The five companies covered in this article are some of the most highly profitable large caps in the S&P 500. These five stocks have an average net profit margin of over 30%. A company's profitability is a very important concept investors must understand before investing in a stock. Each time you consider starting a position in a stock, you should prudently scrutinize its profitability and EPS information. Profit is the financial objective businesses strive to achieve. Often times you'll hear someone say, "What's the bottom line?" They are referring to net profits. One third of all the money these companies take in goes to the bottom line. This is a powerful statistic vital to the sustainability of the concern.
Profits signal to banks, suppliers and other lenders that the business can pay debts. Profits earned which are kept in the business are known as retained profits. These funds can be distributed to shareholders in the form of dividends, used to buy back shares or reinvested in the company to facilitate future growth. Bottom line, profits are what it's all about.
Additionally, these stocks are trading well below consensus estimates. The companies are trading on average 20% below their consensus analysts' mean target prices. These stocks appear undervalued to me. We are in the midst of a sell off based on macroeconomic and geopolitical issues. Often, this is precisely the time to pick up shares in stocks with strong fundamentals and catalysts for future growth. I posit this is a case of throwing the baby out with the bathwater.
Now, simply screening for S&P 500 stocks with the highest net profit margins and trading significantly below consensus estimates is only the first step to finding winners that may provide alpha. In the following sections, we will take a closer look at these stocks to determine if the drop in prices is justified. We will perform a brief review of the fundamental and technical state of each company. Additionally, we will discern if any upside potential exists based on sector, industry or company specific catalyst. The following table depicts summary statistics and Thursday's performance for the stocks.
eBay Inc. (EBAY)
EBAY has a net profit margin of 26.84%. EBAY is trading well below its consensus estimates. The company is trading 10% below the analysts' consensus mean target price of $43.13 for the company. EBAY closed Thursday at $39.14, down 1.81% for the day. The company has many other fundamental positives. EBAY has a forward PE of 14.60, a PEG ratio of 1.21 and a return on equity of 19.18%. Quarter over quarter sales and EPS growth are 28.73% and 20.90% respectively.
PayPal's mobile payments service is the key to EBAY's growth. EBAY's mobile payment business has exploded from a few hundred million dollar business in 2009 to a $7 billion business in 2012. Only a small percentage of smart phone users currently use the service today, I predict that will soon change and eBay's mobile payments exponential growth rate support my thesis. eBay's PayPal exemplifies the exponential growth potential for mobile payments. EBAY recently reported revenue for the first quarter ended March 31, 2012, which increased 29% to $3.3 billion, compared to the same period of 2011.
The mobile payment industry is still in its infancy. I believe the mobile payment industry is a multi-billion dollar, multi-year secular growth market which will have a huge impact to the bottom line of EBAY.
The market has been getting hammered lately. This is the worst May in the last two years. Who said not to sell in May and go away? I would wait for EBAY to close the gap and touch the 50 day SMA of $38 prior to starting a position.
Gilead Sciences Inc. (GILD)
GILD has a net profit margin of 29.51%. GILD is trading well below its consensus estimates. The company is trading 16% below the analysts' consensus mean target price of $58.46 for the company. GILD closed Thursday at $50.10, down 2.87% for the day. The company has many other fundamental positives. GILD has a forward PE of 11.80, a PEG ratio of 1.03 and a return on equity of 39.13%. It's trading at 12.5 times free cash flow. 15 times is considered undervalued.
Gilead primarily develops products for the treatment of HIV. The majority of its revenues were generated from HIV. The company is one of the leading HIV drug manufacturers in the U.S. Additionally, Gilead develops medications for the management and cure of Hepatitis C. To that end, the company acquired Pharmasset Inc (VRUS) in January this year for a total of $11.2 billion. Pharmasset's GS-7977 has robust cure rates to date and is widely recognized as a potential leader in the next generation all oral regiments for hepatitis C. As such, the acquisition of Pharmasset helped Gilead advance its pipeline for hepatitis C treatment drugs considerably. The drug is expected to reach the market in 2014 or 2015.
Gilead had approximately $10 billion in cash. The outsized cash position helped the company to fund its acquisition of Pharmasset. Nonetheless, Gilead incurred $6 billion of new debt to finance the deal. Gilead recently announced the suspension of its share repurchase program in order to focus on debt reduction.
Gilead is 10% off its recent highs and 3% above its 50 day SMA. Nevertheless, it has not broken the recent uptrend. I would wait for the stock to test support at the 50 day SMA prior to starting a position. The stock looks well positioned to advance from this level.
Corning Inc. (GLW)
GLW has a net profit margin of 31.94%. GLW is trading well below its consensus estimates. The company is trading 25% below the analysts' consensus mean target price of $16.04 for the company. GLW closed Thursday at $12.82, down 0.77% for the day. The company has many other fundamental positives. GLW has a forward PE of 8.43 and trades at a 10% discount to book value. The company pays a dividend with a 2.34% yield.
GLW stands to gain from the surge in flat panel TV prices. U.S. flat-panel TV prices continued their year-long surge. iSuppli reported the price of the average set reached $1,248, up 11.4% from December. Adoption of LED TVs and 3D TVs is contributing to the increase, but so are stabilizing LCD panel and glass prices, and an end to the brutal price war TV manufacturers such as Sony (SNE), Panasonic (PC) and Samsung (SSNLF.PK) were engaged in last year. This bodes well for GLW. Not to mention the huge prospects for Gorilla Glass 2.
Corning reported earnings on April 25th. Corning beat expectations on revenues and earnings per share. Corning recorded revenues of $1.92 billion. Analysts polled by S&P were looking for $1.86 billion.
Corning recently broke down and is trading below its recent trading range. The next level of support appears to be at $12.50. I would hold off on starting a position until this area of support is tested.
Oracle Corporation (ORCL)
ORCL has a net profit margin of 26.34%. ORCL is trading well below its consensus estimates. The company is trading 30% below the analysts' consensus mean target price of $34.07 for the company. ORCL closed Thursday at $26.25, down 1.73% for the day. The company has many fundamental positives. ORCL has a forward PE of 9.98 and trades at a PEG ratio of 1.16. The company pays a dividend with a 0.91% yield. ORCL has a ROE of 24.50% and sells at only 11 times free cash flow. This is vastly undervalued.
ORCL has many positives going forward. I recommended the stock at the beginning of May. The stock has come in almost 10% from that point. Strong leadership is required for success. Larry Ellison epitomizes this ethos. What's more, Oracle recently exceeded analysts' estimates for quarterly profit and new license sales, a sign of buoyant demand for programs that help companies organize data and run operations. Moreover, with its recent cloud play acquisitions, Oracle appears well positioned for future growth.
Top tech fund manager, David Tepper, recently more than tripled his position in Apple (AAPL) to 685K shares, and boosted his Microsoft (MSFT) and Oracle positions by 500K and 1.1M shares, respectively. JG Capital's Jeff Gaggin thinks Oracle will make an offer for BMC in order to better compete with IBM (IBM) in systems management software.
Oracle looks like its heading for $25, which is its low point for the year. I would wait for the stock to bounce off this level prior to starting a position. The stock looks vastly undervalued at this level.
Visa, Inc. (V)
Visa has a net profit margin of 42.74%. Visa is trading well below its consensus estimates. The company is trading 16% below the analysts' consensus mean target price of $133.79 for the company. Visa closed Thursday at $115.01, down 2.14% for the day. The company has many fundamental positives. Visa has a forward PE of 16.27 and trades at a PEG ratio of 1.40. The company pays a dividend with a 0.77% yield. Visa has an ROE of 15.39% and has a quarter over quarter EPS growth rate of 58.23%.
The bottom line is Visa is well positioned to take advantage of the coming paradigm shift to mobile/online payments. Visa recently launched the first beta of its wallet service V.me with online retailer Buy.com. Buy.com's 18 million customers will now see the option to enroll in V.me on check-out and login pages. They will be able to create a V.me account that's funded from Visa, American Express, MasterCard and Discover cards. Instead of entering in credit card information to complete a transaction, V.me users can enter in a user name and password. V.me users can also receive alerts and near-real-time notification of transactions on their Visa accounts and will eventually get personalized offers through the wallet. This is a major catalyst for the stock going forward.
The stock has been in a well-defined uptrend, nonetheless, recently broke through the 50 day SMA. I like the stock here, but would wait for a change in the short term trend prior to starting a position. When a stock breaks through a key support level, that support now becomes resistance. Look for the stock to break above the 50 day SMA before starting a position.
Profitability is the most important statistic for a going concern. When buying a stock in a profitable company, you need to consider the price you are willing to pay of those profits. This is how we could to a conclusion of whether value exists. As Warren Buffett would say, "Price is what you pay, value is what you get." I believe all these stocks are undervalued at current levels. Even so, some are technically weak at this time. Time is on your side. Patience pays off. Wait for some semblance of a bottom prior to opening a position.
Use this information as a starting point for your own due diligence and research methods before determining whether or not to buy or sell a security. If you choose to start a position in any stock, I suggest layering in a quarter at a time on a weekly basis at a minimum to reduce risk and setting a 5% trailing stop loss order to minimize losses even further.