Overview
With volatility ruling the day and correlation at all-time highs, several strong stocks have become substantially undervalued. The stocks covered in this article are undervalued based on a price to free cash flow metric. Additionally, they have high quarterly EPS growth rates and net profit margins. In the following section I will expound on these positives and perform a review of each company.
Company Reviews
These five companies are trading for less than 15 times free cash flow. Warren Buffett created the free cash flow method of valuing a company in 1986. A company with a price to free cash flow ratio of 15 or less is considered to be undervalued.
Additionally, these stocks have some very positive fundamentals and a few just recently beat analysts' estimates regarding earnings and raised guidance. These companies have quarter over quarter EPS growth rates of greater than 25% and net profit margins of greater than 20%.
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.
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.
Now, simply screening for S&P 500 stocks trading for less than 15 times free cash flow with booming EPS growth rates and high profit margins is only the first step in finding winners for your portfolio. In the following sections, we will take a closer look at these stocks to determine if the current share prices are 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 Tuesday's performance for the stocks.
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Apple Inc. (AAPL)
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Apple closed Monday at $576.16, up almost 1% for the day. The company is trading 11% below its 52 week high and 24% below the analysts' consensus mean target price of $712.53 for the company. Apple is trading for 12.08 times free cash flow. The company's quarter over quarter EPS growth rate is 92.28%. Apple's net profit margin is 27.13%.
Technically, the company is in a well-defined uptrend. The stock is currently resting on the bottom of the trend channel, which is an ideal time to buy a stock.
Overlooked in Apple's long list of Mac and iOS announcements at Apple's WWDC was the company's release of several iOS features aimed specifically at Chinese users. The features include not only the expected addition of Baidu (BIDU) search, but also the integration of Sina's (SINA) Weibo and merging video sites Youku (YOKU) and Tudou (TUDO), as well as Chinese language support for Siri. Apple's China sales soared three times year over year in the March quarter to $7.9 billion and made up 20% of its sales.
Apple is fundamentally and technically a buy at this level. Couple this information with the opportunity for growth in China and this is definitely a buy at current levels.
American International Group, Inc. (AIG)
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AIG closed Monday at $30.19, up over 2% for the day. The company is trading 14% below its 52 week high and 126% below the analysts' consensus mean target price of $68.33 for the company. AIG is trading for 10.25 times free cash flow. The company's quarter over quarter EPS growth rate is 226.75%. AIG's net profit margin is 33.09%.
Technically, the company is in a well-defined uptrend. The stock recently bounced off the bottom of the current trend channel and looks well positioned to move higher.
On Monday some positive news regarding AIG was released. The NY Fed plans to take bids on Wednesday and Friday on former AIG CDOs that have a face value of $7 billion and are held in Maiden Lane III. Some analysts reckon the sale could facilitate the repayment of the last loan that AIG owes to the Fed for its bailout, although the eurozone crisis and slowing U.S. economy could curtail demand.
CF Industries Holdings, Inc. (CF)
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CF closed Monday at $168.74, up over 1% for the day. The company is trading 17% below its 52 week high and 26% below the analysts' consensus mean target price of $211.81 for the company. CF is trading for 6.65 times free cash flow. The company's quarter over quarter EPS growth rate is 41.64%. CF's net profit margin is 33.09%.
Technically, the company is in a well-defined uptrend. The stock recently bounced off the bottom of the current trend channel and just broke above the 200 day SMA.
Dahlman Rose recently downgraded CF Industries to Sell from Hold, citing the potential for significantly reduced fertilizer prices from an increasingly likely large corn crop. Price target is $155. The firm also cuts CVR Partners (UAN) to Sell from Hold and Rentech Nitrogen (RNF) to Hold from Buy.
Dahlman has a good point here. I would avoid this stock until the next quarter earnings are released. There are too many other opportunities out there to take a chance on this one. The risk reward ratio is unfavorable at this time.
Capital One Financial Corp. (COF)
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COF closed Monday at $52.08, up almost 3% for the day. The company is trading 8% below its 52 week high and 13% below the analysts' consensus mean target price of $65.32 for the company. COF is trading for 3.70 times free cash flow. The company's quarter over quarter EPS growth rate is 30.24%. COF's net profit margin is 21.75%.
Technically, the company is in a well-defined uptrend. The stock recently bounced off the bottom of the current trend channel and just broke above the 50 day SMA which is bullish.
If you are looking to invest in financials Dick Bove, a well-respected Wall Street analyst, likes the regionals including COF. Bove states,
The big universals are dealing with a multitude of issues that impede their competitiveness, while community banks are being weighed down by regulations that are driving them out of the business. Firms in the middle tier however, are growing their key commercial and industrial lending portfolios while their competitors have had to pull back. His picks: US Bancorp (USB), PNC Financial (PNC) and Capital One.
I like COF here. The banks have been in the proverbial doghouse for quite a while. JPMorgan's Jamie Dimon is set to be grilled Wednesday when he appears before a Senate committee to explain massive derivatives trading losses at the bank. I see this as marking the lows for the banks.
Discover Financial Services (DFS)
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DFS closed Monday at $32.92, up almost 2% for the day. The company is trading 5% below its 52 week high and 14% below the analysts' consensus mean target price of $36.60 for the company. DFS is trading for 5.65 times free cash flow. The company's quarter over quarter EPS growth rate is 39.73%. DFS's net profit margin is 33.35%.
Technically, the company is in a well-defined uptrend. The stock recently bounced off the bottom of the current trend channel and just broke above the 50 day SMA which is bullish.
DFS recently got into the mortgage origination business, launching Discover Home Loans. Wells Fargo (WFC) is the industry giant, writing one in three U.S. mortgages and banking coin thanks to a lack of competition. This is a good move by Discover. I like the stock here.
Conclusion
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 for those profits. This is how we come 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. Moreover, all are technically solid at this time. Most have positive catalysts for future growth with the exception of possibly CF Industries. This is a change in stance for me regarding the name. With so many buying opportunities presenting themselves recently, I feel it is prudent to put CF on the back burner until it proves itself next quarter.
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.
