rise next year by 10.67%, we could expect that its FCF will also rise by 10.7%. All things being equal that would also raise the IBM stock price target by 10.7%. In other words, its target value should be 56.5% higher (i.e., 45.8% + 10.7%), or $220.21 per share.
Value Stocks: Square (SQ)
Market Cap: $117.1 billion
Analysts are very bullish on Square, the payments company that has a lot in common with PayPal (NASDAQ:PYPL), especially in terms of its valuation. For example, analysts have upgraded their sales forecasts. Estimates for 2022 sales are $22.74 billion, compared to $22.66 billion earlier. This is also 12% over the $20.3 billion in sales expected for 2021.
Compare that to PayPal. Analysts expect $31.38 billion in 2022 sales, vs. $25.82 billion in 2021, or a growth rate of 21.5%. In other words, SQ’s growth is 55.8% of PayPal’s. We can use this to value SQ stock by giving it a price-to-sales multiple that is 55.8% that of PYPL stock.
PYPL trades for 11.3 times its 2022 sales figure, so SQ stock should be valued at 6.3 times its forecast $22.74 billion in 2022 sales. That gives it a target market value of $143.3 billion, compared to its market cap today of $117.1 billion. This 22.3% upside implies that SQ stock should trade for $318.70, vs its price at the close July 22 of $260.59 (i.e., upside of 22.3%).
Square will announce its earnings for Q2 on Aug. 5. Analysts will likely update their forecasts then and this will likely upgrade my target price for SQ stock as well.
Market Cap: $26.6 billion
ViacomCBS is facing stiffer competition now that WarnerMedia, Discovery Channel, and DirecTV are going to merge and form a separate company (see AT&T, above). Moreover, the company is trying to grow its streaming segment. So far it is doing a pretty good job of that. In Q1 its streaming segment grew 65% to $816 million.
Moreover, the media company is gushing free cash flow. Its Q1 FCF rose by $1.283 billion (i.e., $1.589 billion vs. $306 million a year ago). This also represented a high 21.4% of its $7.412 billion in revenue for the quarter. This also implies that its FCF for 2021 could rise to $5.92 billion, as analysts estimate $27.8 billion in revenue for the year.
This gives VIAC an insanely high FCF yield. If we divide $5.92 billion in FCF by its market value of $26.6 billion, the FCF yield is 22.2%. Just to put this in perspective, most stocks with this huge level of FCF will have a much lower FCF yield ratio of, say, 3% or even 5%. That implies that its target market cap should be much higher.
Just to be conservative let’s use a 10% FCF yield. That implies that VIAC stock should be trading at a market value of $59.2 billion (i.e., $5.92 billion FCF / 0.10). This is still 122.6% higher than today’s market value of $26.6 billion. It also implies that VIAC stock should be trading for $91 (i.e., 2.226 x $40.91, the price as of the close July 22).
Value Stocks: Ault Global Holdings (DPW)
Market Cap: $114.48 million
This is a bit more speculative play than the other stocks listed above. It is also a good deal smaller since its market capitalization is only $114.5 million.
Ault Global is essentially a microcap investment company. It assets are managed by a former broker named Milton Ault. The company is a collection of cash, minority stakes in public stocks, and wholly owned private companies.
For example, DPW owns defense solutions companies under the umbrella name of GWW (including Gresham Power, Microphase, Enertec, and Relec). Ault Global also owns a commercial electronics solutions company called Coolisys. It also has several other companies, including a crypto mining operation in Michigan.
However, its biggest assets are $107.8 million in cash and $18.15 million in marketable securities, as of March 31. As soon as the company releases its Q2 earnings and balance sheet, we can update this amount. This $125.25 million represents more than its present market value of $114.28, implying that the private companies are not worth anything.
However, given that it has likely spent more of that cash by now, we will have to revise its NAV when the new Q2 10-Q comes out. Suffice it to say that it appears that the market is not properly valuing the company’s investments so far. I suspect that means that there is a good amount that could be made in this stock. However, given that DPW stock is quite speculative in nature, any investment in it should be a small large percentage of a total portfolio.
These seven value stocks provide a good basis for upside in a potential investment portfolio if you want to put together one for August. I have tried to show the potential upside in each stock, given their underlying target value.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.