By Implication, Excellent Values
After the ugliest market decline since the 1929 crash, stocks have roared back, with the S&P 1500 Index surging 71% from its March low. Hunting for value is not as easy as it was a few months ago. However, we have uncovered a handful of recommended stocks priced cheaply relative to their peers.
In the table below, we present implied prices for 12 stocks based on average price/earnings ratios for stocks in their industry and sector. We considered P/E ratios based on trailing 12-month earnings as well as projected per-share profits for the current fiscal year and the next year. All 12 stocks have upside potential of at least 4% to the lowest of six implied prices and 14% to the average of the implied prices.
Quadrix also identifies these stocks as strong value plays. All earn Value scores above 70. Four intriguing options are reviewed below:
CA’s ($23; CA) software helps clients manage their information-technology infrastructure. If the stock’s trailing P/E ratio rose to the average for the systems-software industry, CA would trade at $39 per share, up 68%. Based on the average of the six implied price targets in the table, CA has upside potential of 44%.
During the recession, CA has outperformed most of its peers, cutting costs to fatten profit margins. Per-share profits rose 9% over the last 12 months. However, bookings and revenue have declined, indicating clients are holding off on software purchases. That trend could soon change, however. Many industry watchers expect technology spending to rise, albeit modestly, in 2010.
CA anticipates long-term organic revenue growth of about 6%. Wall Street sees per-share earnings rising 9% in fiscal 2010 ending March and 10% in fiscal 2011, targets CA may be able to exceed. CA has topped the consensus profit estimate by at least 5% in each of the past four quarters. Earning an Overall score of 95, CA is a Focus List Buy and a Long-Term Buy.
It’s not easy to recover from losing $4.8 billion in 2010 contracts, as CVS Caremark ($32; CVS) announced in November. That loss alone could potentially deflate the pharmacy-benefit-management (PBM) unit’s operating income by 10% to 12% next year. While CVS won’t restore the PBM business all at once, it has made efforts to steady the ship. A new president was slated to take the helm Jan. 4, and a new $998 million contract will begin in September.
Lost in the fuss over the PBM is the retail-pharmacy unit, which boosted revenue 16% and operating profits 9% in the nine months ended September. Same-store sales rose 5% in the nine months ended September.
As expected, the stock got dinged after news about the contract losses hit the market. But even with the diminished outlook, CVS looks attractive at its current valuation. CVS trades 13% below its sector average based on projected earnings in the next fiscal year. Per-share earnings are expected to grow 8% in 2009 and rise at a 12% clip over the next five years. CVS Caremark is a Focus List Buy and a Long-Term Buy.
Hewlett-Packard ($53; HPQ) has an implied price of $83 based on the average valuation for computer-hardware stocks relative to current-year profits. Based on the average of the six implied prices in the table on page 5, the shares have a potential upside of 54%. At 14 times trailing earnings, H-P trades at a 16% discount to its five-year average.
H-P is the world’s top personal-computer vendor as measured by revenue and ranks second in technology services and servers. It has captured market share during the recession. With the freeze on corporate spending beginning to thaw, CFO Cathie Lesjak said H-P is preparing for “flush” enterprise budgets from U.S. companies that delayed upgrading older equipment during the downturn.
The printing segment, one of H-P’s most profitable businesses, could see a similar rebound. For starters, H-P forecasts double-digit growth in shipments for the January quarter, a sharp improvement from the 20% decline in the October quarter. H-P plans to attract more sales by loading products with new technologies rather than by lowering prices. The imaging and printing group (21% of 12-month sales, 32% of operating income) reported 19% lower sales in the year ended October. The recession put a dent in sales of printing hardware, yet printing supplies remained strong.
Wall Street expects per-share earnings to grow 13% in fiscal 2010 ending October on 5% higher sales, and the consensus profit estimate has risen over the last two months. H-P is a Buy and Long-Term Buy.
TJX ($37; TJX) could thrive even if the economy remains soft in 2010. T.J. Maxx and Marshalls sell brand-name apparel for up to 60% off department-store prices, deals that appeal to shoppers who like quality merchandise but still feel a pinch in the wallet.
More than one-fourth of TJX’s stores are located in the Northeast, giving the company significant exposure to the storm that buried much of the East Coast on the last weekend before Christmas. The storm probably had a negative effect on overall holiday-season sales, though it could also translate to an increase in online sales.
The average of the six implied prices shown in the table below is $45, 23% above current levels. Wall Street expects per-share profits to jump 33% in the January quarter, then rise another 12% in fiscal 2011 ending January. Free cash flow is trending higher. TJX is a Long-Term Buy.