Where Have All The Cheap Stocks Gone? 3 Undervalued Picks

Includes: BLK, CAT, COH
by: Frank J. Constantino

With the S&P 500 trudging toward new highs and up 9% already this year, many investors may ask, "where have all the cheap stocks gone?" Certainly the market, measured by the S&P 500, isn't as cheap as it was a year or two ago. It isn't exactly expensive either, especially when compared to other asset classes. I view the market, at 15 times earnings, as likely right around its fair value. That doesn't mean stocks can't go higher. In fact, stocks tend to overshoot fair value in whichever direction they are trending. Also, fair value doesn't mean you can't find companies trading at a great value. Below are three companies, each from a different sector, that appear to be bargains in a "fair value" market.

Shares of BlackRock (NYSE:BLK), one of the world's largest asset managers, are up 22% year to date. Despite trading at an above-market P/E of 18.4, the stock is undervalued.

BlackRock ended 2012 with nearly $3.8 trillion in assets under management. This was an increase in 8% over 2011. Operating income also grew 8% in 2012. The company's iShares exchange traded funds continue to hold the number one spot in ETFs. iShares is benefiting from investors that are looking for low-cost investment vehicles to reach broad areas of the market. iShares represents 22% of assets under management and has plenty of room to grow. BlackRock's institutional business, which represents 66% of assets under management, continues to see large inflows.

BlackRock has grown operating earnings at an annualized rate of 20.5% over the last ten years. The company is returning excess cash to shareholders, recently increasing its dividend by 12%. Shares yield 2.65%. The company also has more than 10 million shares authorized for buyback. Based on BlackRock's ability to continue its earnings growth, $320 a share seems like a distinct possibility.

Caterpillar (NYSE:CAT) sent investors scurrying last week when it reported a slowdown in global sales during the three months ending in February. Investors are concerned that the global economy isn't as healthy as previously thought. Caterpillar is the world's largest producer of earth moving equipment and depends on global economic growth to increase its earnings potential.

The slowdown in sales shouldn't come as a surprise to investors since Caterpillar had already predicted a weaker 2013. Much of this news is already priced into shares. Caterpillar is extremely undervalued by historical standards. Unless you expect another deep recession, shares seem to have low downside risk. CAT trades at just 10 times earnings, far below its ten year average P/E of 15. Shares are cheaper now than they were in 2009.

Over time the global economy will continue to grow and may even pick up steam later this year. Caterpillar has grown earnings at an annualized rate of 17% over the last ten years. Investors with a time horizon of several years or more may want to use this opportunity to accumulate shares of Caterpillar while they are "dirt" cheap. They'll be paid 2.4% while they wait - more than they can get in a ten year treasury bond.

Coach (NYSE:COH) is another company that hasn't pleased investors this year. The large purveyor of luxury goods has lost some ground (at least in the minds of investors) to smaller, younger rivals such as Michael Kors (NYSE:KORS). However, Coach's classic brand isn't tarnished and it continues to ring up profits in the "affordable luxury" category.

Coach disappointed investors when it reported year-end results in January. CEO Lew Frankfort, who is stepping down as CEO in 2014, stated that the company is transitioning into a "lifestyle" brand company. Coach has traditionally focused on women's handbags with an assortment of complimentary accessories. As a lifestyle company, Coach will expand its offering of shoes, accessories and clothing. This shift in focus may come as management has seen Michael Kors have success in areas outside of handbags. Coach has done a good job of keeping its brand fresh, yet classic. There is always a risk that these companies will saturate the market with tons of merchandise and, in turn, water down their brand. As long as Coach can transition and avoid that temptation, the company can be successful.

Coach is trading at less than 14 times earnings compared to 16.5 times for the overall consumer discretionary sector. On average, Coach has traded at 22.6 times earnings over the last ten years. Coach has grown earnings at an annualized rate of 24.8% over that time period. Despite recent hiccups, analysts are expecting Coach to increase earnings this year. Shares have priced in a lot of negativity that probably isn't justified. While Coach may not be the "flavor of the month", its classic brand has endured the test of time - something that can't be said for many others.

All three of these companies are trading at unjustified levels. Of the three, only BlackRock has seen its stock price rise this year. While the overall market seems to be pretty fairly valued, there are still plenty of companies that are quite cheap. I own shares of all three and have been actively accumulating shares of Caterpillar. As always, long-term investors will be rewarded for turning over a few stones to find bargains.

Disclosure: I am long BLK, CAT, COH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Mr. Constantino is a proprietary investor and does not provide individual financial advice. The stocks mentioned in this article do not represent individual buy or sell recommendations and should not be viewed as such. Individual investors should consider speaking with a professional investment adviser before making any investment decisions.