5 Best Value Stocks to Play for the Long-Term Investor
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Why you need to learn value investing and my favorite value stocks for long term investing
Hey Bow Tie Nation, Joseph Hogue here and it has been a wild year for stocks with our Bow Tie Nation portfolio up 25% and beating the market by more than 11% so far, but not all stocks have zoomed higher. In fact, there are more than 400 stocks within 10% of their 52-week low and dozens hitting their lows every day.
But sometimes betting against the market and picking up these value stocks is the best hand you can play.
In this video, I’ll show you how to find those cheap stocks to buy for a contrarian strategy. We’ll start with an easy screener for value stocks and then how to pick the best. I’ll then reveal the five value stocks I’m watching right now.
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Why I Love Value Investing
Now all you out there in the Nation know, I’m a big fan of value investing. Maybe it’s a part of being a cheap-ass to want the best deals but value stocks just make intuitive sense, right? The golden rule of investing is buy-low and sell-high so what better way to do that than buying stocks that are relatively cheap on those value metrics.
But that value investing strategy hasn’t worked over the several years, not against those popular growth stocks. The chart here shows the performance of both themes, value stocks in blue and growth stocks in red, and you can see for much of that time, value investing was the way to go, beating growth stocks easily.
But not over the last five years. Growth stocks have surged higher and while value investors have made money, it’s been a major case of FOMO!
But there’s reason to believe, that dynamic might finally be shifting back around. That value stocks could once again outperform over the next few years and I want you to be ready for that.
I want to get to those five value stocks so we’re going to start in on that list and I’ll show you why that value investing strategy could outperform later.
To start my list, I used the stock screener on Stockcard and first filtered only for companies over a $2 billion market cap. That market cap is the size of the company, really the value of all the shares in the market, and here I want to make sure I’m sticking with large companies with the financial power to survive whatever is making them value stocks right now.
Next, I’ll toggle on this undervalued stock box and this includes quite a few of the criteria we look for in value stocks.
This is based largely on three things, the price-to-earnings and price-to-sales ratio as well as analyst price targets for the stock. Stockcard compares the current PE and price-to-sales ratio with the average over the last three-to-five years. If the current valuation is at least 10% below that average, that’s two of the three criteria.
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Next, if the current share price is at least 10% below the average analyst price target, then it triggers that good, undervalued stock category.
Screening for value stocks, I also like to filter for good cash availability…so a strong balance sheet. Again, this is a safety precaution. I want to make sure, whatever the company is going through that is weighing on the stock price now, I want to make sure it has plenty of cash to survive this period for that future growth.
Now you see, that still leaves us with almost 600 stocks to research so I’ll go back into the screener and filter for a few more criteria.
Let’s filter for companies with positive sales growth, so companies where revenue isn’t the problem. I’ll also screen for value stocks paying a dividend yield of 3% or higher…because we might as well get paid while we wait for the stock price to come back up.
And just adding those two criteria has narrowed our list to 78 stocks to research for our five to buy.
I’ll leave a link to Stockcard in the video description. Click through and then go to Portfolios in the top menu, you’ll find the Bow Tie Nation portfolio in this Stock Picks section. It’s free to follow and you’ll get email notifications whenever I buy or sell from the portfolio.
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5 Best Value Stocks for Long-Term Investors
Our first value stock is Vertex Pharmaceuticals, ticker VRTX, a leading biotech in drugs for cystic fibrosis.
And the first thing you need to do when looking at biotech and pharmaceutical stocks is go straight to the pipeline. This is the stage of testing for indications the company is developing and what’s important here is does the company have enough drugs at different stages of trials to grow revenue.
You see the problem you’ll find in most biotech companies is, they get a blockbuster drug that boosts sales…the shares take off but there’s nothing in the pipeline. Once the sales start declining from that one drug, the stock just dies because…what’s next?
And you see Vertex has strong candidates in cystic fibrosis, four of which are already approved and earnings revenue but it does have a phase three gap so that’s probably what the market is looking at on the shares. The idea that it might be a while before those phase two drugs get to approval and start adding to sales. It’s still a fairly strong pipeline though and expanding beyond the core-CF theme.
Shares of Vertex trade for just 16-times earnings and seven-times on a price-to-sales basis. That sales multiple is 47% below the five-year average of 14-times sales, so definitely in the value stock territory.
The company has a strong balance sheet to see it through those pipeline gaps with $6.7 billion in cash and just $893 million in debt. This kind of cash-heavy, strong balance sheet is typical for biotech companies that have high research spending and long stretches for drug testing, so they need that cash on hand.
The average analyst price target of $258 per share is 43% higher from here and even on a miss in sales, I think you get to low-200s on the shares.
We’ve still got four more value stocks to highlight but I want to quickly share why you need to consider adding more value stocks, why after five years, value could once again start outperforming growth stocks.
Why You Need to Add More Value Stocks Now
First is going to be one of the biggest themes over the next few years, inflation and higher interest rates.
With the higher inflation that’s already building along with the economic recovery, most economists expect interest rates to keep rising. The interest rate on the 10-year
‘ Treasury, the benchmark against which other rates are measured, has almost doubled over the last year from 0.85% to over 1.6% recently. And we all remember what happened when rates jumped during the first months of the year, tech stocks in the Nasdaq 100 dropped 4% and growth stocks in the ARK Innovation Fund plunged more than 11%.
Most analysts believe interest rates will top 2% by early next year and I think could even touch 2.5% sometime over the next 12 months. That could be catastrophic for growth stocks and bring investors rushing back into value once again.
This next reason is a two-fer for why value could again outperform, slower economic growth and earnings growth next year.
Trillions in stimulus money and the recovery have boosted the economy to growth of 5.7% this year but not for long. The Conference Board estimates next year’s growth at just 3.8% and then just 3% the year after.
Economic growth this year has translated to booming corporate profits with earnings growth in each sector shown here by FactSet. Earnings for companies in the S&P 500 have jumped 44% this year, that’s about four-times the normal annual earnings growth and it’s pushed investors into the highest-flying growth stocks.
Earnings growth is expected to come back down to earth next year with the S&P 500 forecast to post growth of just 8.6% in profits…less than a fifth of what it did this year. And that forecast is coming down. Just two months ago, stocks in the broad market index were expected to post earnings growth of 9.6% next year. That forecast has now been downgraded a full percent and could fall further.
That drop in growth of sales and earnings is going to take away one of the biggest arguments for growth stocks…in fact, it could take the ‘growth’ out of ‘growth stocks’.
Without earnings growth in the high double-digits, the market and record-high valuations starts to look a little shaky as well. That could mean more corrections where stocks selloff five- or ten-percent. In those scenarios, it will be the value stocks that protect your portfolio because…well, they’ve already sold off into that value territory.
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Next here, one of my favorites…uh, for personal reasons. Anheuser-Busch InBev, ticker BUD, is a solid value stock along with stable cash flows and safety if we see any market weakness.
The company is the world’s largest brewer and controls five of the top 10 beer brands by sales. In what could signal a turnaround, shares jumped 11% on third-quarter earnings when Anheuser reported sales of $14 billion for 11% growth over the year. Both volume and pricing were strong, especially across the company’s premium portfolio of Bud, Corona and Stella.
It’s not quite the balance sheet I like to see on value stocks with just $7 billion in cash against $90 billion in debt but it’s a stable, cash-flowing company so you expect to see more leverage.
Shares trade for 18.6-times earnings and 2.4-times sales which is a 25% discount to the five-year average price-to-sales multiple.
The average analyst target of $73 per share would be 22% higher from here but I wouldn’t be surprised to see it get closer to the 52-week high around $80 a share.
I’ll reveal those last three value stocks to watch next but I do want to warn you about one risk in value investing. The fact is that many value stocks, cheap stocks…are cheap for a reason.
Don’t fall into the trap of thinking you’ve found hidden value in every value stock that makes your screening list. In fact, I’d say the market is right on nine-out-of-ten value stocks, that there isn’t as much ‘value’ hidden in the stock as you think.
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This is where the fundamental research we talk about the channel comes into play. Finding those companies that really do have a competitive advantage and strong future growth. Because more often than not, with value stocks, it’s just because the rest of the market doesn’t have the patience to wait for that fundamental story to play out. It might be a great company but some near-term news is driving shares lower.
That means you’ll need to have the confidence in your investments that the long-term picture will win out and that confidence only comes with doing the research on a stock.
That also means you need to be honest about the market’s perspective, why does the market think the shares aren’t worth as much and does it have a point? That can be tough when you’ve found a stock you really like but look at the other side of the story and, as you’re working through your list of value stocks, you should be scratching off more than you buy.
One of my favorite dividend plays is also a value stock, Energy Transfer, ticker ET, is one of the largest master limited partnerships which means it owns the pipelines through which oil and natural gas is moved and the terminals where it’s stored. And a $26 billion market cap and size of the portfolio gives this one a safety you won’t find in other MLPs.
One thing you’ll see across stocks in the energy sector over the next few years is, energy prices are going to stay fairly high but companies aren’t going to be spending on new exploration or new assets like they used to…they’ve got their eye on that long-term drop in demand for oil and gas, so will be spending less on new assets. That’s going to translate into huge cash flow and higher dividends for these stocks.
For example, Energy Transfer spent $5.5 billion in 2017 on developing pipelines and assets but is forecasting capital spending of just $1.6 billion this year. That’s resulting in earnings jumping from $7.3 billion five years ago to as high as $13 billion this year.
In those valuation metrics, you can’t use the price-to-earnings ratio for MLPs or real estate stocks because they book so much in depreciation that earnings aren’t a good measure of true profitability. Instead, you want to look at metrics like this price-to-cash flow which is just 3.65-times here for ET.
The average analyst target is for $14.50 a share which would be 49% higher from here and that’s on top of the 6.4% dividend yield on this stock.
Teva Pharmaceuticals, ticker TEVA, is one I’ve owned for more than a year now and a strong value stock candidate. Not only is the company the world’s largest maker of generic drugs but it also has a strong pipeline of branded medications along with blockbusters like Ajovy and Austedo contributing to more than $16 billion in annual sales.
Shares have stabilized over the last few years but two factors are really contributing to the stock’s 80% plunge since 2015. Before 2017, the company was using an aggressive acquisition strategy, borrowing tens of billions to buy other drugmakers. Those acquisitions failed to produce the sales expected and the company was stuck with as much as $34 billion in debt. It’s since paid that down to $21 billion, which is still high but manageable.
The other factor is the six-year litigation over opioid sales in the U.S. with thousands of state’s attorney generals and local governments filing lawsuits against pharmaceutical companies. The majority of these lawsuits have been settled but Teva and Johnson & Johnson are still contesting some.
And on that, the company just got its first good news last week when a California judge ruled Teva and JNJ did not make misleading statements and aren’t liable for the opioid crisis.
Shares of Teva shot up 10% on the news but are still in value territory trading for just 4-times on a price-to-earnings basis and just 0.63-times sales. For reference, the stock traded as high as two-times price-to-sales back in 2016.
The average analyst target of $11.47 per share is only 12% higher but I think we see increased targets on this recent news and wouldn’t be surprised if Teva hits its 52-week high above $13 a share.
Alibaba, ticker BABA, is about the only China stock I would even consider buying right now but it does check all those value criteria.
On the one hand, the group of companies serves more than a billion users, up more than 140 million in the first half of the year. Alibaba amounts to 15% of the total retail sales in China, the second-largest economy in the world and grew total revenue by 34% in the June quarter, with 54% growth internationally.
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Analysts expect sales to rise 26% to $141 billion this year for $10.78 in per share earnings. That puts the stock at just 3.3-times on a price-to-sales basis and 15.8-times earnings. Compare that to Amazon, which is an almost identical business model, that trades for 3.9-times sales and 58-times earnings and you see how cheap the shares are. On that comparable price-to-sales basis, Alibaba could be worth 18% more and shares would be 267% higher on a price-to-earnings comparable.
Of course, the wildcard here is the Chinese government and I think the recent crackdowns are more than just a socialist government trying to take more control. China is facing some serious economic problems with its property sector and wants to control capital flows as closely as possible heading into 2022. That’s why it’s clamping down on cryptocurrencies and companies.
Analysts have an average target for Alibaba of $246 per share, 42% above the current price and an eventual run back to the $311 high would be an 83% return.
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