Last year was an excellent year for investors. The S&P 500, Nasdaq, and Dow Jones crushed performance, with the S&P 500 having its best yearly performance in the 21st century.
2022 Returns May Be More Volatile Than 2021
While growth investing has been a trend in recent years, especially as popularized by Cathie Wood, 2022 is the year to consider value stocks that stand to benefit in the rising interest rate environment. From a purely fundamental perspective, value investing defines the premise of buying low and selling high. Let's dive into the benefits of value investing in 2022.
Across All Market Caps, 2022 Has Been Favoring Value
Value stocks are identified as fundamentally solid shares of a company being undervalued with an opportunity for upside, based upon price-to-earnings ratio, yield, and other metrics. By and large, over the last decade growth trumped value. However, as seen by the chart below, during the last year, value has outperformed growth.
Rotational Change: 1YR Price Performance Value (IWD) vs Growth (IWF)
In 2022, however, the backdrop seems to favor value over growth investing, as investors are rotating into cyclical, energy, real estate, and financials. Historically, these sectors benefit from strong economic growth and can pass along the cost of rate increases. Primarily high priced, overvalued big tech growth stocks that are unprofitable are sold in this environment. Names like Roku (ROKU), Zoom (ZM), and Peloton (PTON) thrived during the height of the pandemic. Now, they are somewhat experiencing a bust in their stock prices because their valuation levels are high, and their future earnings are becoming uncertain. When you start discounting these cash flows and earnings to higher interest rates, they're even more overvalued, hence why we've seen a significant pullback in those types of securities since the Fed hinted at rate increases. On the other hand, many value stocks' earnings are less susceptible to rising interest rates when discounting their future earnings. We'll discuss this further as we look at three forces favoring value investing, followed by five value stocks to consider based upon our quant ratings.
Rising interest rates benefit value stocks because in instances like we are seeing now when 10-year yields rise, expensive stocks like tech and faster-growing companies tend to underperform those cheaper stocks in areas like cyclicals, financials, and energy. With growing consensus over the Fed winding down asset-purchases by March and that they will start raising the lending rate sooner than later, we are seeing investors bailing on a number of the growth-stock and COVID darlings of 2020, that tend to be unprofitable in a high-interest rate environment. Historically, value stocks like financials typically outperform growth stocks in a high-interest rate environment.
Inflation is positive for value stocks. Along the lines of the rising interest rates, inflation is less likely to have a negative impact on value stocks than growth, again, because value companies come at a discount relative to the unprofitable tech companies. Typically, value has more stable margins and can absorb rising costs better than unprofitable companies that tend to make up many growth stocks. It's all about absorbing rising costs like wage growth, raw materials, input costs because inflation will erode margins, and to begin, it's all about who has margins.
COVID reopening bodes well for value stocks because they're typically found in more cyclical sectors like leisure, hospital, financials, energy, and commodities, which were crushed during the pandemic. As the economy reopens, value stocks stand to benefit, particularly as the demand for the stay-at-home-COVID-darlings start to unravel, like Peloton. Many economists expect the economy to strengthen as COVID rates come down.
Many Stocks Outside of S&P 500 Are Very Cheap
Four of the five stocks we will discuss trade outside of the S&P 500. As evidenced by the Bloomberg chart above regarding 'Ridiculously Cheap' Stocks outside of the S&P 500, the stocks not in the S&P 500 are cheap relative to stocks in the S&P 500 on a current year P/E ratio perspective. Companies outside the S&P 500 or asset classes like mid-and small-cap companies are attractive from a valuation standpoint relative to the S&P 500. Relatively speaking, stocks in the S&P 500, especially the Mega-Tech stocks, are overvalued. To put this into perspective, we will look at five stocks currently trading below the average value of their sector, which we believe will provide a superior return in the future. Petrobras (NYSE:PBR), Safe Bulkers (NYSE:SB), Mr. Cooper (NASDAQ:COOP), and The Andersons, Inc. (NASDAQ:ANDE) are four companies outside of the S&P 500, trading in various sectors that we think will benefit your portfolio in the long term. In addition, we will look at Hewlett Packard (NYSE:HPQ), a well-known tech company that is at a steep discount to the IT sector and trades in the S&P 500.
Market Capitalization: $79.78B
Forward P/E ratio: 5.69x
Quant Rating: Strong Buy
Brazilian oil and gas company Petrobras engages in the drilling, refining, and processing of crude oil, natural gas, and other liquid hydrocarbon products. With the growth in global oil demand and reopening of economies, this stock stands to benefit. In addition to signing a production-sharing agreement in 2021, PBR exceeded its full-year guidance, producing 2.77M boe/day plus 1.95M boe/day in offshore pre-salt reserves, equivalent to 70% of the company's total output for the year.
With gross profit margins of 58.62% and EBITDA of 55.49%, the future appears bright for PBR. Many profitability metrics like ROE, Net Income Margin, and ROC scored A+ grades "The Company is getting stronger and healthier, and being able to substantially contribute to the Brazilian society…we had a very solid operational quarter that resulted, of course, in an important generation of cash from our operations of $10.5 billion and a free cash flow of $9 billion", said Rodrigo Araujo Alves, CFO during the Q3 Earnings Call.
At a price point under $13, PBR comes at an extreme discount. It possesses an A+ Valuation grade with Forward P/E of 5.71x, 56% below the sector, and an A for the PEG ratio of 0.24x. Compared to the broader market and in this environment, PBR is a bargain play with potential expansion into the renewable energy space. In addition to strong profitability and a solid valuation framework, 21Q3 EPS of $0.47 beat analysts' estimates by $0.14. This earned the company a SA grade of A- for Earning Revisions and further supports the overall Growth grade of A and its A+ Profitability Grade. "Petrobras is well placed to take advantage of the sector's return to profitability, given it relies on tankers to distribute its fuel, it is an industry leader in terms of profitability, does not have any significant geopolitical risk," writes SA Author Mike Thomas in Petrobras is Well-Placed To Take Advantage of Growth In Global Oil Demand.
Market Capitalization: $435.47M
Forward P/E ratio: 1.28x
Quant Rating: Strong Buy
"There are shortages across a number of industries, perhaps nowhere more acutely than in front-line workers such as port workers and truck drivers," said Aaron Terrazas, Convoy Director of Economic Research. Taking advantage of the favorable market environment and the high demand for cargo shipping, Safe Bulkers stock is poised to grow. With an A+ valuation grade, stocks with an A grade in the Value category are solid stocks in the market right now, and this one fits the bill and is attractive on valuation with a forward P/E at only 2.73x; at a +86% discount to the sector.
With the demand for goods increasing, the company seems to be on solid footing for another few years of exceptional growth. The stock gets an A on Forward EPS growth at 186% compared to only 12% for the sector. Year-over-year, they rang in EBIT growth of +1,472%, earning an A+ grade against the sector. As Seeking Alpha Contributor Oakoff Investments mentions here, Safe Bulkers are well-positioned for the following reasons:
Rising commodities prices have a positive effect on dry bulk carriers, because they do not transport fuel oil, but burn it.
China is giving up Australia's steel and iron ore, moving to more remote regions, for example, Brazil.
The order book remains quite low compared to the number of vessels demanded.
In addition to growth, Safe Bulkers is at the top of the class for some of its profitability metrics. They have straight A+ grades for Gross Profit Margin (TTM) at +71%, EBIT margin at 47%, EBITDA margin at 65%, and Net Income Margin at 40%. SB's potential for growth given the industry and increased demand for shipped products should prove lucrative for this stock, particularly as rising inflation costs begin to be passed off to the consumers.
Value investors should be watching SB right now, as it's sporting an A+ valuation grade according to our quant ratings and holds a P/E ratio of 2.60, versus the sector median, which is at 19.78, a difference of -.86.84%. At its current price point trading below $5/share, Safe Bulkers comes at an extreme discount and is a strong buy to add to a portfolio, particularly as you couple it with the strength of its earnings outlook.
Market Capitalization: $40.74B
Dividend Yield: 2.73%
Forward P/E ratio: 8.77x
Quant Rating: Strong Buy
HP, a multinational information technology company, continues to provide world-class computing and devices, focusing on cloud-based solutions to help transform the way people connect and do business. The stock is also one of the few top dividend payers in the IT sector and recently declared a $0.25 dividend. With a dividend yield of 2.73%, attractive overall dividend grades, and the company's track record for paying consistent dividends over a long period, it is noteworthy and demonstrates its allegiance to shareholders.
Reliable dividend payouts are appealing and a top priority for many income investors, which is why value stocks like HPQ are a great option in preserving capital to keep investors on track to meet their income goals. Seeking Alpha's Quant team introduced Dividend Grades in 2020 to showcase How Our Dividend Grades Averted 99% of Dividend Cuts since 2010. Many dividend stocks expose vulnerability, and our goal is to provide you with those stocks that we expect will prove beneficial in the future.
"Looking ahead to FY '22, we expect to continue aggressively buying back shares at elevated levels of at least $4 billion. Our share repurchase program, combined with our recently increased annual dividend of $1 per share, has us on track to exceed our $16 billion return of capital target set in our value creation plan," Marie Myers, CFO - HP, Q4 Earning Call.
In addition to appealing dividend grades, HP has an excellent reputation and an ultra-low valuation relative to others in the tech sector, with forward P/E nearly 63% below the sector at 8.77x and PEG ratio almost 80% below sector value, making the A valuation grade very attractive.
As we consider HP's overall Factor Grades and growth potential, it's clear that HPQ has taken advantage of the current environment, benefitting as a solid contender and improved supply-chain solutions during the pandemic. Following HP's Q4 earnings results, HP stock surged 8% to an intraday high of $38.19 after announcing that results beat expectations and outlined growing strength in sales. After the announcement of Q4 earnings results on November 23, 2021, shares of HP reached a 52-week high. EPS of $0.94 beats by $0.06; revenue of $16.68B (9.29% YoY) beats by $1.25B. The HPQ Revisions Grade of A- is warranted, as there have been 17 FY1 UP revisions in the last 90 days and zero down.
Market Capitalization: $3.32B
Forward P/E ratio: 5.07
Quant Rating: Strong Buy
Mr. Cooper Group Inc. is a financial services company that provides thrifts, mortgage financing, and origination for single-family residences. The current U.S. mortgage market is quite healthy, and COOP is the mortgage giant that you've never heard of with a market capitalization of over $3B and a Quant ranking of 1 out of 53 in its industry. COOP has seen a one-year price increase of +45% and nearly 150% over the last 5 years.
Despite the 5.9% decline of the S&P 500 YTD, COOP is up 3.3%. Real estate continues to bustle in the United States, and thus the mortgage sector will likely continue its expansion, as people take advantage of the current low-interest-rate environment before rates increase. With stellar A+ underlying valuation metrics and an overall A valuation grade, COOP's undervaluation is reflected in its 5.07x Forward P/E ratio, nearly 57% below the sector. As fellow SA Author Harrison Schwartz writes, "In my opinion, right now is the time to be a bit more greedy when it comes to the mortgage market…While Mr. Cooper Group is not a traditional bank mortgage lender, I believe their non-bank status gives them far more versatility and growth potential as it allows them to reach strong but less reached areas of the market like self-employed people and even those who may not normally qualify."
In the current environment where small business is growing and people are reinventing themselves, Schwartz may be on to something that COOP can capitalize on. Last year was great for COOP from a profitability, growth, and momentum perspective. They continue to be on an upward trend with its latest quarter's earnings beating top-and bottom line; EPS of $2.42 beats by $0.61; revenue of $860M beats by $211.68M. There have been 5 FY1 upward revisions in the 90 days, and we anticipate that despite the potential rise in interest rates, home prices and demand will continue to increase, as will the household net worth, which rose by $2.4T in Q3. COOP is a stock to watch.
Market Capitalization: $1.23B
Dividend Yield: 1.95%
Forward P/E ratio: 14.11
Quant Rating: Strong Buy
Agricultural company Andersons, Inc. operates in four segments including trade, ethanol, manufacture and distribution of plant nutrients, and rail. A food distributor and consumer staple company, we consider ANDE a strong buy, following three consecutive robust quarters. Its latest Q3 earnings beat all-time record earnings, resulting in ANDE shares trading up nearly 7% following the announcement.
With record trade results driven by increased margins and merchandising income, ANDE reported a YoY improvement of $20.7M for 21Q3. Additionally, Andersons raises its dividend nearly 3% to $0.18/share quarterly which should bode well with investors, emphasizing the strength of their profits. During the Q3 earnings report, President and CEO Pat Bowe said, "We benefited from outstanding execution by our team, strong demand, and relatively low grain stocks - including growth in new markets, such as renewable diesel and supply chain extensions." On December 16, 2021, Andersons declared a $0.18/share quarterly dividend, a 2.9% increase from the prior dividend of $0.17.
Agriculture is in a great position with growth that's expected to last, according to SA Author Leo Nelissen who writes, "The company's Trade segment expects to encounter growth opportunities due to a large grain harvest and high agriculture demand. Ethanol expects the same due to higher driving demand and high demand in co-products. Plant Nutrient sees tight supply and strong demand going into the fall application season…[2021 was] hard to get cyclical stocks to outperform. Once that changes, investors will rush back to buy value in agriculture and energy." And with its A+ Momentum Grade, ANDE is in a great position given its diverse segments to continue to outperform.
The Andersons, Inc. stock increased 1.16% this last Friday and has seen a one-year price increase of more than 50%. When compared to its sector median, ANDE's price/sales ratio is 92.83% lower, clearly indicating this stock is undervalued relative to its competitors. At a current price below $40/share, ANDE is a consumer staple ripe for the picking.
Value stocks should outperform in 2022, given the inflation concerns, and investors should look to embrace stocks that will benefit from rising prices. We're not suggesting to steer clear of growth stocks altogether, instead select companies with more significant margins and sustainable earnings whose valuations aren't stretched, and they have a solid earnings track record.
Value stocks typically come at a great price point, and this year, it's projected they should do relatively well, given the geopolitical factors. While growth stocks go through high growth periods and volatility, each company is evolving, and our goal is to identify low-cost stocks with solid fundamentals using our Quant System.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.