By Larry Gellar
Investment Underground took a look at a few undervalued stocks that deserve a higher price. Some of these companies deserve a higher multiple based off of historic measures, and others will see multiple compression over the next year, even with significant price appreciation. Here is what we found:
Oracle (ORCL): Although less known to the general public than companies like Apple (AAPL) and Microsoft (MSFT), Oracle is actually ranked the #1 application server software platform based on market share. The most recent headline affecting this company has been its lawsuit against Google (GOOG). The litigation claims that Google’s Android mobile operating system infringes on Oracle’s Java patent. While a judge said that both companies were making unreasonable demands, this lawsuit should turn out favorable for Oracle. Oracle is currently trading at a 0.88 PEG, so the stock certainly looks enticing in that respect. Additionally, the company’s most recent quarter saw a net cash flow of $4.299 billion. Oracle also stands to benefit from new products that are coming out, such as User Productivity Kit 11.0 and Unified Directory 11g. In fact, this is what makes Oracle such an attractive company – its numerous products allow businesses to go to Oracle for all of their needs at once. Another way that Oracle’s business model works out well is that even after the initial sale, companies are still paying for upgrades and maintenance. See this article for more details.
Research in Motion Ltd (RIMM): The once great BlackBerry maker seems to be losing market share left and right. The stock has tanked lately and trades for less than half of what it did earlier in the year. This has actually resulted in a very attractive P/E ratio of 4.43. Research in Motion is now focused on developing its Playbook tablet, and the company recently purchased Swedish video-editing firm Jaycut to develop software for the product. While the Playbook is certainly a great piece of technology, it’s hard to imagine anybody wrestling the tablet market away from Apple. If the Playbook was cheaper than the iPad, there could be a market there, but this is not the case. In fact, consider reading this article for a great comparision between the two products. There are actually a couple of good things about the Playbook. It’s smaller than the iPad, which makes it more mobile. Also, Research in Motion recently announced that the Playbook would be the first tablet licensed for use by the U.S. government. Research in Motion will also benefit if it can find a way to make its smartphones cheaper.
Intel (INTC): Recent earnings have many investors excited about this stock. In fact, Intel has proven time and time again that it can perform well in a tough economy. With a PEG of 0.88, the stock may still be underpriced despite trading within a dollar of 52-week of highs. There are also some investors who prefer Maxim (MXIM) and Linear Technology (LLTC). Both have higher gross margins, but seeing that they are not focusing primarily on the consumer markets, they don't pose a real threat. Advanced Micro Devices (AMD) is Intel's most similar competitor, but Intel has exponentially greater funds to sink into research and development, which should ultimately allow Intel to continue to push the boundaries of technological innovation. Intel is also having increasing success in the emerging markets. In fact, some aspects of the U.S. economy stand to benefit Intel. Specifically, although consumers still feel very economically challenged, businesses are doing quite well as proven by the earnings season we’re currently in. Not only Intel is a favorite amongst companies that are looking to add technology, but also many companies have the cash it will take to do this.
eBay Inc. (EBAY): After seeing some 6-month lows at the end of June, eBay has been on an upswing. The company has benefited from strong sales, but note that earnings technically did not improve due to costs associated with eBay’s acquisition of GSI Commerce. eBay also announced at the earnings conference that some brick-and-mortar stores will soon be accepting payments via PayPal. This is certainly an interesting development, but don’t be surprised if it takes time for everything to be finalized. Regardless, eBay’s valuation measures are still very attractive compared to its biggest competitor Amazon (AMZN). Note that eBay has a P/E of 23.59 and PEG of 1.53, while Amazon has a P/E of 93.77 and a PEG of 2.98. Not only is PayPal doing well, but also University of Michigan recently announced that StubHub will be the official marketplace for fans selling tickets to other fans. Even eBay’s original marketplace, which has taken some criticism from long-time sellers, has had improving revenues. Bank of America Merrill Lynch has taken notice with a target price of $40 for the stock in addition to raising earnings estimates through 2013.
Wells Fargo & Company (WFC): A recent article described Wells Fargo perfectly. It explains how Wells Fargo is the fourth largest bank in America, but two-thirds the size of the next biggest bank Citigroup (C). On the other hand, it is still three times larger than the fifth-largest bank HSBC North America Holdings (HBC). Regardless of Wells Fargo’s awkward position, the company recently reported record profits. Part of this may be attributed to the fact that Wells Fargo did not report any exposure to Greece. In fact, we think WFC's relatively North-America-centric focus will spare it for the most part. On the other hand, Wells Fargo may be the odd man out if the U.S. debt ceiling is not raised. More specifically, many analysts have speculated that the big banks would actually benefit from a U.S. default because it would cause an increase in sales and trading for bonds. At the same time, Wells Fargo’s more Main Street-focused business could take a shellacking at the hands of reduced consumer confidence. Additionally, a look at WFC’s 6-month chart suggests that the current stock price may be nearing resistance.
Valero (VLO): With Valero’s earnings set to be released on July 26th, many investors are excited. The company has beaten expectations for four quarters in a row, and last quarter the company beat expectations by a whopping 37 cents per share. Valero has also been affected by the recent news that Conoco Phillips will be splitting up into two companies. One company will produce oil and the other will focus on refining it. As a company focused on refining, Valero may experience tougher competition once the deal is completed. Valero’s valuation statistics provide another interesting piece of information. The company is trading at 28.75 times earnings, but only 0.80 times 5-year earnings growth. In other words, the company is expected to see some enormous growth in the coming years. This makes sense because the company has a lot of room to grow compared to giants like Exxon Mobil (XOM) and Chevron (CVX). Despite this opportunity for growth, the company also pays out a dividend, which could be enticing for some investors. In fact, consider reading this article to understand why Valero’s dividend is expected to maintain its consistency.
CarMax (KMX): After a strong end to the month of June, demand for this stock has weakened a bit. Regardless, this is a great buy in the face of an economy that seems to be stuck in neutral. For seemingly unexplainable reasons, Americans are still updating their cars despite the country’s numerous economic problems. Other companies, like AutoNation Inc (AN), Group 1 Automotive (GPI), Penske Automotive Group (PAG) and Sonic Automotive (SAH), have tried to mimic CarMax's business model in the past and failed, leading us to believe the company has carved out a competitive advantage. This leg up on the competition will allow CarMax to expand profitably once macroeconomic conditions improve. Additionally, CarMax’s finances have benefited enormously from low operating costs. Specifically, CarMax’s operating margin is much better than its competitors. Additionally, CarMax lots are known for having great locations and great prices. The company’s PEG (currently 1.25) is a bit high, but this should not be overly concerning.
For interested buyers, we suggest a covered call strategy. We like the October 2011 sold calls and January 2012 sold calls.
Fastenal (FAST): Perhaps less known to some, Fastenal is a seller of industrial materials. Like CarMax above, Fastenal ended June strong but has wavered since then. Despite this recent decline, some statistics still put the stock as grossly overvalued. Note a P/E ratio of 32.01 and a PEG ratio of 1.74. The company’s negative cash flow for the past three quarters is also a red flag. Regardless, the company’s recent earnings were strong and other reasons to consider this company can be found in this article. Revenues were particularly strong but margins less so. Fastenal has also yet to expand in countries besides the U.S., so there is certainly room for growth if the company goes in that direction. This is important because Fastenal depends heavily on the health of the U.S. economy, which does not seem to improving. Fastenal also has a unique business model because its product selection is so much better than its competitors. The company is also known for its superior customer service. One other unique thing about Fastenal is the vending machines it offers – these are literally vending machines that sell industrial goods.
Paychex Inc. (PAYX): This stock has been on a downward trend as of late, and it’s not hard to see why. This payroll processor relies on a low unemployment rate for its profits. On the other hand, there really is no telling when the U.S. will have a normal unemployment rate again. This company’s cash flow is also worth taking a look at. Note the negative cash flow in three of the past four quarters. Not all the statistics are bad though. As discussed in this article, Paychex has a strong return on equity, net margin, and leverage ratio. Those numbers are 35.6%, 24.7%, and 3.66 respectively. The company has also benefited from its insurance division, and this was recently ranked #30 in the magazine Business Insurance. Paychex is also an appealing investment for its dividends. In fact, dividend yield is currently a whopping 4.20%. Another perspective though should lead shareholders to ask themselves how management could possibly afford this. Look for the stock to take a tremendous hit if/when management has to reduce the dividend. For more information on how to play this stock, consider reading this.
Campbell Soup (CPB): Campbell Soup is perhaps the most famous defensive stock ever. The stock’s beta is 0.26 and dividend yield is 3.40%. Additionally, cash flow has been solid for the past four quarters. Furthermore, for 2010, net sales came in at $7.6 billion with an EBT margin of 15.3%. In comparison, Sara Lee (SLE) and Heinz (HNZ) had EBT margins of 5% and 12.6%, respectively. For some more statistics on Campbell, consider reading this article. The author suggests there may be signs now that poor earnings are in the company’s future. While this may have some validity, it will not fundamentally change what Campbell is – an insensitive stock with strong dividends. In fact, the company’s lack of flare could be what makes it so appetizing – even if the economy continues to sour, people will still buy food, especially the products that Campbell makes. If there is one issue that could negatively affect this stock severely though is its use of BPA. More information on that can be found here.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.