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3 Cheap Dow Stocks Poised to Rebound in 2012 - 21682 views
NEW YORK (Stockpickr) -- When it comes to investing, never confuse “cheap” and “bargain.” Many struggling stocks can look cheap by a range of measures and likely deserve their dowdy valuations. Yet low-priced stocks that hold clear appeal, well, those are bargains.
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With that in mind, the current tough stock market offers an ideal time to review lists of cheap stocks that are true bargains. Right now, we’re looking at the most unloved stocks in the Dow Jones Industrial Average. These 10 stocks sport the lowest price-to-earnings ratios, based on projected 2012 profits.
To be sure, many of these low-P/E stocks are likely to remain that way. Merck (MRK) and Pfizer (PFE) will be hard-pressed to boost sales and profits as any new drugs will merely offset the loss of existing drugs that will soon lose patent protection. Pfizer, for example, will lose exclusive branded rights to blockbuster cholesterol drug Lipitor in November, which is why analysts think 2012 sales will fall 5% (to $63 billion). That’s a hardly a recipe for an expanded P/E ratio.
Might major oil firms Chevron (CVX) and Exxon Mobil (XOM) also stay inexpensive under the weight of tepid sales growth? They’re expected to see sales rise 5% and sink 5%, respectively, in 2012. They’re boosting profits at a more impressive clip, thanks to stock buybacks and other balance sheet moves, but investors will only reward these shares a higher multiple when more robust organic growth is in place.
After digging through the business models, we’re found three companies that won’t just survive but could really thrive in the years ahead.
Major corporations find that it can be awfully difficult to take market share from rivals -- unless, of course, those rivals are under duress and forced to re-trench and conserve cash. That’s why executives at New York-based bank JPMorgan Chase (JPM) welcomed the challenges of 2008 and 2009. As rivals such as Lehman and Bear Stearns collapsed, JPMorgan was able to snag customers and boost market share.
It’s happening again. Firms such as Bank of America (BAC) in the U.S. and a wide range of banks across Europe are hunkering down, trying to preserve cash and ensure that their balance sheets don’t collapse. Spending to defend or boot market share is not really a priority. You can almost hear the message coming from JPMorgan Chase’s bankers and brokers: “Why not bring your business over here, and avoid all the potential land mines out there.”
Of course, a weak economy is no fun for any bank right now. Revenue from IPOs have dried up, customers aren’t trading as many stocks, and most major corporate clients seem to prefer sitting on their cash, rather than seek out acquisitions -- a key driver of investment banking profits. That’s why JPMorgan’s EPS power seems stuck in the $4-to-$5 range these days.
Yet you need to look ahead to the days when the economy is on firmer footing, and earnings per share can move up to the $6 to $7 range. After having fallen from $45 this spring to a recent $35, JPMorgan shares look like a real bargain against this bank’s long-term earnings power.
JPMorgan, one of the top holdings at Lee Ainslie's Maverick Capital, shows up on a recent list of 15 Cheap High-Dividend Stocks for Defensive Investors.
Has technology titan Cisco (CSCO) been through a lost decade? Considering that the stock is at levels seen back in 1998 (on a split-adjusted basis), the answer is a definite “yes.”
Then again, Cisco’s business is now far more advanced than it was back then, with a sales base that has tripled. More important, Cisco has always been a very profitable company, with gross margins typically exceeding 60% and operating margins usually within the 20%-to-25% range.
All those profits have steadily flowed onto the balance sheet: In the last eight years, Cisco has generated $67 billion in free cash flow. That fuels stock buybacks, acquisitions, a new dividend and most important, plenty of “rainy day” money. At last count, Cisco had $49 billion in cash (against $17 billion in long-term debt).
OK, so shares are cheap, but why are they a bargain? Because analysts are increasingly convinced that Cisco may soon be back in growth mode. Sales growth is expected to bottom out at around 5% in the current fiscal year that ends next July. In fiscal 2013, growth is expected to tick up a few hundred basis points, but analysts are assuming that the economy will still be in a deep funk. If they’re wrong, and the economy finally regains its footing, Cisco may finally move back into double-digit growth territory in 2013 as sales approach $50 billion.
This stock may look impressively valued at less than 10 times projected 2013 profits. But if you exclude that $32 billion net cash position, then the forward P/E ratio falls to just 7. That’s a bargain-basement price for a company that is still a clear leader in its field.
While Cisco is healthier than its struggling stock price would indicate, technology firm Hewlett-Packard (HPQ) is a mess. The corner office has been a revolving door recently, the company’s reputation among consumers is in tatters as seen by a recent bungled effort to compete in the tablet computer space, and rivals are trying to poach customers.
But it’s just too hard to ignore the company’s market value in relation to its still-considerable market presence. Simply put, $126 billion in trailing annual sales and $52 billion in market value is hard to square. So is the fact that the P/E ratio is just 5.5 times projected 2011 profits. You read that right: A Dow stock that trades for less than six times profits.
But every stock needs a positive catalyst. Hewlett-Packard has only negative catalysts in its wake. However, new CEO Meg Whitman is taking an inventory of all of the company’s strengths and weaknesses and can be expected to make some bold moves when her analysis is complete. Some think she’ll look to shed the underperforming PC business. Others think she’ll look to beef up certain divisions to move one step ahead of rivals such as IBM (IBM) and Dell (DELL). Some think that a massive cost-cutting initiative will be the trick to push annual free cash flow back up beyond the $10 billion mark. (It peaked at $10.8 billion in 2008 and fell to $7 billion by 2010.)
The key takeaway is that this is a broken -- but fixable -- business with clear catalysts. It would be hard to find the stock appealing in light of the challenges if it were valued in line with the peer group. But now that it trades at a very steep discount to other major tech stocks, the reward looks so much more clear than the risk.
To see these stocks in action, visit the Dow Bargains portfolio.