By: Thomas Pangia
The technique of value investing focuses on buying stocks that have fallen in price beyond that which might be considered a fair price. When the price returns to a mean, the intrepid investor who purchased at the lows has reaped a gain. There are risks involved, as investors could be buying into dying companies, but a bit of research can help avoid many of the potential pitfalls. Overall, profitable companies are rarely a poor investment, yet our inefficient market continues to misprice several of them. If a company trades below its average 5 year price/earnings history, it could be a candidate for a value investor’s portfolio. Companies trading at these depressed prices that have dividends can compound gains while they revert to a mean, or dividend reinvestment can provide additional buys if the share price lags for a period before rebounding. A good example of a successful value candidate has been International Business Machines (IBM). For years IBM has been giving its shareholders the blues while the share price declined.
Although the share price declined significantly during part of that time, earnings did not decline to the same extent. The company’s P/E during 2014-early 2016 was at a discount to its own average P/E of roughly 13.
Since reaching its P/E lows, IBM has recovered nicely during 2016, beating the S&P 500’s returns this year.
For those who might not have been able to reap gains from IBM this year, there are still many other companies that are trading at discount prices, and with some patience could see nice rebounds during 2017.
This next pick has sort of a classic value profile. Beaten down because of revenue declines, Gilead Sciences (GILD) is trading at a sub-10 P/E. In fact, GILD shares trade hands at 6.7 times earnings. If value investing is bargain shopping, buying GILD is treated like dumpster diving. Or it would be if GILD didn’t earn roughly $13 billion over the past 12 months. That said, investors haven’t liked the company’s performance over the same time with shares falling nearly 30% to the current level of around $75/share. Although GILD’s share price is down, it looks like a bargain at these levels.
The reason why GILD looks like a bargain is a combination of the discount from its highs, combined with strong earnings over this time. The company’s P/E is far lower now than it has been over the past 5 years.
GILD’s price declines have made it look more like a bargain as this year has gone by. These declines make a good entry point, and GILD looks like a nice buy at levels under $73/share at a price of just under 7 times earnings.
In addition to robust earnings, GILD does pay a nominal dividend of roughly 2.5%. This dividend isn’t large now, but the current payout level is less than 20% of the company’s previous 12 month’s earnings and could easily rise from here.
Another company trading at what seems to be a bargain basement price is GameStop (GME). Although the company has had some good performance during the last five years, a steady price retreat puts it close to where it was years ago, only 6% net appreciation.
Although GME’s price has been falling over the past several years, its earnings have not fallen as dramatically, and its P/E is close to five year lows (for the periods which GME had positive earnings).
GME has been maintaining a robust share repurchase program in addition to a generous dividend of 5.6%. GME’s price has shown some recovery recently in 2016, although the company has lagged the broader market.
Because the company’s dividend will only be about 40% of the last 12 months’ earnings, it appears that the dividend is sustainable while the share price recovers. GME looks like another viable value target during the rest of 2016 and into 2017.
Not all value stocks belong on the ground, some fly high in the sky. Delta Airlines (DAL) hasn’t been a stock suffering from price crashes. However the company has been producing prodigious profits that have driven its P/E down even as the price growth has accelerated.
DAL has had some volatility in 2016, but its earnings have remained strong.
DAL has had a good recovery from 2016 lows, although its low P/E indicates that the company could continue to climb into the new year. Valuing the company at a conservative 10 times trailing earnings would place the share price at around $61/share, up over 20% from the current price.
While IBM has been a successful value pick that could have given a large portion of its potential return, GILD, GME, and DAL seem to be undervalued and could bring good returns to investors during 2017. In general, companies that are trading below 5 year average P/E, or at discounted prices to the company’s 52 week range, could be good targets for value investors. Additionally companies that are both undervalued and dividend payers can compound returns while investors wait for a return to a fair value.
Disclosure: Author holds long position(s) in: IBM, DAL, GILD.
Additional Note: The author is neither a certified investment advisor nor a certified tax professional, and does not claim to be either. The data presented here is for informational purposes only and is not meant to serve as a buy or sell recommendation. Investors and potential investors should do their own research and make their own decisions. In the event that an investor or potential investor does not feel qualified to make such a buy or sell decision on their own, they should consult a certified advisor that they trust or feel comfortable with. Investing may involve losses, including potential loss of principal.
The author relies on external links for some information that may have appeared on this perspective. These external links, although believed to be accurate, have not been verified independently. Therefore the author is unable to guarantee their accuracy.