These 2 Deep Value Stocks Have Significant Upside Potential And Could Be A Way To Play Defense

 |  Includes: GNW, JGW
by: Hawkinvest


While the market is near record highs, there are still stocks that offer "deep value" in terms of the PE ratio and book value.

A number of financial services companies are trading at cheap valuations when compared to the rest of the market and could outperform in market pullback.

Both Genworth and JGWPT Holdings look deeply undervalued and have significant upside potential after recent pullbacks.

These stocks offer deep value and could also be "defensive" in a market pullback.

Even as the market dropped 161 points on July 17, these stocks were barely down which shows relative strength.

With the market near record high levels, many stocks are either fully valued or even overvalued. Obviously that does not mean that the stock market can't keep going higher as the momentum could clearly keep the markets on an upswing. However, as a value investor, I prefer to invest in stocks that are bargains. This is also called "deep value" investing which typically is used to define stocks that are either trading well below book value or at a very low price to earnings ratio (or both). Stocks that offer deep value are often out of favor at least temporarily, and that is why investors can buy cheap.

Many investors are caught up with momentum investing which is basically chasing stocks that are moving up (almost regardless of valuation). That can work well for a long time but with the markets near record highs this type of investing can be very risky. This could especially true now with geopolitical issues popping up around the world from the Middle East to Russia. At a time like this, it could really make sense to rotate out of high-flying momentum stocks that could be hard-hit in a market pullback and go into stocks that offer significant value. Value stocks are likely to outperform richly valued momentum stocks in a market decline and that is why these types of stocks could be a great way to make your portfolio more defensive. But, playing defense as the market trades near record highs is not the only reason to buy value stocks. The main reason is because value stocks that are out of favor often have low expectations built into the share price and that means these stocks can often surprise to the upside.

I have invested in and highlighted the two stocks below because both are trading at deep value levels due to the book value and the PE ratios. The cheap valuation these stocks are trading at could make them great defensive plays if the markets get volatile or sees a pullback. These stocks also offer significant upside according to analysts price targets and that is another reason why I have focused on the investment potential of these two bargain stocks:

JGWPT Holdings, Inc. (NYSE:JGW) shares trade at nearly half their 52-week high and appear too cheap to ignore. Furthermore, the stock appears to be building a solid base at around $11 per share and this could be a sign the stock is ready to start trending higher. It often pays to buy out of favor stocks because that is where you can get a real bargain. After an earnings miss and investor concerns over compliance requests, this stock has been beaten down to bargain levels. Furthermore, with the earnings miss behind it (as it was probably a one-time event), and with investor concerns appearing overblown regarding compliance information requests, this stock could be poised to surprise to the upside.

This company is a leader in buying structured settlement payments, annuity payments, and lottery payments. It operates under the J.G. Wentworth and Peachtree Financial Solutions brand names and it is one of the world's largest buyers of deferred financial payments. This is a niche business in the financial services industry and that means competition is limited and profit margins are relatively high. However, since many investors are not as familiar with this industry, some of them seem to misunderstand the business model and fail to realize that the potential downside risks are relatively low. For example, some investors might believe that credit risk is a major potential issue but it is lower than most realize since this company often sells the settlements it buys to other investors.

Some investors might also get concerned about regulatory risks and the legality of buying settlements, but this concern is also overblown because judges must approve structured settlement deals and agree that these transactions are in the best interests of the parties involved. Finally, some investors appear concerned about a request in May from the U.S. Consumer Financial Protection Bureau to make sure it is in compliance with the Consumer Financial Protection Act of 2010. However, this concern seems overblown, especially as the company has stated that it believes it is fully compliant with these laws.

A recent earnings miss is the main reason this stock has declined. For the first quarter of 2014, JGWPT Holdings reported earnings of 34 cents per share which missed consensus estimates of about 43 cents per share. The miss was primarily due to a temporary spike in interest expenses during the first quarter. Interest rates have since come back down significantly and that means improved financial results are likely in the coming quarters. Even if this stock earns 34 cents per quarter, it is still cheap since that annualizes to about $1.36 per share, which would imply a PE ratio of about 8 times. However, analysts expect the company to earn far more than that on an annual basis with estimates at $1.63 per share in 2014, $1.94 per share in 2015, and $2.49 per share in 2016. That means the stock is extremely cheap in terms of the PE ratio, as it is trading at only about 5.5 times forward earnings.

All this company has to do is meet expectations and the stock could be poised to surge from current levels. Furthermore, at just $11 per share, potential downside risks appear minimal and a lot of bad news seems to be priced into the stock. In fact, expectations seem so low for this company that it could be set to surprise to the upside. Analysts at Credit Suisse have a buy rating and set a $19 price target for this stock. However, a leading investment management firm sees even more upside since M&A activity suggests a potential value of $36 per share. To read more about this stock, and about the "smart money" that has invested in it, read this article.

Here are some key points for JGWPT Holdings:

  • Current share price: $11.03
  • The 52 week range is $9.43 to $19.88
  • Earnings estimates for 2014: $1.63 per share
  • Earnings estimates for 2015: $1.94 per share
  • Earnings estimates for 2016: $2.49 per share
  • Annual dividend: n/a

Genworth Financial Inc. (NYSE:GNW) is a leading provider of mortgage insurance, annuities and other financial products. This company was hit hard during the financial crisis but it has proven to be a survivor and it continues to make progress in terms of financial results. Investors have been well rewarded by buying this stock on pullbacks for the past couple of years and this trend appears poised to continue. A recent pullback in Genworth is giving investors another ideal buying opportunity right now.

Click to enlarge

As the chart above shows, Genworth shares were trading for nearly $18 in the past few weeks. However, the stock is now trading for just over $16, which appears to be an ideal buying opportunity, especially since the 200-day moving average is $16.05 per share. The 200-day moving average is considered to be a strong support level and that could mean potential downside risks are limited at these levels. The 50-day moving average is $17.47 per share, which is where the stock could be heading in a rebound.

Genworth shares are cheap after this recent pullback, especially when you consider the book value which is around $31.28 per share. This stock also looks undervalued when considering the PE ratio. Analysts expect Genworth to earn $1.43 per share in 2014 and $1.65 per share in 2015. This shows earnings growth and a PE ratio of just about 10 times earnings estimates for 2015. With the U.S. real estate market and the overall global economy continuing to recover, the potential economic downside risks appear limited at this time. If the economic recovery continues to expand, Genworth could see earnings grow for years to come and that is another reason why the price to earnings multiple should expand.

Analysts' price targets suggest that Genworth shares have significant upside potential. For example, in March analysts at UBS set a buy rating and raised the price target from $18 to $20 per share. Earlier this year, analysts at Compass Point also put a buy rating on Genworth shares and set a $22 price target. With the stock now trading for about $16 per share, even a rise to $20 would give investors a healthy gain of about 25%.

Here are some key points for Genworth Financial:

  • Current share price: $16.05
  • The 52 week range is $11.55 to $18.74
  • Earnings estimates for 2014: $1.43 per share
  • Earnings estimates for 2015: $1.65 per share
  • Earnings estimates for 2016: $1.91 per share
  • Annual dividend: None

Data is sourced from Yahoo Finance.

Disclaimer: No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.

Disclosure: The author is long GNW, JGW. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.