5 Undervalued Stocks With Rich Cash Flows

by: Investment Underground

By Larry Gellar

We’ve identified 5 stocks with price-to-free cash flow ratios of below 15. This important value metric can be a good indicator of which stocks to hold in your portfolio. Many have been beaten up in the recent market turmoil, so now could be a good entry point. Companies such as Travelers, Morgan Stanley, and Discover are good plays for portfolios in need of some exposure to the financial industry. My analysis concludes that these stocks are a buy. Let’s see what’s been affecting these stocks:

Dish Network Corp. (NASDAQ:DISH) has been volatile lately, although some analysts think this stock could be a keeper. Dish Network’s main problem is that while DirecTV (NYSE:DTV) has been adding record amounts of subscribers, Dish Network’s number of subscribers has stayed about flat. The key for Dish Network though is its ownership of Blockbuster. Blockbuster offers Dish Network a great opportunity to cross-market as described here, and many customers still recognize the Blockbuster brand despite its bankruptcy debacle. Meanwhile, Dish Network’s earnings report was received with excitement by many shareholders. Both revenue and net income were up significantly, and the company even announced a one-time dividend. Besides DirecTV, Dish Network also competes largely with Comcast (NASDAQ:CMCSA). CMCSA has higher ratios for price to earnings and price to sales but about the same number for price/earnings to growth. Additionally, CMCSA has better margins – gross margin is 52.92% and operating margin is 19.85%. As for cash flows, Dish Network had $534 million come in during 2010 and $404 million come in during the first 9 months of 2011. The recent inflows have been boosted by taking on more debt, however. Regardless, cash from operating activities remains strong. Potential investors should note that this stock has a beta of 1.12, which can add a bit more volatility to an average index-based portfolio. Dish is a buy due to its growth prospects.

The Travelers Companies, Inc. (NYSE:TRV) has been on the decline, and debt problems throughout the world are probably the culprit. On the other hand, Travelers has just announced its support for Small Business Saturday, which could be a good way to sell some insurance to these enterprises. Joan Woodward, Executive Vice President of Public Policy, said, “Travelers is committed to helping small businesses succeed and influencing public policy leaders to improve the business environment.” In fact, this isn’t the first time that Travelers has supported small businesses. As described here, the insurer did a survey recently that showed a majority of small business feel that they are impacted by regulation more than large businesses. This was part of Travelers Institute’s “Small Business, Big Opportunity” conference, and Travelers pledged to help small businesses there as well. Important competitors for Travelers include Hartford Financial Services (NYSE:HIG) and W.R. Berkley (NYSE:WRB). Those stocks have lower price to earnings ratios, although Travelers comes in the middle for price/earnings to growth. As for margins, Travelers is about average – gross margin is 22.62% and operating margin is 8.71%. Meanwhile, cash flows have been mixed with $55 million flowing out in 2010 and $31 million flowing in during the first 9 months of 2011. TRV is a good bet going forward.

Morgan Stanley (NYSE:MS) has fallen quite a bit, although the company’s partly owned subsidiary Morgan Stanley Smith Barney has hired 9 new advisers which are expected to bring in quite a bit of new revenue. Morgan Stanley Smith Barney, also owned by Citigroup (NYSE:C), has brought in these new hires from Merrill Lynch (owned by Bank of America (NYSE:BAC)), RBC Dain Rauscher (owned by Royal Bank of Canada (NYSE:RY)), and LPL Financial. On the other hand, Morgan Stanley Smith Barney is losing one adviser to Wells Fargo (NYSE:WFC). Meanwhile, at least one analyst thinks Morgan Stanley is due for a rebound. Collins Stewart analyst Matthew Czepliewicz believes the amount of risk in the stock is not nearly as much as the price implies, making it a good buy. Additionally, problems in the eurozone should be able to be worked out. Morgan Stanley’s biggest competitor, Goldman Sachs (NYSE:GS), has also taken a hit lately. Regardless, Goldman Sachs still has higher ratios for price to earnings, price/earnings to growth, and price to sales. Goldman Sachs also has slightly lower margins – those numbers are 92.10% gross and 27.78% operating. As for cash flows, Morgan Stanley brought in $15.624 billion during 2010 and $6.292 billion during the first 9 months of 2011. MS is a solid financial stock.

Abbott Laboratories (NYSE:ABT) stock has moved down recently, although the latest FDA approval should have many investors excited. Indeed, Abbott has designed a blood test for Chagas disease, which is common in Latin America. Abbott also recently discussed the results of a study from the National Heart, Lung, and Blood Institute. Here’s what John Leonard, one of the company’s senior vice presidents, said at American Heart Association Scientific Sessions 2011:

Niaspan remains an important treatment option to help patients reach their lipid treatment goals, many of whom require multiple medications to do so. Even when looking only at the high-risk patient group evaluated in the AIM-HIGH study, epidemiologic data tell us that in clinical practice more than three-quarters of these patients do not reach their recommended goals for lipid therapy.

Data for another drug that Abbott is developing is also being seen as good news. This treatment seeks to help those with coronary artery disease. Important competitors for Abbott include Merck (NYSE:MRK), Roche (OTCQX:RHHBY), and Sanofi (NYSE:SNY). Abbott has the lowest price/earnings to growth ratio, although price to earnings and price to sales are higher than average. Meanwhile, Abbott’s margins are a bit low – those numbers are 59.44% gross and 20.62% on an operating basis. ABT is a buy on valuation.

Discover Financial Services (NYSE:DFS) is one stock that’s starting to recover from recent market turmoil. In fact, good news comes in the form of a deal that was signed between Discover and WorldPay, which does quite a bit of payment processing in Europe. The deal mainly concerns Diners Club (owned by Discover), and here’s what one of Diners Club’s vice presidents had to say: “WorldPay’s global reach, local knowledge and robust products and services will enable us to increase our merchant presence in the U.K., benefiting our Discover, Diners Club and Network Alliance card members as they travel to Europe.” Additionally, Zacks is reporting that Discover is experiencing both a lower delinquency rate and a lower default rate for its credit cards. While that may have to do with the recent tightening of credit, future delinquency/default rates might not be as rosy. That’s because many financial institutions (including Discover) are starting to be less discriminating with who they give credit cards. Discover also recently redesigned its ShopDiscover web site, which seeks to reward those who hold Discover credit cards. The web site allows customers to rack up rewards at a variety of retailers. Important competitors for Discover include American Express (NYSE:AXP), MasterCard (NYSE:MA), and Visa (NYSE:V). Those stocks have higher price to earnings and price/earnings to growth ratios, although Discover’s price to sales is about average. DFS is a buy.

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