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5 Hidden Earnings Bargains Worth Buying Now - views
BALTIMORE (Stockpickr) -- If I told you stocks were cheap right now, you’d probably think I was crazy.
After all, equities have been in the midst of a broad-based rally for the last few years, and the venerable S&P 500 index finally hit new all-time highs last week. Price action like that doesn’t exactly go hand-in-hand with bargain valuations on Wall Street, but in fact, some stocks are looking downright cheap in this environment.
One of the biggest reasons for that is earnings. While stock prices have been moving swiftly upward since 2009, earnings have actually moved in lock-step with stock prices, justifying the loftier cost to buy shares for your portfolio. As I write, the S&P’s average price-to-earnings ratio, a measure of how much investors are paying for every dollar of a firm’s earnings, sits at 15.4.
That’s well below the index’s average P/E reading of 18.8 over the last 25 years.
But take out one big factor from P/E, and the “stocks are cheap” story gets even more interesting; I’m talking about cash. As I write, U.S. corporations are sitting on record cash reserves, a balance sheet number that totally skews the valuation numbers for firms with lots of dollars in their coffers by inflating the P/E ratio. I think that it makes more sense to look at stocks’ earnings multiples ex-cash. And after backing out cash, there are some head-scratching valuations on Wall Street right now.
Today, we’ll take a look at five of them.
There isn’t much excitement going on at Goodyear Tire (GT). Shares of one of the world’s largest tire and rubber manufacturers have mostly meandered sideways in the last year, underperforming the broad market rally that’s been lofting most other equity names higher over that same time period. But that boring business does have at least one exciting aspect: It’s dirt-cheap. While the firm’s P/E ratio currently sits in bargain territory at 7, Goodyear’s ex-cash P/E is a floor-hugging 1.61.
Goodyear’s name is synonymous with tires, and that’s a good thing. Tires are a must-do action item for car owners, since driving on bald or damaged tires is one of the easiest ways to get in an accident. America’s aging car fleet currently sports a higher average age than ever before, which should help spur tire sales in 2013. At the same time, a growing pace of new car sales is increasing the number of OEM sales Goodyear is booking right now. That pace should continue as long as central banks keep shoveling cheap money to consumers.
That doesn’t mean that Goodyear is without some challenges. Rising input costs and a costly, unionized North American workforce has made GT look unattractive to shareholders in the past. But now, the combination of a bargain price tag and industry tailwinds could send shares higher this quarter. From a technical standpoint, I’d recommend sitting on the sidelines until shares are able to settle at a support level.
It shouldn’t come as a huge surprise that E*Trade Financial (ETFC) is having a good year in 2013. Shares of the discount brokerage pioneer have rallied more than 15% year-to-date, buoyed by the rally in stocks since the calendar flipped over. E*Trade currently has a huge P/E ratio of 35.7, but back out its cash position and that number drops down to just 2.46. Why the big difference?
A big part of it has to do with how E*Trade has realigned itself post-2008. The firm has been putting effort into building out its banking business, an operation that complements its retail brokerage business nicely. Banking offers cheap access to capital as well as attractive fee-based revenue streams, and it also provides stellar cross-selling opportunities with E*Trade's legacy brokerage business. Rallies are a goldmine for brokerage firms, as enticed investors ratchet up their trading (and their commissions, in kind). That’s a big tailwind that bodes well for ETFC right now.
E*Trade sports a strong balance sheet -- a nice change from the bloodbath that was 2008 for this company. With a more robust financial position coming in 2013, ETFC is better prepared to weather a few bumps in the road this time around. And its bargain valuation isn’t going to last forever.
Western Digital (WDC) has some nice industry tailwinds of its own. As the biggest hard drive maker in the world, the firm is riding the rising tide of data consumption in the IT industry, providing storage solutions for PCs, consumer products and enterprise users. The firm’s P/E ratio of 5.45 is cheap to begin with, but back out cash and that number drops to 3.7.
WDC’s biggest move in the last year was the acquisition of Hitachi’s hard drive business, which hugely increased Western Digital’s share of the HDD market. The computer industry is undergoing a transformation in storage technology as users embrace technology cloud computing, and one major byproduct of that is ramped-up demand for hard drive storage to fuel their datacenters. As data needs continue to increase, WDC should continue to see its sales increase too. That argument only gets accelerated as WDC is able to sell a larger proportion of high-margin drives used in datacenters.
The firm’s position in to the solid state drive market should stave off some analysts’ concerns that WDC’s main hard drive business will get overtaken by the speedier and pricier technology. While buying Hitachi was costly, the combined firm still sports a deep net cash position right now, a fact that greatly decreases the risk of owning this stock right now.
The world’s largest marketing company, Interpublic Group (IPG) is another name that’s sporting a huge earnings discount right now. The $5.3 billion collection of advertising agencies sports of nominal P/E of 18.9, but back cash out of the equation and that number drops to 9.9.
Interpublic’s portfolio of agencies includes McCann, Draftfcb and Lowe -- names that have considerable brand value in the marketing world. That marketing value translates into premium pricing for IPG’s collective services, and it’s a major contributor to the firm’s double-digit net margins. IPG is also one of a handful of advertising organizations with a global reach, which means that the firm is able to court a category of multinational advertisers that smaller firms can’t offer the same services to. As the advertising market continues to convalesce, investors should expect profits to keep creeping higher.
Financially, IPG is in solid shape, with a small net cash position on its balance sheet and $2.6 billion in top-line liquidity. Efforts to increase integration of IPG’s service portfolio should stair-step the firm’s revenues in the next few years as big clients pony up for add-ons.
Last up is Manulife Financial (MFC), a $27 billion insurance company. While Manulife’s insurance business does dilute the ex-cash argument for the firm’s P/E a bit (insurance companies need to have cash and investments on hand, and they can’t just dole it out to shareholders), the degree of the difference is what makes MFC look so cheap right now. While the firm’s P/E ratio sits right around the industry average at 15.8, that earnings multiple drops down to 7.77 once cash is accounted for.
Manulife is the largest life insurer in Canada, but it’s really the firm’s other businesses that make it an interesting name right now. Insurance has become an extremely challenging business in recent years thanks to commoditization -- effectively, as long as policy terms are the same, consumers don’t care who is insuring them, so price competition has become fierce. To limit its exposure to that battle, Manulife has built an attractive wealth management business, selling investments and managing 401k accounts. Most importantly, that asset management business provides an incentive for customers with existing relationships to buy insurance products from MFC.
As with E*Trade, an equity rally is hugely beneficial for insurers such as Manulife -- both because of its big equity portfolio and because of the fees it earns from its wealth management arm. The combination of an attractive valuation and a hefty 3.5% dividend yield should get investors interested in MFC in 2013.
To see these stocks in action, check out this week’s Hidden Earnings Bargains portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.
At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.