Sometimes, as we all know, words can have different meanings to different people. For investors, the word “cheap” is one of those terms that can carry different meanings. To some investors, cheap stocks are those offering value, while others emphasize price when defining cheap. The first group looks at metrics like low price-to-earnings (P/E) ratios or they apply other valuation tools. The second group looks at the market price and calls a stock cheap when it’s trading below $1 a share, or $5 a share or maybe $20 a share.
There are advantages and disadvantages to both definitions.
Many investors believe value stocks are more likely to deliver gains in the long run. This has been demonstrated by a number of academic studies over the years. Researchers consistently find stocks with low P/E ratios, low price-to-book ratios or low scores on other value screens outperform growth stocks, on average. That’s an advantage of using cheap defined as a value stock.
The disadvantage of ignoring price is that sometimes a value stock will trade at a high price. This can, on occasion, mean the stock is less likely to make a large move. This week, as an example, there are 63 stocks priced at more than $100 a share with at least average liquidity. None of them have delivered a triple-digit gain in the past year. On the other hand, there are about 1,466 liquid stocks priced under $100 a share and 35 of them delivered gains of more than 100% in the past year. This isn’t a comprehensive test but the numbers do demonstrate that if we want to find big winners, we increase our odds by looking at lower-priced stocks.
The ability to make a large price move is an advantage of defining cheap in terms of price, since low-priced stocks are more likely to deliver large gains. The disadvantage is that we sacrifice safety because many lower-priced stocks are likely to lag the market or even fall into bankruptcy.
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It is possible to “split the difference” between the two definitions and look for value stocks trading at a low price. We identified four large cap value stocks priced at less than $20 a share. Large cap stocks have a degree of safety built into them because these are established companies. Value has been shown to outperform growth in the long run and low prices indicate a large move in the stock is possible. As a bonus, all four of these stocks provide current income in the form of dividends. As an added bonus, they also make up a well-diversified portfolio, since each one of the four represents a different sector.
The stocks are:
Ford Motor Company (NYSE: F) the global car company that arguably was the best performer during the global financial crisis. F didn’t need a government bailout to survive and remains well-positioned to grow in the future. F is organized like it was before the crisis. The automotive sector of the company develops, manufactures, distributes, and services passenger cars, trucks, SUVs, light commercial vehicles, trucks, vans, and electrified vehicles, as well as offers parts and accessories. The financial sector of the company offers financing options to and through automotive dealers. Financing can improve sales performance, but this contributed to the crisis in 2008. Some automakers had made too many subprime loans and defaulted loans threatened the survival of these car companies. F did not face this problem and has maintained reasonably high loan underwriting standards.
F has reached a point where its financial performance can be described as steady. Revenue has been near $145 billion in each of the past three years. This year, F is expected to report revenue of $144 billion with small growth to $146 million expected next year. Earnings per share (EPS) are expected to come in at $2.09 this year and $2.08 next year, slightly better than the $1.93 recorded in 2015.
Investors are skeptical of car companies and they trade at low valuations. F is trading at about 7 time earnings. At a P/E ratio of 8, the stock would gain about 17%. Including the dividend yield of 4.4%, F could provide a total return of more than 20% in the next year.
Action to take: F is a buy at the current market price to provide income. Consider a stop loss at $10.90. The initial price target is $16.
HP Inc. (NYSE: HPQ) provides commercial personal computers (PCs), consumer PCs, workstations, thin client PCs, tablets, retail point-of-sale systems, calculators and other related accessories, software, support, and services. HPQ also provides printer hardware and software to both the commercial and consumer markets.
HPQ sold off with the broad stock market after the recent Brexit vote, but the company responded to the news by announcing a price increase for its products in Great Britain. The price increase was needed, the company noted, because of the decline of the British pound. Traders seemed to like the company’s response to Brexit and HPQ quickly recovered from its selloff.
HPQ could continue higher as the PC market recovers. After an extended down trend in sales, analysts expect PC sales to gain in the second half of 2016. Analysts at Gartner and IDC, two highly-respected information technology research firms, believe the PC market is showing signs of improvement.
Both firms expect a slight recovery in PC shipments in the second half of the year, in part driven by large businesses transitioning to Windows 10 toward the end of this year. One analyst noted “The second and third quarter are typically PC buying season for the U.S. public sectors. Positive second-quarter results could suggest healthy PC sales activities among the public sectors. There is an opportunity for a Windows 10 refresh among businesses, which we expect to see more toward the end of 2016 to the beginning of 2017.”
These developments could be bullish for HPQ which pays investors a dividend yield of about 3.5% to wait for the recovery in PCs.
Action to take: HPQ is a buy above $14 with an initial price target of $15.66. Consider a stop at $12.60.
Regions Financial Corporation (NYSE: RF) provides consumer and commercial banking, wealth management, mortgage and insurance products and services throughout the South, Midwest and Texas. The company has 1,627 banking offices, 1,962 ATMs and $126 billion in assets.
Regional banks usually follow conservative business models using deposits to fund loans. This makes them relatively easy to compare to each other. RF reported a return on assets (ROA) of 0.8% in the most recent twelve months. ROA is an important metric for banks because it provides a standardized measure of how much money management earns with the assets at its disposal. RF’s ROA is in line with the industry average of 0.8%. An average bank should be expected to trade with an industry average valuation but RF’s P/E ratio of 11.8 is below the long-term industry average of 14.1. The discount is most likely an overreaction to the economic problems feared in the bank’s operating region with concerns about the oil market creating an opportunity to buy the stock at a discount to its peers. Momentum on the weekly chart indicates a potential rally in the stock could be starting.
Action to take: RF is a buy at $9.25 or higher. Consider a stop at $7.80. The initial price target is resistance at $10.87.
Host Hotels & Resorts, Inc. (NYSE: HST) is a publicly owned real estate investment trust (REIT). HST primarily invests in luxury and upscale hotels in the United States, as well as Canada, Mexico, Chile, the United Kingdom, Italy, Spain and Poland.
As a REIT, HST is valued for its dividend. The company rewards its shareholders with a dividend yield of more than 4.7%. The dividend has increased from $0.04 a share in 2011 to $0.80 last year. REITs are required to pay out a minimum of 90% of taxable income under IRS rules and analysts are projecting growth of 9% in income this year, which should result in another dividend increase.
HST’s yield is well above its historic average of 2.6% and is also above the long-term industry average of 4.2%. This indicates HST is potentially undervalued by about 12%. With the dividend, HST conservatively offers a potential total return of almost 17% over the next twelve months.
Action to take: HST is a buy at $17.20 and above. Consider a stop at $16. The initial price target is $19.