Not Everything Is Expensive
Don't let the fact that stocks look somewhat expensive stop you from seeking out attractive values. They're still available, just a bit harder to find.
The average stock in the S&P 1500 Index trades at 22.8 times trailing earnings, in line with the average for the last three years but 5% above the five-year average and 11% above the 10-year average.
While the level of priciness varies from sector to sector, just about all of them look expensive relative to historical norms, as shown in the chart below. Only consumer-discretionary stocks trade at a discount to the sector's five-year average P/E ratio, and none of the sectors seems cheap relative to 10-year norms.
The consumer-staples, telecom, and utility sectors sport particularly high premiums — no surprise, given that those three sectors delivered solid returns over the last year as investors rotated into defensive, dividend-paying stocks. During the last 12 months, the average utility stock returned 17% and the average staples stock 14%, good for best and second-best among the 10 sectors.
A more granular analysis finds that, unlike the case with sectors, many industries seem genuinely cheap. Among the cheapest are homebuilders and airlines; we recommend stocks in both groups, builder D.R. Horton ($32; DHI) and Alaska Air Group ($67; ALK) and Southwest Airlines ($37; LUV).
With stocks as a group expensive, we screened for bona fide values that look cheap relative to both their history and their sector and industry. The table below features 12 stocks that meet that criteria, with four reviewed in the following paragraphs:
At 13 times trailing earnings, Apple ($109; AAPL) trades at a P/E ratio roughly half that of the average computer-hardware company in the S&P 1500 or the typical stock in the technology sector. That appealing valuation stands out all the more given the stock's 13% rally since Apple declared earnings last month.
Apple bulls point to the June quarter, with its 23% decline in iPhone revenue, as the likely trough of the iPhone cycle. The stock's rally since the report suggests investors have some confidence the iPhone 7, expected to be released in September, will help stop the bleeding. The 7% gain in iPad revenue in the quarter was the first increase in 10 quarters, driven by sales of the iPad Pro, which is taking share from personal computers in the business market.
The consensus projects sales will fall 8% and profits 10% for the year ending September, recovering to gains of 4% in sales and 8% in profits in fiscal 2017. Apple, yielding 2.1%, is a Buy and a Long-Term Buy.
Biogen's ($314; BIIB) trailing P/E ratio of 17 is at least 35% below the company's three-â€Š, five-â€Š, and 10-year average. The stock also trades 41% below the typical biotechnology stock and earns a Quadrix Value score of 71, well above the average of 48 for S&P 1500 biotechs. Despite its value chops, Biogen also qualifies as a solid growth stock.
Over the last year, Biogen grew sales 9% and per-share profits 20%. The company grew per-share profits at least 17% in 11 of the last 12 quarters and hasn't posted a quarterly sales decline in at least 10 years. Since the company topped the June-quarter profit consensus by $0.54 per share (12%), analyst targets for this year and next year have risen 6% and 4%, respectively. The consensus projects profit growth of at least 12% in the September and December quarters, equating to 18% for the full year.
In May, Biogen announced plans to spin off its hemophilia-drug operations as a public company by early 2017. The hemophilia business may be worth about $6 billion. Biogen, with an Overall score of 98, is a Buy and a Long-Term Buy.
At 14 times trailing earnings, Foot Locker ($60; FL) trades at half the average P/E ratio of its sector (consumer discretionary) and 18% below its industry (apparel retail). Historically, Foot Locker hasn't usually seen that kind of discount. Blame weak recent returns; Foot Locker has declined 10% over the last six months, while the typical apparel retailer has gained 1%.
Foot Locker's operating momentum has slowed, with sales growth averaging 4% in the last five quarters versus 9% in the previous five. A slowdown in growth of basketball-shoe revenue surprised analysts in the April quarter, and same-store sales fell short of expectations. However, expectations for Foot Locker are modest, with the consensus projecting 8% growth for the July quarter and 10% for the year ending July 2017. Foot Locker, a Buy and a Long-Term Buy, was expected to declare quarterly results Aug. 19.
As an industry, health-care distributors are among the 15 cheapest in the S&P 1500 Index, as measured by average trailing P/E relative to the group's five-year average. McKesson ($196; MCK) looks cheap even relative to that bargain-priced industry, trading at 15 times trailing earnings, 16% below the industry average. McKesson earns a Value score of 70, higher than typical stock in its industry, which scores 60.
McKesson shares have risen fairly steadily over the last six months; the stock's total return of 26% during that period is tops in the industry, as is its Overall score of 93. McKesson is by far the largest company in its industry, with sales of $193 billion over the last 12 months and a stock-market value of $44.6 billion. Despite its size, the company seems capable of delivering solid growth, with the consensus projecting profit growth of 13% in fiscal 2017 ending March and 10% annually over the next five years.
The company does face some operational headwinds, including a slowdown in price inflation of generic drugs and a decline in the number of new branded drugs. However, the company says it expects to grow drug-distribution revenue at high-single-digit rates, powered by both organic growth and acquisitions. McKesson is a Buy and a Long-Term Buy.