Whenever there is a rise in stock values as we have experienced over the past year or so, it seems to be human nature to automatically assume that valuations have become too high. However, although it is possible that this is true, it is not necessarily so. A lot has to do with where valuations were before the run-up occurred. For example, if valuations were extremely low, then even after a rise, they can continue to be low or perhaps only have risen to becoming fairly valued.
Seth Klarman On Margin Of Safety Investing
This is part nine of a ten-part series on some of the most important and educational literature for investors with a focus on value. Across this ten-part series, I’m taking a look at ten academic studies and research papers from some of the world’s most prominent value investors and fund managers. All of the material Read More
On the other hand, if valuations were already extended prior to the run, then current valuations may have become dangerously high. The important point here is that valuation is a very relative concept. Moreover, we would argue that valuation needs to be evaluated on a company-by-company basis. This is simply an extension to the concept that it is a market of stocks, rather than a stock market, that we introduced in our last article found here.
A Good Run Broadly Based
The following graph, courtesy of the leading financial blog, Seeking Alpha, clearly illustrates just how good and how broad recent stock price rises have been. We suggest the reader focus on the one year, and year-to-date numbers first and foremost. However, the last three months are impressive as well.
This next graphic, once again courtesy of Seeking Alpha, breaks the recent rise in stock prices more specifically by sector. Once again, we discover that even amongst a lot of reporting of doom and gloom, and even considering several dire forecasts that stock markets were set to collapse, recent performance has been rather strong. Therefore, we feel safe in stating that we have actually been in a bull market over the last year or so.
On the other hand, and to stay true to our thesis that it is a market of stocks and not a stock market, we offer the following qualifier. It has been our experience that in every market, whether it is a bull market or a bear market, there will always be individual stocks that are overvalued, undervalued or fairly valued. Therefore, it’s up to the individual investor to put in the effort and to do the necessary work to find them.
Common sense would tell us that there will be more overvalued individual stocks in a bull market, and conversely, there will be more undervalued stocks in the bear market. Nevertheless, we contend that the discerning investor willing to do his or her homework can find good value in any market environment. This recent bull market is no different, as we will demonstrate later in this article. Note that this perspective is in addition to what we offered in our introductory remarks.
Mining the S&P 500 for Value
Even though the S&P 500 is comprised of 500 individual stocks, thanks to the FAST Graphs™ research tool, it is a rather easy matter to review each constituent of this large universe one company at a time. In fact, that is precisely what I did. Since the S&P 500 is preloaded with my premium subscription, I am able to easily review the entire index as a whole, and I have several options on ways to organize the list, for example, by dividend yield, alphabetically, by total return, etc.
Accordingly, I started with reviewing the index in alphabetical order, then I ran the group by estimated total return to provide a perspective of valuation, and then by dividend yield order. This aggregate portfolio review allowed me to ascertain a good feel for the relative valuation of the index as a whole. But even better than that, since it was based on a review of each of the component parts, my insights were greatly enhanced because I went through each individual graph on all 500 constituents one at a time.
Again, thanks to the efficiency of the FAST Graphs™ research tool, this was a relatively easy task that I was able to accomplish in approximately one hour. To me, the result was nothing short of amazing. Once I completed this exercise, my perspective and feeling of the relative valuation of the S&P 500 as an index, but based on reviewing each individual company, resulted in what I felt was a much deeper understanding than any mere review of statistics could ever have provided me.
Moreover, what I discovered supports my general thesis previously stated above “that in every market, whether it is a bull market or a bear market, there will always be individual stocks that are overvalued, undervalued or fairly valued.” By carefully dissecting the S&P 500 one company at a time, I was able to find all of the above. The remainder of this article will provide sample examples of undervalued, overvalued and fairly valued companies on several different categories of stocks that are in the S&P 500.
It is important to state in advance that what follows is not intended to be a comprehensive list. Instead, we are simply offering a few examples to illustrate the validity of the concept that it is a market of stocks. However, an additional benefit to this exercise is the vivid illustration that companies come in all different sizes, shapes and flavors. Furthermore, although we will focus primarily on examples of various categories of companies that appear to be in value, we will include a few overvalued examples for perspective at the end.
(Note: For the reader’s information and convenience, follow this link to a FAST Graphs™ portfolio review of the complete list of the S&P 500 constituents and key fundamental metrics presented in order of highest total estimated return to lowest based on current valuation and estimates of future growth. The results may astound you.)
Fairly Valued S&P 500 Dividend Growth Stocks
Three examples of fairly valued and or undervalued S&P 500 dividend growth stocks would include, but is not limited to Hasbro, Inc. (NASDAQ:HAS), AFLAC Incorporated (NYSE:AFL) and Microsoft Corporation (NASDAQ:MSFT). Since a picture is worth 1000 words we offer the following historical and forecasting graphs on Hasbro Inc.
Hasbro Inc – Directly from their website:
“Hasbro is a branded play company providing children and families around the world with a wide-range of immersive entertainment offerings based on the Company’s world class brand portfolio. From toys and games, to television programming, motion pictures, digital gaming and a comprehensive licensing program, Hasbro strives to delight its global customers with well-known and beloved brands such as TRANSFORMERS, LITTLEST PET SHOP, NERF, PLAYSKOOL, MY LITTLE PONY, G.I. JOE, MAGIC: THE GATHERING and MONOPOLY. The Company’s Hasbro Studios develops and produces television programming for markets around the world. The Hub TV Network is part of a multi-platform joint venture between Hasbro and Discovery Communications (NASDAQ: DISCA, DISCB, DISCK), in the U.S. Through the Company’s deep commitment to corporate social responsibility, including philanthropy, Hasbro is helping to build a safe and sustainable world for future generations and to positively impact the lives of millions of children and families every year. It has been recognized for its efforts by being named one of the “World’s Most Ethical Companies” and is ranked as one of Corporate Responsibility Magazine’s “100 Best Corporate Citizens.”
Fairly Valued S&P 500 High-Yield Stocks
Three examples of fairly valued high-yield stocks would R.R. Donnelley & Sons Company (NASDAQ:RRD) Cliffs Natural Resources Inc (NYSE:CLF) and Altria Group, Inc. (NYSE:MO). Once again, since a picture is worth 1000 words we offer a sample historical earnings and price correlated graph, and a forecasting graph on R&R Donnelley & Sons. As a caveat, we are not necessarily recommending this stock (or any others that we feature later on), but simply providing an example of a high-yield opportunity that appears undervalued. The reader is encouraged to conduct their own due diligence.
RR Donnelley & Sons – Directly from their website:
“R.R. Donnelley & Sons Company (NASDAQ:RRD) is a global provider of integrated communications. The company works collaboratively with more than 60,000 customers worldwide to develop custom communications solutions that reduce costs, drive top-line growth, enhance ROI and ensure compliance. Drawing on a range of proprietary and commercially available digital and conventional technologies deployed across four continents, the company employs a suite of leading Internet based capabilities and other resources to provide premedia, printing, logistics and business process outsourcing services to clients in virtually every private and public sector.”
Fairly Valued S&P 500 High Growth Stocks
High growth stocks are categorized by a significantly above-average historical earnings growth rate, coupled with a forecast for significantly above-average growth going forward. However, future growth does not necessarily need to equal past growth, and most importantly, current valuation should be given a higher weighting based on forecast growth than on historical growth.
Three examples of high-growth companies that appear to be undervalued are DirecTV (DTV), Fossil, Inc. (NASDAQ:FOSL) and how could we exclude Apple (NASDAQ:AAPL). Again, since a picture is worth 1000 words we provide the following earnings and price correlated historical graph and a forecast graph on DirecTV.
DIRECTV – Directly from their website:
“DIRECTV (NASDAQ:DTV) is one of the world’s leading providers of digital television entertainment services delivering a premium video experience through state-of-the-art technology, unmatched programming and industry leading customer service to 33 million customers in the U.S. and Latin America. In the U.S., DIRECTV offers its 19.9 million customers access to more than 170 HD channels and Dolby-Digital® 5.1 theater-quality sound, access to exclusive sports programming such as NFL SUNDAY TICKET™, Emmy- award winning technology and higher customer satisfaction than the leading cable companies for 11 years running. DIRECTV Latin America, through its subsidiaries and affiliated companies in Brazil, Mexico, Argentina, Venezuela, Colombia, and other Latin American countries, leads the pay-TV category in technology, programming and service, delivering an unrivaled digital television experience to 12 million customers. DIRECTV sports and entertainment properties include three Regional Sports Networks (Northwest, Rocky Mountain and Pittsburgh) as well as a 60 percent interest in Game Show Network.”
Fairly Valued S&P 500 Cyclical Stocks
We define cyclical stocks as companies that may achieve an above-average long-term record of earnings growth; however, the achievement of this growth often occurs in fits and starts. Three examples of fairly valued cyclical stocks would include Caterpillar Inc. (NYSE:CAT), Cummins Inc. (NYSE:CMI) and Deere & Company (NYSE:DE). Again, since a picture is worth 1000 words we include a historical earnings and price correlated graph and a forecasting graph on Deere & Co.
Deere & Co – Directly from their website:
“Deere & Company (NYSE:DE) is a world leader in providing advanced products and services and is committed to the success of customers whose work is linked to the land – those who cultivate, harvest, transform, enrich and build upon the land to meet the world’s dramatically increasing need for food, fuel, shelter and infrastructure. Since 1837, John Deere has delivered innovative products of superior quality built on a tradition of integrity.”
Fairly Valued S&P 500 Turnaround Stocks
In many ways, turnaround stocks could also be considered cyclical. However, in the context of this article we’re referring to stocks that although they have checkered pasts, are forecast to produce accelerated earnings growth going forward. Three examples of turnaround stocks include The Goodyear Tire & Rubber Company (NYSE:GT), Southwest Airlines Co. (NYSE:LUV) and Ensco plc (NYSE:ESV). We include the historical earnings and price correlated graph and a forecasting graph on Ensco PLC.
Ensco PLC – Directly from their website:
“Ensco plc (NYSE:ESV) brings energy to the world as a global provider of offshore drilling services to the petroleum industry. For 25 years, the company has focused on operating safely and exceeding customer expectations. Ensco is ranked #1 for total customer satisfaction with top honors in 13 of 17 categories in the most recent annual survey by EnergyPoint Research. Operating the world’s newest ultra-deepwater fleet and one of the largest fleets of active premium jackups, Ensco has a major presence in the most strategic offshore basins across six continents. Ensco plc is an English limited company (England No. 7023598) with its registered office and corporate headquarters located at 6 Chesterfield Gardens, London W1J 5BQ.”
A Sampling of Overvalued S&P 500 Stocks
As stated in our introductory remarks, there will also exist overvalued stocks that can be found in any market whether it be bear or bull. The following three examples are comprised of S&P 500 constituents that are currently being priced at what we consider to be inexplicably high valuations.
Whole Foods Market (NASDAQ:WFM) – Directly from their website:
“Founded in 1980 in Austin, Texas, Whole Foods Market , Inc. (NASDAQ:WFM) is the leading natural and organic food retailer. As America’s first national certified organic grocer, Whole Foods Market was named “America’s Healthiest Grocery Store” by Health magazine. The company’s motto, “Whole Foods, Whole People, Whole Planet”™ captures its mission to ensure customer satisfaction and health, Team Member excellence and happiness, enhanced shareholder value, community support and environmental improvement. Thanks to the company’s more than 67,000 Team Members, Whole Foods Market has been ranked as one of the “100 Best Companies to Work For” in America by FORTUNE magazine for 15 consecutive years. In fiscal year 2011, the company had sales of more than $10 billion and currently has 329 stores in the United States, Canada and the United Kingdom.”
Range Resources Corp (NYSE:RRC) – Directly from their website:
“Range Resources Corporation (NYSE:RRC) is a leading independent oil and natural gas producer with operations focused in Appalachia and the southwest region of the United States. The Company pursues an organic growth strategy targeting high return, low-cost projects within its large inventory of low risk, development drilling opportunities. The Company is headquartered in Fort Worth, Texas.”
Lennar Corp (NYSE:LEN) – Directly from their website:
Summary and Conclusions
There were several objectives and goals that we hoped to accomplish by writing this article. First and foremost we offer it as additional evidence validating our notion of a market of stocks rather than a stock market. We hope that we have provided enough examples that illustrate how different individual companies can be in relation to each other. Therefore, we believe this provides additional evidence of why we eschew talking about markets in general in favor of focusing on individual stocks based on their own specific merits.
A second, but perhaps equally or even more important objective, is to illustrate how vague and generalized notions about valuation can be very misleading. As a case in point, we think it’s a sad commentary that so many investors today are avoiding equities at precisely a time when valuations are providing extraordinary opportunities. These opportunities can be found in both long-term growth of principal as well as attractive and growing dividend yields.
The following report from Financial Advisor Magazine on September 17, 2012 corroborates our concerns:
|“September 17, 2012|
|Despite Low Interest Rates, Bond Funds Gain Over $1.1 Trillion Since ’08|
|Long-term mutual fund inflows were just $20.7 billion in August, with open-end U.S.-stock funds facing yet another month of outflows, losing $14.3 billion, according to Morningstar Inc.Additional highlights from Morningstar’s report on mutual fund flows:|
• Investors poured $26.4 billion into taxable-bond funds ($30.0 billion if ETF flows are included) and another $5.6 billion into municipal-bond funds in August. Altogether, inflows into these funds surpassed $1.1 trillion since the end of 2008 when the Fed cut rates to zero.
• U.S.-stock mutual funds and ETFs bled $22.4 billion in August, making it the worst month in two years and the fifth worst during the past five years for the asset class.
• International-stock funds had $2.8 billion in outflows, the group’s worst showing since December 2011.
• Investors seem to have lost their taste for world-bond and inflation-protected bond funds. These two former market darlings absorbed just over $600 million in combined August inflows.
Old Westbury burst on the scene in August with inflows of $1.4 billion, while the American Funds logged another $5.5 billion in outflows, Morningstar said.”
This pessimistic investor behavior is especially tragic when you consider that the S&P 500 has averaged producing returns in excess of 15% since the beginning of 2009 (the last approximately four years). Investors who were traumatized by what happened in 2008 were willing to accept virtually zero returns instead because they were afraid, at precisely the time when US equities had gone on sale. Instead they should be following Warren Buffett’s sage advice: “Be greedy when others are fearful and fearful when others are greedy.”
After conducting the research cited above, we have concluded that there remains a lot of opportunity for solid returns at reasonable levels of risk in today’s market environment. However, the trick is in separating the wheat from the chaff. Not all companies are good investments at this time, but we do believe that there are more good ones out there than many suspect.
This, part 1, of what will be a series of articles, postulated the foundational notion that there is a lot of value in this market. Future installments will cover specific examples of companies that we believe represent good value at reasonable risk levels based on valuation. We intend to provide examples covering the five broad categories that we presented in this article. To reiterate, the companies we will cite will not be all-inclusive, but instead will represent examples of companies offering growth, yield, or a combination of both, again, at reasonable levels of risk.
This addendum covers each of the 500 constituents of the S&P 500 index. It is meant to be reviewed and utilized in conjunction with a series of articles we are writing under the general title: There is a Lot of Value in this Market. Here is a link to our first article. Utilizing the portfolio function of the FAST Graphs™ fundamentals analyzer software tool, we have organized the S&P 500 constituents in order of highest estimated total return.
Furthermore, we are providing the following metrics based on fundamentals that provide a quick indication of valuation. Most notably, we show the current PE ratio followed by the normal 15-year PE ratio which is the PE ratio that the market has historically, on average, applied to each of the stocks listed. Although this is statistically correct, we caution the reviewer that only by reviewing each individual company can an accurate assessment of valuation be made.
Additionally, we caution that the estimated EPS growth rates are based on the consensus of leading analysts reporting to Standard & Poor’s Corp. Capital IQ. Therefore, estimated calculations of future return are based on assigning a reasonable or sound valuation to future earnings growth based on those estimates. This may or may not be what actually occurs, however, it at least offers a reasoned point of embarkation.
Ascertaining the Relative Valuation of the S&P 500
One way to get a good feel for how many of the 500 S&P 500 constituents are overvalued versus fairly valued is to review the five-year estimated annual total return column (the last column on the table). We suggest that any stock that offers an estimated return in excess of the 6% to 9% long-term average of the S&P 500 could be considered fairly valued and/or undervalued at estimated rates above that average.
However, we also caution that this analysis is based on statistical representations that may or may not unfold as presented. We believe this highlights one of the major dangers and pitfalls of relying on statistics alone. On the other hand, since this information is offered on a company-by-company basis, we believe it is superior to drawing conclusions based on aggregate averages.