Investors are increasingly worried about a bear market. This is probably almost always true but there are more reasons than usual to worry right now. Valuations are stretched, with many fundamental metrics exceeding levels reached in 2007 and 2000.
In addition to the fundamentals, technicals are a cause for concern. Prices have been going up for more than a year without even a 10% pullback. There hasn’t been a 20% pullback in more than 8 years. Pullbacks relieve the excesses that build up over time and are usually considered healthy.
Of course, these indicators apply to the stock market, as a whole. Many investors like to point out that we trade stocks rather than the stock market and the truth is there are a number of individual stocks that are attractive in the current stock market environment.
A Low Risk Screen for Low Priced Stocks
We often complete quantitative screens to identify potential buy candidates. These screens are often focused on low priced stocks, which are those trading for $20 or less. These stocks are capable of delivering large percentage gains since their share prices are relatively low.
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Quantitative screens are designed to identify stocks that meet certain defined parameters. These lists should be considered the starting point for research since they are simply looking at data rather than considering nonquantitative risks.
For example, a number of retail stocks will pass value screens but the sector carries above average risk right now. The quantitative screen cannot identify the changes in the sector but the screen is still useful. Retail will survive, probably after a shakeout of weak players. The screen will find the stocks that offer value and are likely to survive but additional research could be needed.
This week, we searched for stocks that could do well even in a bear market. Our search began with the stocks in the S&P 500. These are larger companies and large companies are more likely than small companies, on average, to survive or even prosper in an economic downturn.
We then searched for income, requiring that the stock pay a dividend. We required that the company have earnings for the past year and that analysts expect the company to be profitable in the next twelve months. This was simply designed to eliminate unprofitable companies. Then we searched for value.
For value, we used the PEG ratio. We have used this metric before. It compares the price to earnings (P/E) ratio to the earnings per share (EPS) growth rate. This metric recognizes the fact that a fast growing company deserves a higher P/E ratio than a slow growth company.
Many value investors apply a static measure of value in their analysis. They might, for example, require the P/E ratio to be less than 15 or some other number. The problem with this approach is that it ignores growth companies, even when the growth company is offering value.
The PEG ratio corrects for this problem by adapting to the company’s growth. The PEG ratio divides the P/E ratio by the EPS growth rate. This normalizes the value measure (the P/E ratio) and accounts for growth. The PEG ratio accepts the fact that a company with 40% EPS growth should trade with a higher P/E ratio than a company whose earnings are contracting or growing at a slow rate.
In our screen, we looked for a PEG ratio of 3 or less. This is higher than the cutoff for many investors but recognizes that large cap stocks often carry premium valuations.
We used the free screening tool at FinViz.com with the following settings.
The reason we focused on large cap value stocks offering income is because these could be the type of stocks of interest to investors in a market downturn. There are many investment managers who will be required to maintain a fully invested portfolio, even in a market downturn. These investors may prefer the relative safety of large caps, income and value.
Six stocks passed our screen.
Potential Investment Candidates
Huntington Bancshares Incorporated (Nasdaq: HBAN) is a holding company for The Huntington National Bank that provides commercial, small business, consumer, and mortgage banking services. The company provides services in the following areas, commercial, small business, and consumer banking, mortgage, treasury management and foreign exchange, equipment leasing, wealth, and investment management, as well as trust, and brokerage. As of December 31, 2016, the company had 24 private client group offices and 1,091 branches.
HBAN offers a dividend yield of 2.5% and is trading with a PEG ratio of 1.55.
Regions Financial Corporation (NYSE: RF) provides banking and bank-related services to individual and corporate customers in the United States. The company is one of the nation’s largest full-service providers of consumer and commercial banking, wealth management, mortgage, and insurance products and services. Regions serves customers across the South, Midwest, and Texas, and through its subsidiary, Regions Bank, operates approximately 1,500 banking offices and 1,900 ATMs.
RF offers a dividend yield of 2.6% and is trading with a PEG ratio of 1.27.
KeyCorp (NYSE: KEY) is the bank holding company for KeyBank National Association that provides various retail and commercial banking services to individual, corporate, and institutional clients in the United States. The company offers branch-based deposit and investment products, personal finance services and loans to financial, estate and retirement planning, and asset management services.
KEY offers a dividend yield of 2.1% and is trading with a PEG ratio of 1.58.
Host Hotels & Resorts, Inc. (NYSE: HST) is a publicly owned real estate investment trust (REIT). The firm primarily engages in the ownership and operation of hotel properties. It invests in the real estate markets of the United States, Canada, Mexico, Chile, the United Kingdom, Italy, Spain, and Poland. The firm primarily invests in luxury and upper upscale hotels.
HST offers a dividend yield of 4.5% and is trading with a PEG ratio of 2.51.
HP Inc. (NYSE: HPQ) formerly known as Hewlett-Packard Company, provides products, technologies, software, solutions, and services to individual consumers, small- and medium-sized businesses, and large enterprises, including customers in the government, health, and education sectors worldwide. It operates through two segments. The Personal Systems segment offers commercial personal computers (PCs), consumer PCs, workstations, thin clients, commercial tablets and mobility devices, retail point-of-sale systems, displays and other related accessories, software, support, and services for the commercial and consumer markets. The Printing segment provides consumer and commercial printer hardware, supplies, media, solutions, and services, as well as scanning devices; and laserJet and enterprise, inkjet and printing, graphics, and 3D printing solutions.
HPQ offers a dividend yield of 2.7% and is trading with a PEG ratio of 1.94.
The Interpublic Group of Companies, Inc. (NYSE: IPG) provides advertising and marketing services worldwide. The company operates through two segments, Integrated Agency Networks and Constituency Management Group. It offers consumer advertising, digital marketing, communications planning, and media buying, public relations, and specialized communications disciplines. In addition, the company provides various diversified services, including public relations, meeting and event production, sports and entertainment marketing, corporate and brand identity, and strategic marketing consulting. It offers its services under various brands comprising McCann, MullenLowe, IPG Mediabrands, Carmichael Lynch, Deutsch, Hill Holliday, and The Martin Agency, as well as Foote, Cone & Belding.
IPG offers a dividend yield of 3.6% and is trading with a PEG ratio of 1.32.
You’ll notice the list of stocks contains three banks. It might not be best to hold too many stocks in one industry, even under the best market conditions. It’s important to diversify among industries. An investor looking at this list could pick just one of the banks and build a diversified portfolio with the other stocks.
Income stocks are one strategy for income investors to consider. Options can be used to implement a number of other income trading strategy. To learn more about safe income strategies based on options, click here.