5 Inexpensive Stocks In An Overheated Market

Includes: BAC, BP, C, GNW, INTC
by: Jake Huneycutt

Since the market bottom of March 2009, the S&P 500 index has risen about 140%. Over the past year, we've seen gains of about 26%. It's been an extraordinary four-year run; one of the best in US history, and the past year has been particularly hot. Unfortunately, there are many problems lurking beneath the surface. Given the risks and current valuations, I view the market as being a bit "overheated" right now.

On the macro front, we seem to be entering a brave new world. The US Federal government is addicted to fiscal stimulus, and we haven't had a balanced budget since 2000. What's more frightening to me is that the broader economic profession has re-classified these huge budget deficits as 'not a stimulus' because we're not increasing the rate of spending growth fast enough.

Likewise, I'm becoming increasingly concerned that the Fed doesn't understand when it's time to apply the brakes. We saw this in the early 00's as well, as Greenspan wanted the Fed to keep pushing on the gas even while housing prices were rising at near double-digit rates annually. The housing market is beginning to recover, but there are few signs that Bernanke wants to start taking even minor, baby steps towards normalcy.

But it's not just the US that has problems. China, Europe, and Japan may have even bigger issues than us. China's addiction to stimulus rivals Charlie Sheen's addiction to cocaine and $25,000 escorts. The result has been a massive real estate boom that has resulted in entire ghost cities. It all has to come to an end sometime and the slump in commodity prices, such as copper and oil, suggests that it has already started to slow.

The eurozone's problems make the US's growing problems look rather tame. The eurozone's structure is unsustainable and either fiscal integration or dissolution is needed to solve the problems, with the latter being preferable. I've written extensively about the eurozone before, and my views haven't changed much in the past two years, except I now view Italy as most likely to exit first.

All of this is to say, there are a lot of justifiable reasons to be risk-averse now. Yet, in spite of the gloom and the potential macro hurdles, there are still some inexpensive stocks out there that could provide great long-term returns.

Here are five of my top picks right now.


BP has become my favorite stock for 2013. BP has traded sideways since around September 2010. In the same time period, the S&P is up about 45%. Of course, we all know the major reason BP has struggled is related to the Deepwater Horizon oil spill in 2010. BP has spent billions on the clean-up in the Gulf of Mexico, and still has about $15 billion on its balance sheet provisioned for future liabilities. That said, even with the huge Deepwater Horizon liabilities, BP looks very inexpensive to me right now. It's trading at a slight 5% premium to book value, which is historically low for an oil major.

Trailing P/E ratio is likewise low at 6.24x. However, remember that this is a volatile industry and profits over the past four quarters have been above-average (primarily based on a strong Q1 2013). That said, even if you use the much lower 2012 EPS figure of $3.63 per ADR share, the P/E still looks very reasonable at around 11.85x. This is notable because if you exclude 2010, the year of the Deepwater Horizon spill, 2012 was one of BP's worst years on paper. And yet, it still looks inexpensive using earnings figures from a poor year.

So why is BP so "cheap"? There are two legitimate concerns. The first is the ongoing liabilities for the Deepwater Horizon spill. There's little certainty over what the final costs will be for BP, once all the legal cases are resolved. A second less mentioned, but perhaps more legit reason to be concerned, is BP's high capital expenditures, which have made them free cash flow negative for the past few years.

In spite of the negatives, the market seems to be putting too much of a risk premium on the stock. The likely reasoning: big institutional investors are afraid of it due to the uncertainty. Since large institutional investors are the biggest drivers of large-cap stock prices, BP's stock price has stayed depressed over the past few years. However, it wouldn't be surprising if we see it trade closer to its peer group as that uncertainty is slowly removed and big institutional investors once again feel safe and confident about the continuity of the dividend stream.

Here are a few good articles on BP that I've seen on Seeking Alpha recently.

5 Reasons BP is Still A Buy

Resolution of Legal Issues Will Propel BP Higher

Risks of BP and How to Hedge Them

BP in a Year of Transition?

It's also worth noting that Seth Klarman's Baupost Group holds a sizable $725 million position in BP. While I'd never buy a stock solely on the basis of a famous investor holding it, it does give me a bit of added confidence when I see that a few great investors have reached similar conclusions.

2. Citi (NYSE:C)

3. Bank of America (NYSE:BAC)

Both Citi and Bank of America are well-capitalized and look cheap at the current prices. What's more: rising housing prices are quickly cleaning up the balance sheets for both banks.

Citi sells slightly below its tangible common equity per share value of $52. Bank of America is right at its TCE of $13.14 per share. Both sell at very low forward P/E ratios, with Citi at 9.1x and BAC at 10.1x. Both firms are being held back mostly by balance sheet concerns, but with the way housing prices are rising right now, there aren't going to be any "toxic assets" left in another 24 months.

One concern for Citi might be an emerging markets crisis. Citi has an international footprint that makes it a bit more vulnerable overseas, whereas Bank of America is a bit more US-centric. There's also legitimate reason to worry that in spite of an improving housing market, that loan volume will stay historically depressed at the banks. Yet, in spite of these risks, I see Citi and BofA as good investments right now; both with a reasonable margin of safety even if things go awry on the macro front. The improving housing market provides a good tailwind, as well.

4. Genworth (NYSE:GNW)

Genworth is another housing and mortgage market recovery play. Even after a significant run-up in the past few months, GNW still sells at a 56% discount to its tangible common book value of around $25.86 per share.

A few good articles on GNW:

Genworth: Value and Catalysts

Shares Up on Mortgage Profits; Still Undervalued

Can Genworth Make Enough Money in Long-Term Care Insurance

I also like that Genworth is one of the better plays on interest rates rising over the next several years. Alongside BP, this is my highest confidence investment at the moment, as the macro tailwinds will likely be very favorable and it still looks very cheap.

5. Intel (NASDAQ:INTC)

Finally, we come to Intel . While I did recently add a small 2015 call option position on it, it's the only stock on this list I don't outright own. I remain very intrigued, nevertheless. My only hesitancy comes from my general disdain for the tech sector. Over the past decade and a half, I believe that investors have consistently underestimated the risks in high-tech.

Take BlackBerry (BBRY) as an example. BBRY was on top of the world in 2007 and by 2012, it has already become a has-been. In most industries, it can take decades for this sort of radical displacement to happen, but it can happen within the tech world within a few years.

Yet, almost every argument I can make on obsolescence doesn't seem to apply much to Intel. The market thinks INTC has lost its competitive edge as tablets and smartphones become more prevalent. While Intel has lagged behind a bit on hitting these markets, there are few firms in the world with the technological edge that Intel has over its rivals.

With a P/E of 12, and a large untapped market, Intel might actually be fairly cheap here. My tech aversion leaves me uncommitted to buying a significant position, but I'm certainly intrigued by it and may dive in deeper in the upcoming weeks.

There's an abundance of bullish articles on Intel, but here are three that I thought were high quality.

Quantifying Impact for Intel On Its Entry Into Mobile

Intel Could Hit Share Price of $40 By 2016

The Bull Case for Intel

As the market for chips grows, due to the growth in tablets and smartphones, INTC could benefit even if the overall US economy falters.


There are a lot of reasons to be more risk averse in this overheated market. While it's certainly wise to hold a bit more cash, there are still some good deals out there, and it makes sense to find a few good core holdings. With the five stocks I've named, there's good potential that a few of them will produce outsized returns over the next few years, even if it turns out that the broader market sees a pullback.

Disclosure: I am long BP, C, BAC, GNW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own long-dated call options in INTC.