Amidst today's market uncertainty as markets reach historical highs and corporate management is more optimistic than ever before, investors large and small are searching for relatively safe places to park their investable capital. Many are turning to index funds or fixed income securities to ensure that in the event of a market downturn, they are able to preserve their capital. However, these often do not offer the same upside potential as equities. I would argue that there are good opportunities for safe capital investment with income generation potential. For instance, the component companies of the S&P 500 index (NYSEARCA:SPY) offer some interesting possibilities.
The companies I list here are varied in terms of their market capitalizations, industries, products, customer bases, and geographies, but they all share the basic characteristic of being undervalued on a fundamental basis. Without further ado, then, here are the companies in the S&P 500 index, which are currently trading at less than 10 times forward earnings, less than 20 times free cash flow per share, and have PEG < 1:
Delta Air Lines (NYSE:DAL):
DAL, founded in 1924 and headquartered in Atlanta, Georgia, provides scheduled air transportation for passengers and cargo worldwide. The company operated a mainline fleet of about 700 aircraft as of June 2014.
DAL's market capitalization is just over $32.4 billion, and the company has income of just under $11 billion from a top line of just under $40 billion. Profit margin is 27.8%, and the shares currently trade at just 3 times earnings, less than 1 times sales, 2.7 times book value and just under 8 times cash. In addition, price to free cash flow is at relatively low levels below 14. This is likely a result of general industry bearishness on the airline industry in general. An investor might consider an options play here to generate income on the short put side, or alternatively going long DAL stock while shorting a basket of other airline stocks to hedge away industry risk and extract the alpha available in this name alone.
Most sell-side equity research analysts maintain positive ratings and price targets on DAL, and price targets have increased into the high $40s and low $50s in recent weeks. Buying DAL under $40 today could, in my opinion, see 20% price appreciation or more before the summer of 2015, given the several investor touch points and earnings reports catalysts expected over the next year.
Discovery Communications (NASDAQ:DISCA):
DISCA is a global media company headquartered in Maryland that operates across three segments: U.S. networks, international networks, and education. Content is varied and the company operates about 240 distribution feeds in 40 languages worldwide.
DISCA's market capitalization is just over $19 billion, and the company has income of $1.15 billion from a top line of just under $6 billion. Gross margin is nearly 68%, and the shares currently trade at below 10 times forward earnings, 3.2 times sales, and 2.4 times book value. In addition, price to free cash flow is at relatively low levels at 16.3. Given the immense amount of activity in the media space, DISCA may be a speculative candidate for a large acquisition by an even larger media conglomerate wishing to diversify a bit. An investor might choose to go long DISCA stock while selling covered call options on the trade to generate income to support downside in case the stock lags this year.
Many sell-side equity research analysts also maintain positive ratings and price targets on DISCA as well, and price targets have increased into the high $80s and low $90s in recent weeks. Buying DISCA in the $40 range today could, in my opinion, see 55% price appreciation or more before this time next year, and I believe it would be a fantastic component of a more conservative portfolio.
GME, founded in 1994 and headquartered in Grapevine, Texas, operates as a multichannel video game, consumer electronics, and wireless services retailer. As of the end of last month, GME operated about 6,600 stores in 15 countries.
GME's market capitalization is just under $5 billion, and the company has income in the mid $350 million range from a top line of just over $9 billion. Gross margin is just under 30%, and the shares currently trade at just 13.3 times earnings, less than 1 times sales, and 2.1 times book value. In addition, price to free cash flow is a very low 8.6. GameStop's relatively inexpensive price might be attributed to its low operating and profit margins, at 6.9% and 4% respectively. However, for a stable company with decent cash flow, there is value to be gained here through some trading strategies.
Most sell-side equity research analysts maintain positive ratings and price targets on GME, and price targets have increased into the high $50s and low $60s in recent weeks. Buying GME in the low $40s range today would have potential for capital returns while still paying holders a not-too-shabby 3.2% dividend yield. If investors were to add in covered calls on top of this, this yield could be pushed above the 4% level.
Lincoln National Corporation (NYSE:LNC):
LNC, founded in 1904 and headquartered in Radnor, Pennsylvania, is (through its subsidiaries and related entities) engaged in insurance and retirement businesses in the United States. The company offers annuities, retirement plan services, life insurance, and group protection in addition to other products and solutions.
LNC's market capitalization is $13.6 billion, and the company has income of $1.4 billion from a top line of just under $13 billion. Profit margin is 11.2%, and the shares currently trade at just 10 times earnings and 8.6 times forward earnings, 1.1 times sales, less than 1 times book value and 9 times cash. In addition, price to free cash flow is at relatively low levels at 14.1. Because this is a financial play, investors should analyze these ratios and LNC's financial results a bit differently than for other industries and companies, but the fundamental value thesis remains intact after this analysis is done.
Sell-side equity research analysts have maintained and increased their positive ratings and price targets on LNC, and price targets have been in the high $50s in recent weeks. Buying LNC in the low $50s today would likely be a more tradable income play, since the company pays a 1.2% dividend to its equity shareholders. Options selling strategies could be good for those wishing to generate more income with some additional speculation involved; for instance, selling short-dated $50 strike price puts might offer some interesting premium potential given how close to the money they are.
Micron Technology (NASDAQ:MU):
MU, founded in 1978 and headquartered in Boise, Idaho, manufactures and markets semiconductor solutions globally to original equipment manufacturers and retailers through its various sales forces and distribution channels.
MU's market capitalization is just over $33.2 billion, and the company has income of $3.6 billion from a top line of just under $15 billion. Profit margin is 24.1%, and the shares currently trade at just 10.2 times earnings and just under 9 times forward earnings, 2.2 times sales, 3.3 times book value and just under 8 times cash. In addition, price to free cash flow is at relatively low levels, at 10.2. The relatively cheaper valuation exists even after the recent summer analyst conference delivering upbeat guidance on demand for company products and signals of potential supply restriction in coming quarters.
Most sell-side equity research analysts maintain positive ratings and price targets on MU, and price targets have increased into the $40s in recent weeks. Buying MU at just over $30 today could, in my opinion, see 25% price appreciation or more before the summer of 2015, given industry dynamics and the economics of the semiconductor space today.
As with any long investment thesis, there comes significant specific downside potential in addition to systematic market risk with these five names despite their fundamental undervaluation. Investors should be cautious of potential downside drivers and should factor in all potential scenarios into their bearish cases when attempting to reach their own price targets for these potentially undervalued names.
DAL, for instance, could fall victim to the general bearishness affecting airline industry stocks today and fall even further despite conviction in the company's operations and recent positive performance. DISCA could see performance lag due to Internet-based media content competing heavily with their more traditional media products. GME may suffer due to macroeconomic worries affecting video game retail space particularly, while LNC could see downside in the event of another financial sector crisis, downturn, or liquidity event. Finally, MU may not be able to compete with the larger semiconductor players and management guidance may overstate the supply and demand case, causing expectations to be higher than realistic outcomes.
On balance, however, I believe these five names can by the metrics outlined above be considered among the "best" of the S&P 500 index with respect to fundamental valuation. Allocating 1% of a portfolio to each of these five names, for instance, for a total exposure of 5% of portfolio equity across these names would not be a bad call. Their risk-adjusted return potential is likely amongst the highest of their peers, and investors would be wise to consider them for their portfolio after appropriate additional diligence. I will aim to provide a similar analysis each month as the market situation continues to evolve. Good luck!
Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in DAL, DISCA, GME, LNC, MU over the next 72 hours. 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.