3 Big-Name Value Stocks and Why They’re Cheap Today

The post 3 Big-Name Value Stocks and Why They’re Cheap Today appeared first on Millennial Money.

We all love a deal, right? Don’t tell me you haven’t been driving down the street to that cheaper gas station.

Investors shop around too when they buy so-called value stocks. They’re simply buying companies that others won’t because the other investors are overlooking the businesses’ full potential. When that potential is eventually realized and the stock prices rises, the value investors cash out. 

As Warren Buffett put it, “If I can buy dollar bills for 90 cents, I’ll buy them.”  

How Much is $1 Worth?

Although Buffett’s strategy sounds easy, determining the value of those dollar bills can be complex. The key to value investing is to sift through all the chatter in the financial news and find a company’s “intrinsic value”—the value a stock would have if everybody in the market were on the same page about the business’s prospects.

Once you’re able to find that intrinsic value, the next part is easy: You buy companies whose intrinsic value is higher than the current stock price. 

Understandably, the concept of “value” is a source of intense debate and involves looking deeper into a business to find an angle that other investors are overlooking.

By way of example, here are three businesses that aren’t getting their due in the market today.

1. Verizon Communications

  • Verizon Communications (NYSE:VZ)
  • Price: $55.22 (as of close Aug 5, 2021)
  • Market Cap: 228,948,415,187

You know Verizon. What you might not know is that the company is one of the biggest value stocks in the S&P 500. Verizon’s shares have risen just 6% in the past three years, compared with the S&P 500’s 56% gain. Remember, value investors are looking for stocks that are unloved by most investors, and Verizon certainly fits that bill.

Many investors are hesitant to invest in Verizon right now because of its wireless business. The company is still a market leader, but growth in the industry itself is slowing down and also getting highly competitive, with T-Mobile stealing significant market share.

Verizon also has much at stake in the declining subscription television business. Not only is this an industry on the decline as consumers cut the cord, but it also requires tons of spending for maintenance. Because of Verizon’s wireless and TV business units, it’s been hard for the company to increase sales.

In fact, full-year revenue of $128.3 billion in 2020 was lower than each of the two previous years. Verizon also has debt it needs to pay off, which could affect its profitability if the company’s revenue continues to decline. 

It’s understandable for Verizon’s stock to be trading at its currently low price, but many value investors think the reduced price is extreme. They point to the company’s growth potential from the Internet of Things that will be powered by 5G connectivity. As long as Verizon is able to make money from this emerging technology, the stock could be considered a true bargain today.

How much of a deal is it? I’ll get to the numbers in a bit. Now, another good value stock for you to consider.

2. Berkshire Hathaway (aka) Let Warren Buffett find the deals for you 

  • Berkshire Hathaway (B shares) (NYSE:BRK.B)
  • Price: $285.63 (as of close Aug 5, 2021)
  • Market Cap: 640,497,771,916

Warren Buffett runs the holding company Berkshire Hathaway, whose M.O. is to invest in other companies—ones that Buffett thinks are selling for less than they’re worth.

Berkshire is heavily invested in finance, energy, and transportation. (These are all industries typically associated with value investing.) Buffett recently said that most of the company’s value comes from its insurance businesses (including GEICO), the railroad Burlington Northern Santa Fe, Berkshire Hathaway Energy, and its 5% interest in Apple.

Pro tip: Buffett is a master investor, but he talks about investing using language everyone can understand. That makes him an incredible teacher. If you want to learn more about business and investing, check out his most recent annual letter to Berkshire shareholders. Buffett tells it to you straight.

However, Berkshire’s value focus is found in more than just its biggest holdings. As of year-end 2020, Berkshire owned 5% or more in three major banks, including Bank of America, Bank of New York Mellon, and U.S. Bancorp. 

As for why Berkshire is a deal today, think of it as a collection of companies that were deals when Buffett bought them. And we’ll get to some numbers soon, too.

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3. Home Depot

  • Home Depot (NYSE:HD)
  • Price: $0 (as of close Aug 5, 2021)
  • Market Cap: 354,182,016,949

Retail is a notoriously tricky industry to make money in, with constant threats from employees, customers, and suppliers—not to mention the disruption of e-commerce. 

Many investors avoid the sector altogether, and this lets savvy value investors find opportunities like The Home Depot. The company’s focus on home improvement, with hard-to-ship materials, has prevented Amazon from moving forcefully into its niche. 

Home Depot is also competitive at the store level by hosting workshops aimed at do-it-yourselfers. Unlike other retailers that have been disrupted, home improvement appears to be a more difficult market for e-commerce. 

But the most exciting thing about Home Depot for value investors today might be the company’s willingness to buy back its shares. Stock buybacks are one way companies can reward their shareholders, and Home Depot has done this aggressively: In the last five years, the company has lowered its share count by 14%.

Lower share counts mean that current shareholders own more of the company. In other words, investors who bought shares of Home Depot five years ago are entitled to 14% more of the company’s earnings simply by having held their shares. 

Home Depot recently approved a $20 billion share buyback, a figure currently equal to 5% of the company’s current market capitalization, so investors will continue to be rewarded through buybacks. Home Depot is built to last, and investors today have the opportunity to buy this leading retailer at a discount to the greater stock market. 

The Numbers Part of Stock Valuation

There are quite a few ways to measure value in the stock market. Here, I’ll explain a few of the most popular methods used by real-life investors like you (what the Wall Street analysts do is a whole other thing).

One note before we start: If this seems daunting and numbers aren’t your thing, know that you don’t have to do all this data-based research and math on your own. There are many places to get ideas about good value stocks that will do all the number-crunching for you, including The Motley Fool, which—full disclosure—owns Millennial Money.

Earnings-based valuation 

One of the easiest valuation methods is the price-to-earnings (PE) ratio. It’s a simple calculation that divides the current stock price by per-share earnings over the last 12 months (sometimes called “trailing 12 months”).

Verizon is currently trading for about 11.5 times trailing earnings, compared with 34.5 times for the S&P 500. That makes it undervalued as compared with the broader market.

Another deal? Berkshire, which trades at only 6 times earnings, again at a discount to the greater market.

Home Depot is currently trading at 24 times trailing 12-month earnings. 

Using price-to-earnings ratios to compare companies is simple but not totally accurate. For starters, earnings are calculated on past results and can often be influenced by one-time gains or losses.

Other earnings-based metrics include forward price-to-earnings ratios, but these depend on analyst estimates that might not be realized if the economy changes or if the company loses market share to competitors. 

Asset-based valuation

Other value investors prefer to look at asset-based valuations like price-to-book, which divides the market capitalization by the book value (the company’s value reported on the financial statements). The rationale is that the less you pay for net assets (book assets minus book liabilities), the better deal you’re getting. 

There are flaws with this approach as well, particularly if the assets don’t generate earnings. Other approaches, like price-to-tangible book, attempt to correct some of these issues.

As for our companies, Verizon is truly an asset-based value investor’s dream. Thanks to its significant wireless and cable-TV assets, the company has a price-to-book value of 3 compared with the S&P 500, which now trades at an astronomical 900!

Because of his focus on financials, Buffett likes to talk about Berkshire Hathaway’s book value. Currently, Berkshire’s price-to-tangible book value is 1.4, slightly elevated from its 10-year historical average but significantly lower than the S&P 500’s 900.

Cash flow and hybrid valuation

Another type of value investor focuses on cash flow. This makes sense because investors are looking to eventually get paid in cash instead of accounting earnings or physical assets.

Cash flow investors often focus on distributed cash (dividend yield) as their preliminary metric, and more advanced investors often look at operating cash flow or free cash flow as their valuation metric. 

Finally, there are hybrid approaches that incorporate prospective growth into the value framework like growth-at-a-reasonable-price (GARP) or the PEG ratio (price to earnings divided by estimated earnings growth rate). 

For us, we’ll just say that shares of Verizon hit the value-investing trifecta by paying a dividend yield of 2% in addition to the company’s other favorable metrics.

Unfortunately, Berkshire doesn’t pay dividends. Many investors are willing to look past this considering Buffett is considered one of the best capital allocators ever. 

(Despite the lack of a cash dividend, Berkshire does return cash to shareholders in the form of stock buybacks, which it did to the tune of 5% of total shares outstanding last year.) 

Typical Characteristics of Value Stocks

When it comes to value investing, not all industries are created equal. Value stocks tend to be older, established companies in the mature phase of their business cycle, making them less prone to disruption.

There tends to be less innovation and growth in these industries, so value stocks tend to pay above-average dividends and/or stock buybacks to reward investors (instead of putting the money back into the business to reward shareholders by expanding the company). 

Many value stocks are clustered in a handful of industries. Banking and insurance are well known for their robust balance sheets and asset bases, and most pay an above-average dividend.

Consumer staples like food producers, big box retailers, pharmaceutical companies, telecoms, industrials, energy, and materials companies tend to be classified as value industries.   

While there are value stocks in the technology sector, tech is not typically known as a value industry. For one thing, it takes a lot of cash to plow into growth to continue to earn market share and to not be disrupted. This lends itself to above-average growth rates but can reduce cash flow and earnings.

Additionally, many technology companies operate a light-asset model, which makes price-to-asset investors avoid the sector.

Why Value Stocks are Heating Up

Shares of the S&P 500 have more than doubled since March 2020, when the pandemic was new and everyone was running scared. Although strong performance has been widespread, growth stocks have overperformed value stocks coming out of the covid recession.

It’s part of a bigger story: In the last decade, growth has overperformed value, but the difference has become too large to ignore.

Last year, Morningstar noted that large-cap growth stocks outperformed large-cap value stocks by 32.15 percentage points, a larger differential than at the height of the dotcom bubble!  

Although investors are happy with recent gains, Wall Street is increasingly worried that the market might be getting ahead of itself. 

Valuation concerns have increased in recent weeks as large-cap growth darlings Facebook, PayPal, and even Apple have been falling despite beating expectations in their most recent earnings reports. 

As a result, many investors are re-evaluating their portfolio and looking for value stocks. If you’re one of them, consider Verizon, Berkshire, and Home Depot the next time you put money in your brokerage account!

The post 3 Big-Name Value Stocks and Why They’re Cheap Today appeared first on Millennial Money.