It's noteworthy that the S&P 500 has risen 28% since Oct. 3,
2011, working out to be a nearly 60% annualized gain. What's even
more notable is that almost all of the upside (outside of
) has been in the riskiest end of the
, from heavily-shorted stocks that saw
, to stocks that already sported fairly high price-to-earnings
If you've been focusing on safer stocks with lower P/Es, then you
may feel like you missed out on the fun. These value stocks have
simply not been in focus. But it would be foolhardy to shift gears
now. After the very strong run for aggressive growth stocks, the
valuation gap when compared with value stocks has rarely been this
stark. That's not to say that value stocks are suddenly poised to
start appreciating much faster than growth stocks, but it does
that they should at least hold their own in terms of upside, while
significantly more downside protection.
I dug into more than 100 stocks in the S&P 500 that are trading
for less than 10 times projected 2013 profits. I found three stocks
that I think
an especially compelling combination of low-risk and high-reward.
1. Goodyear Tire & Rubber (NYSE:
Making tires is a straightforward business. When input prices (such
as rubber) increase, you simply raise the prices that your
customers pay. That's why this tire maker's
margins hover around 17% every year.
The key factor is
. When car and truck sales slump, demand for tires weakens and
gross profits start to get eroded by
costs. Yet it works the other way as well. Rising volume could lead
to outsized operating profits. That was surely the case for
Goodyear in 2011 as a 20% jump in sales to $22.8 billion pushed
operating profits from just $8 million in 2010 up to $618 million,
or $1.91 a share. Although sales growth is now moderating, that
should remain in effect, so a modest jump in sales in 2013 should
north of $2.50 per share.
Trading at around $11 means this stock trades for less than five
times projected 2013 profits. Analysts at Citigroup expect the
stock to move up to $21, because "
are meaningfully undervalued versus the company's present/future
earnings power and strong global franchise." They expect Goodyear
to garner hefty returns on its capital base: return on equity
exceeded 70% in 2011, should top 50% this year, and exceed 40% in
2014. That high rate should help boost
from $3.07 a share this year to $11 a share by 2014 (where the
stock price sits now), according to Citigroup.
2. Hewlett-Packard (NYSE:
There is no such thing as a quick
. Any company that has been losing its focus for several years
needs several quarters -- or more -- to get back on track. Yet
investors are already losing patience with former
Meg Whitman, who was brought in last summer to lead a turnaround at
Investors had been hoping that Whitman's first moves would quickly
lead to improving results. So when she recently discussed her
turnaround plans and the fact that they will modestly dampen
profits in the near-term, investors were pretty disappointed,
pushing shares down to below where they were when she first came
Yet her strategy looks quite sound, though. She intends to
streamline operations by standardizing products, as well as
optimize the supply chain and automate more production processes.
She also plans to invest the resources to regain market leadership
in some segments such as security and enterprisewide IT management.
She won't succeed on all fronts, but investors should be heartened
by a management team that has a proven track record and a plan to
play offense and not defense.
Even with modestly lowered 2012 and 2013
assumptions, this stock is still remarkably cheap, trading at less
than eight times fiscal (October) 2012 profits and just seven times
projected fiscal 2013 profits. This is still a business with a high
degree of recurring revenue, thanks to long-term contracts, so
those forward profit forecasts are unlikely to move much lower,
even if Whitman's plans are slow to impact results. Shares have
likely found a floor in the low $20s and could easily move into the
$30s as signs of the turnaround finally take shape.
3. Cliffs Natural Resources (NYSE:
It's "back to basics" for this mining firm, which went on a recent
spree that doubled sales in 2010 (to $4.7 billion) and boosted them
another 45% in 2011 (to $6.8 billion). The broadened sales base
(along with rising
prices) helped boost
from $37 million in 2009 to a whopping $1.3 billion in 2011.
But investors began to overlook this on fears of a rising
that now stands at $3.7 billion. Shares have fallen from $100 last
summer to a recent $70. This helps explain why management recently
met with analysts to announce a new strategy: Forget about more big
acquisitions. Instead, look for rising dividends. Shares
roughly 3.6% right now (after a nice recent boost), and could rise
much higher, as the
now stands at just 27%.
Moreover, management aims to use the prodigious free cash flow to
steadily pay down debt. The de-leveraging process should help boost
the sagging P/E ratio as investors begin to value the company's
earnings more,. Right now, the stock trades for less than eight
times projected 2012 profits (of $9.50 a share) and around six
times projected 2013 profits (of $11.50 a share). That's among the
lowest forward P/E ratios in the S&P 500.
Risks to Consider:
Each of these companies will need at least a slowly improving
to hit their targets. This appears to be happening, though the
economy slipped back last summer after showing similar signs of
growth in the early spring.
Action to Take -->
The low P/E ratios tell you these stocks are out of favor. Yet they
will really start to pop up on investors' radars if and when
sentiment shifts into a less
mode and value stocks move into focus. Any of these three stocks
are good buys in anticipation of that happening.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.