The market continued its downward spiral Monday. The indices closed the day off the lows, yet still down significantly as deleterious European headlines continued. Spain requested 100 billion euros to recapitalize its banks, Greece's newly appointed finance minister resigned and Cyprus asked the European Union for help as well. The final hour brought a small rally which boosted the markets off the bottom, yet the S&P 500 was still down over 1% for the day.
It's times like this that I search for diamonds in the rough. Diamonds in the rough are stocks hitting their lows which may have been undeservingly sold off. The stocks have fallen to levels where significant value is created. The extreme correlation in stocks combined with recent unbridled volatility often results in the creation of buying opportunities. I believe the following five companies may fall into this category. Please review the subsequent section for an analysis of the five companies.
The five companies covered in this article are S&P 500 stocks trading at bargain basement prices based on the fundamental indicator known as the PEG ratio (Price/Earning/Growth). The PEG ratio is a widely accepted indicator of a stock's prospective value. Similar to the price to earnings ratio, a lower PEG means that the stock is more undervalued. Many investors use one as the cut-off point for PEG ratios. A PEG of 1 or less is believed to be a promising indication that significant value exists. As Warren Buffett would say, "Price is what you pay, value is what you get."
One caveat regarding the use of the PEG ratio is you need to perform additional due diligence and determine if the projected growth of the company is from healthy sources such as organic growth. Growth by acquisition or stock buy backs may be unsustainable at some point. These stocks have PEG ratios of less than two and EPS growth rates for next year of greater than 10%.
Finally, these stocks are trading well below consensus estimates and 52 week highs. The companies are trading on average 41% below their 52 week highs and 47% below their consensus analysts' mean target prices. Now we must discern if these stocks are value traps or trades. We need to separate the wheat from the chaff by performing further due diligence. Simply screening for S&P 500 stocks with low PEG ratios and positive EPS growth rates trading significantly below consensus estimates and 52 week highs is only the first step to finding winners for your portfolio. The following table depicts summary statistics and Monday's performance for the stocks.
Alcoa, Inc. (AA)
Alcoa is trading well below its consensus estimates and its 52 week high. The company is trading 49% below its 52 week high and 39% below the analysts' consensus mean target price of $11.69 for the company. Alcoa was trading Monday for $8.39, down over 2% for the day.
Fundamentally, Alcoa has several positives. The company has a forward P/E of 8.72. Alcoa is trading for 13 times free cash flow and approximately two thirds of book value. EPS next year is expected to rise by 88.46%. Insider ownership is up 20% over the past six months and the company pays a dividend with a yield of 1.40% and has a PEG ratio of 1.83.
Alcoa's CEO Klaus Kleinfeld told CNBC overall demand for aluminum is strong, particularly for full-body lightweight cars and planes. "The demand structure is very strong," Kleinfeld says, adding that "demand increased by 10% last year and this year it's up 7% so far." optionMONSTER says one investor is trying to bottom-fish Alcoa as the stock attempts to hold its lows from last year. optionMONSTER's tracking systems detected the purchase of more than 20,000 January 9 calls for $0.75 against open interest of 7,223 contracts. Almost all the volume occurred in a single large block. These are bullish indicators for the stock. I feel good about owning this stock into earnings on July 9th.
While Moody's downgrades could lead to increased borrowing rates for the affected banks, the action isn't expected to have a big impact on consumers in the short term. One reason, says RBC's Joseph Morford, is that "commercial banks are flush with deposits and liquidity," and are thereby relying less on debt to fund their operations. The downgrade along with the recent turmoil in Europe should mark the lows for these stocks. I see them up big within a year's time. These bank stocks look good here if your risk tolerance is high.
Citigroup is trading well below its consensus estimates and its 52 week high. The company is trading 39% below its 52 week high and 52% below the analysts' consensus mean target price of $40.64 for the company. Citigroup was trading Monday for $26.75, down over 4% for the day.
Fundamentally, Citigroup has several positives. The company has a forward P/E of 5.79. Citigroup is trading for 1.63 times free cash flow and approximately half of book value. EPS next year is expected to rise by 12.97%. Insider ownership is up 29% over the past six months and the company pays a dividend with a yield of 1.40% and has a PEG ratio of 0.83.
The Goldman Sachs Group, Inc.
Goldman is trading well below its consensus estimates and its 52 week high. The company is trading 34% below its 52 week high and 39% below the analysts' consensus mean target price of $126.65 for the company. Goldman was trading Monday for $91.22, down over 3% for the day.
Fundamentally, Goldman has several positives. The company has a forward P/E of 7.08. Goldman is trading for 2.32 times free cash flow and slightly over half of book value. EPS next year is expected to rise by 14.27%. The company pays a dividend with a yield of 2.02% and has a PEG ratio of 1.82.
Ford Motor Co. (F)
Ford is trading well below its consensus estimates and its 52 week high. The company is trading 29% below its 52 week high and 57% below the analysts' consensus mean target price of $15.75 for the company. Ford was trading Monday for $10.01, down almost 2% for the day.
Fundamentally, Ford has several positives. The company has a forward P/E of 5.82. Ford is trading for 8.10 times free cash flow and 2.3 times book value. EPS next year is expected to rise by 16.22%. The company pays a dividend with a yield of 2.00% and has a PEG ratio of 0.34.
According to a report by AlixPartners LLP, U.S. auto sales growth may slow through at least 2016 as high unemployment lingers and young people drive less. A strong dollar eroding margins on overseas sales combined with slowing sales translates into missed expectations for Ford's earnings this summer. The stock is a sell.
Chesapeake Energy Corporation (CHK)
Chesapeake is trading well below its consensus estimates and its 52 week high. The company is trading 52% below its 52 week high and 50% below the analysts' consensus mean target price of $25.51 for the company. Chesapeake was trading Monday for $17.03, down almost 9% for the day.
Fundamentally, Chesapeake has several positives. The company has a forward P/E of 10.02. Chesapeake is trading for 68% of book value. According to Finviz.com, EPS next year is expected to rise by 246.94%. The company pays a dividend with a yield of 2.06% and has a PEG ratio of 0.87.
The shenanigans at Chesapeake continue. According to the Financial Times, Encana has launched an internal investigation into allegations of collusion with Chesapeake Energy, a US rival, to avoid competing when bidding for oil and gas development leases in Michigan in 2010.
Whether it's true or not doesn't matter. The damage is already done. I question Chesapeake's ability to execute on 2013's plan. The company is facing some major hurdles over the next few years. Chesapeake is a sell. There are better alternatives out there.
Times of market turmoil provide opportunities to buy into fundamentally strong stocks beaten down from macro-economic headlines. Nevertheless, the strong fundamentals can sometimes be misleading, creating value traps rather than trades. Ford and Chesapeake look like traps.
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.
Disclosure: I am long AA.