The stock market is on an incredible run, with all three major U.S. stock indexes hovering around their all-time highs. As most growth stocks are trading at high valuations, investors are looking seriously now at cheaper stocks that possess quality fundamentals and are well positioned to rebound with an anticipated vaccine-driven economic recovery next year. A rotation away from the tech is due (for valuation reasons if for no other) and is expected to take place with the gradual recovery of the economy.
Investors typically use price-to-earnings (P/E) ratio or price-to-sales (P/S) ratio to evaluate whether a stock is over- or undervalued. If a stock is trading at a discount in terms of these ratios relative to its peers or sector, it is considered undervalued and could be due for solid gains in the future. Hence, value investors identify companies that have earnings and revenue growth prospects and the ability to generate cash but are currently trading at discounts relative to the broader market.
The recent outperformance of value stocks is evident in the iShares Russell 1000 Value ETF’s (IWD) 14.3% returns quarter-to-date versus the iShares Russell 1000 Growth ETF’s (IWF) 10.3% gain, and the SPDR S&P 500 Trust ETF’s (SPY) 10.2% gain. Analysts believe that this trend can continue with an economic recovery next year.
Caterpillar Inc. (CAT), Alexion Pharmaceuticals, Inc. (ALXN), Rent-A-Center Inc. (RCII) and Danaos Corporation (DAC) are currently trading at discounts to their peers and possess solid revenue and earnings growth potential. So, it could be wise to pick these undervalued stocks before the market recognizes their worth.
Caterpillar Inc. (CAT)
CAT manufactures primarily construction and mining equipment, diesel and gas engines, industrial gas turbines, and locomotives. The company principally operates through three segments — construction industries, resource industries, and energy and transportation. It also provides financing services through its financial products segment.
In terms of trailing-12-month P/E, CAT is currently trading at 29.77x, close to par with the sector average of 29.46x.
CAT was recently named to the 2020 Dow Jones Sustainability Indices (DJSI), including both the World and North America indices. This marks the 21st time that CAT has been included in the DJSI. In October, the company signed an agreement to acquire Weir Oil & Gas, the Oil & Gas division of the Weir Group PLC, a Scotland-based global engineering company. The deal aims to integrate Weir’s established pressure pumping and pressure control portfolio with CAT’s engines and transmissions.
CAT’s revenue and EPS have grown at a CAGR of 1.2% and 59.3%, respectively, over the past three years. In its last reported third quarter, the company declared a top-line of $9.9 billion, declining 23% year-over-year, due primarily to lower sales volume. However, operating profit increased 25.6% quarter-over-quarter to $985 million while its EPS increased 45.2% sequentially to $1.22.
CAT’s North America sales have been on a decline, but the company is successfully tapping into international markets. CAT is taking advantage of booming construction, mining, and energy needs in China and other Asian countries. Consequently, the company is also benefiting from the continued weakening of the U.S, dollar.
Analysts expect CAT’s revenue and EPS to grow 9.7% and 35.8%, respectively, next year. Now that mass distribution of coronavirus vaccines has started, the infrastructure space is expected to rebound, making CAT a favorable stock to bet on.
How does CAT stack up for the POWR Ratings?
A for Trade Grade
A for Buy & Hold Grade
A for Peer Grade
B for Industry Rank
A for Overall POWR Rating.
It is ranked #2 of 62 stocks in the Industrial – Machinery industry.
Alexion Pharmaceuticals, Inc. (ALXN)
ALXN is a global biopharmaceutical company that develops and commercializes life-transforming therapeutic products for rare diseases and devastating illnesses. The company focuses its research efforts on novel molecules, and targets its development efforts on hematology, nephrology, neurology, metabolic disorders, cardiology, ophthalmology, and acute care, serving patients in more than 50 countries worldwide.
ALXN’s trailing-12-month P/E ratio currently stands at 35.43, lower than the sector average of 37.85. In terms of trailing-12-month P/S, the stock is currently trading at 5.74x, 22.4% lower than the sector average of 7.40x.
AstraZeneca (AZN) has recently entered into an agreement to acquire ALXN. The deal aims to accelerate the company’s strategic and financial development and to add innovative complementary-technology platforms. In November, ALXN received approval from the European Commission (EC) for its new intravenous (IV) formulation, Ultomiris (ravulizumab), for the treatment of two ultra-rare diseases. The U.S. FDA had approved the same in late October.
Over the past three years, ALXN has grown its top-line and EPS at CAGR of 19% and 24.4%, respectively. In the third quarter, the company reported net revenue of $1.59 billion, rising 26% year-over-year. The growth was driven primarily by a5% increase in Soliris sales, which contributed $1.04 billion to the top-line. Ultomiris’ net product sales were $289.3 million, surging 222% year-over-year. Moreover, non-GAAP EPS came in at $3.24, up 16% from the prior-year period.
In the previous quarter, ALXN established Ultomiris as a new standard of care in PNH disease, ahead of a set goal, with more than 70% patient conversion from Soliris (eculizumab) in three of the largest markets – the U.S. Germany, and Japan. Moreover, the company has a robust product pipeline and has been developing multiple drugs catering to various ailments.
ALXN currently has a total of 29 candidates in its pipeline, of which 17 are in Phase three trials. Analysts, thus, expect ALXN’s current year revenue and EPS to rise 20.8% and 15%, respectively, year-over-year.
It is no surprise that ALXN is rated “Strong Buy” in our POWR Ratings system. It also has an “A” for Trade Grade, Buy & Hold Grade and Peer Grade, and a “B” in Industry Rank. It is ranked #1 out of 408-stock Biotech industry.
Rent-A-Center Inc. (RCII)
RCII is a leading omni-channel lease-to-own (LTO) provider that rents household durable goods to credit-constrained customers, such as consumer electronics, appliances, computers, furniture, and accessories. The company runs more than 1,950 Rent-A-Center stores, including 460 franchise stores, in the United States, Mexico, and Puerto Rico, and through its e-commerce platform. RCII operates through four segments: Rent-A-Center Business, Preferred Lease, Mexico, and Franchising.
In terms of forward P/E, RCII is currently trading at 10.50x, 53% less expensive than the sector average of 22.39x. Moreover, the stock is less expensive in terms of forward P/S (0.74x versus 1.32x).
RCII recently entered into an agreement to acquire Acima Holdings LLC, a leading virtual lease-to-own solutions provider. The deal positions RCII as a premier fintech platform in both the traditional and virtual LTO segments and provides access to Acima’s more than 15,000 active retail locations and e-commerce platforms. Moreover, RCII launched a new platform for its virtual business last month, to pilot digital platforms with seven national retailers.
RCII’s revenue has grown at a CAGR of 0.2%, over the past three years. In the third quarter, the company reported a top-line of $712 million, rising 9.6% year-over-year, due primarily to an increase in same-store sales revenue of 12.9% in the Rent-A-Center business segment and a 9.3% increase in total revenues in the Preferred Lease segment. The company generated $80.2 million in operating profit compared to $38.8 million in the prior year. EPS came in at $1.04, surging 121.3% year-over-year.
RCII’s preferred lease invoice volume accelerated significantly this year as the company onboarded new partners and achieved broader diversification across product categories. The company has also benefited from digital sales as demand for home-related goods has remained strong amid the pandemic. Consequently, analysts expect RCII’s current year revenue and EPS to grow 5.2% and 53.6%, respectively, year-over-year.
RCII is rated “Strong Buy” in our POWR Ratings system, consistent with its strong fundamentals. It holds an “A” for Trade Grade and Peer Grade, and a “B” in Buy & Hold Grade. It is ranked #4 of 37 stocks in the Specialty Retailers industry.
Danaos Corporation (DAC)
DAC is one of the world’s largest independent owners and operators of modern, large-size containerships. The company offers seaborne transportation services, such as chartering its vessels to liner companies in Greece and internationally. As of October 31, 2020, it had a fleet of 63 containerships aggregating 385,769 twenty-foot equivalent units (TEU) in capacity.
DAC’s forward P/E ratio currently stands at 1.67, significantly lower than the sector average of 27.83. In terms of trailing-12-month P/S, the stock is currently trading at 1.07x, 23.3% lower than the sector average of 1.40x.
In October, DAC announced a repurchase program of 4.33 million shares of its common stock for an aggregate purchase price of $31.1 million in privately negotiated transactions, including 2.5 million shares from the Royal Bank of Scotland and 1.8 million shares from Sphinx Investment Corp. The company also entered into agreements to acquire two 9,000 TEU container vessels in the same month, for a purchase price of $62 million. These vessels are expected to be delivered by the end of January 2021.
DAC’s revenue has grown at a CAGR of 0.2% over the past three years. In the most recent quarter, the company delivered operating revenues of $118.9 million, rising 6.4% year-over-year, because of contractual increases in charter rates of vessels under long-term charters. Fleet utilization for the quarter came in at 98.7%. However, DAC reported an EPS of $1.73, declining from the prior-year value of $2.20.
DAC currently has charter coverage of 87% for the next 12 months based on current operating revenues, and 64% in terms of contracted operating days. In its third-quarter letter to shareholders, DAC noted that, “Time charter rates have increased across all vessel sizes, and the time charter market is at or close to multi-year highs for all vessel sizes.” Analysts further expect DAC’s revenue and EPS to grow 12% and 31.7%, respectively, next year.
DAC’s POWR Ratings reflect a promising outlook. It has an overall rating of “Strong Buy” with an “A” for Trade Grade, Buy & Hold Grade and Peer Grade. Among the 46 stocks in the Shipping industry, it is ranked #2.
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CAT shares were trading at $178.81 per share on Monday afternoon, down $0.75 (-0.42%). Year-to-date, CAT has gained 24.73%, versus a 17.82% rise in the benchmark S&P 500 index during the same period.
About the Author: Sidharath Gupta
Sidharath’s passion for the markets and his love of words guided him to becoming a financial journalist. He began his career as an Equity Analyst, researching stocks and preparing in-depth research reports. Sidharath is currently pursuing the CFA program to deepen his knowledge of financial anlaysis and investment strategies. More...
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