Quality Stocks That Merit A Look Based On Valuation

Includes: AFL, SPLS
by: Greg Group

According to Investopedia, when a company's stock seems undervalued, investors are sometimes drawn into purchasing it in hopes of a stock price appreciation. If stock price is the only factor an investor looks at before buying a stock, he or she could end up with a stock whose value is likely to decline even further. How do stay away from the value trap? I like to look at a stock’s 10-year trend to ensure revenue has grown 10 years in a row and EPS has remained positive each year. I omit any distressed stocks as there is always a chance there is something hidden below the surface. Then you can look at traditional valuation to what future potential a stock may have. I have identified two stocks meeting this criteria that can bounce back in the near future.

One stock is Aflac (NYSE:AFL) that offers supplemental health insurance and life insurance in the two largest insurance markets in the world, the U.S. and Japan. In addition to its cancer policies, the company has broadened its product offerings to include accident, disability, and long-term care insurance. It markets its products through independent distributors, selling most of its policies directly to consumers at their places of work.

While Aflac writes policies domestically, its primary market, representing around 75% of annual premiums, is Japan. Currently, Aflac insures around 80% of all cancer polices in Japan. Economic dynamics in Japan indicate that demand for Aflac's supplemental policies will continue to be strong. Results in Japan continue to be strong, and profit growth there is impressive. Japanese demographic trends are working to increase demand for supplemental policies. Clients, especially in Japan, are very sticky once they purchase policies. Persistency in Japan usually hovers around 95% as the average customers stays with Aflac for nearly 20 years.

Although the numbers look even better than they were on an ongoing basis due to currency fluctuations, Aflac released another strong report with its third quarter. Net earnings increased 7.8% to $744 million, or $1.59 per share, driven by an 11% increase in revenue. Aflac is projecting premiums increasing at a 4% compound annual growth rate during the next five years.

AFL has increased revenue in each of the last 10 years. It has an average 10-year return of 7%. It has a projected EPS growth rate of 11.7% over the next 5 years. It has an ROE of 15% and a forward PE of 6.33. It has a dividend yield of 2.93% and a 5-year dividend growth rate of 20%.

AFL is undervalued based on its Price/Cash Flow (TTM) of 2.04, which is less than the Financials sector’s bottom quintile value of 4.20. AFLAC Inc.'s operating earnings yield of 15.1% ranks in the top 20% of stocks. AFLAC Inc.'s stock price is down 23.2% in the last 12 months, but bounced up 18.7% in the past quarter and up 0.2% in the past month. This is still a strong stock to enter on any pullback below $40 with a future price target around $60.

Staples (NASDAQ:SPLS) is the world's leading office products company, with $24 billion in sales and over 2,000 stores in 25 countries. The company's three segments allow it to serve individual consumers, Fortune 1,000 companies, and every customer category in between, worldwide. Staples' growing e-commerce business has garnered it the number-two spot in online retailers, behind Amazon (NASDAQ:AMZN).

While Staples' quarter wouldn't appear impressive (revenue up just 0.5% to $6.6 billion and margin expansion of 10 basis points to 8.1% excluding restructuring), the company continues to outperform its rivals. By segment, North American delivery sales were healthy (up 1.8%), thanks to strong growth in facilities and break-room supplies and promotional products. International revenue fell 1.9% or 7.0% on a local currency basis, because of weak economic conditions. European same-store sales were down 12.0%, and management noted weakness in the Australian market. Staples' sales outside North America represent just 22% of total revenue, leading to our opinion that Staples is well-poised to take advantage of international growth opportunities. Staples raised its share-repurchase target for the year to $600 million from $300 million-$500 million.

SPLS is in a cyclical industry and subject to the negative effects of high unemployment. This reality is compounded by the fact that a portion of Staples' customers are small businesses, even more sensitive to poor macroeconomic trends compared to larger companies.

Staples has increased revenue in each of the last 10 years. It has an average 10-year return of 3%. It has a projected EPS growth rate of 10.72% over the next 5 years. It has an ROE of 14% and a forward PE of 9.3. It has a dividend yield of 2.86% and a 5-year dividend growth rate of 16.75%.

SPLS appears undervalued based on its Price/Earnings (TTM) of 10.14 and a price-to-cash flow of 6.43. On a relative basis, SPLS has strong technicals and fundamentals. You can buy SPLS below $16 with a long price target of $25.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.