Who likes cheap stocks? Raise your hands!
Naturally, you’d have to be a fool (lowercase) not to raise your hand as you read that. But trying to determine whether or not a cheap stock is a real value, is one of the hardest tasks investors face.
Thankfully by using just two of the most important metrics–return on equity and the PEG ratio–to screen for new buys, can lead you to wonderful value investments. It’s my opinion that purchasing a large portfolio of stocks with a PEG under 1, and returns on equity over 20%, will lead to market beating returns.
Here are some of the most compelling values that meet this criteria today:
Fruitless headlines
By now you’ve probably heard all of the negative headlines about Apple Inc. (NASDAQ:AAPL), particularly that it has “lost its cool” or isn’t innovating “these days.” But should these opinions really have Apple Inc. (NASDAQ:AAPL) trading at a multiple (9) befitting a slow growing utility?
In my opinion, the answer is obviously no. Apple Inc. (NASDAQ:AAPL)’s fundamentals are currently disconnected from its stock price, which could make it a tremendous value.
For instance, despite the headlines, the company is still earning a robust 33% return on equity. With a PEG ratio of just 0.49, combined with the wonderful returns on equity, Apple easily meets my value criteria.
Usually companies of Apple Inc. (NASDAQ:AAPL)’s size, with market caps in the hundreds of billions, don’t trade at such cheap valuations. This is simply because value investors scoop in before they get that cheap, because they’re visible. But with Apple, the high market cap has meant high scrutiny, everyone has an opinion on this one.
But if Apple Inc. (NASDAQ:AAPL) really deserves its P/E of 9, why are analysts still projecting growth? Apple’s PEG is only 0.49, meaning the companies projected growth rate is still nearly 20%. Analysts actually expect EPS to grow $4 per share by 2014, and with such a high return on equity Apple should report quality earnings.
Anything could happen but my opinion is that value investors will eventually warm up to Apple, once the market get’s over what Apple “is not.”
Cyclical swings
While Apple is new to rough headlines large industrial powers, like Caterpillar Inc. (NYSE:CAT) and Ford Motor Company (NYSE:F), experience them perpetually. These two companies operate in industries that are subject to constant headwinds, but they’ve weathered a lot of storms over the years.
Caterpillar Inc. (NYSE:CAT) currently earns a return on equity of 29.93, while trading at a scant PEG of 0.80. Like Apple, this value is not underneath anyone’s nose, the company has a massive market cap of nearly $46 billion.
Meanwhile, Ford Motor Company (NYSE:F) earns a staggering return on equity of 34.38% and trades a scant PEG of just 0.88.
These stocks depend on the global economy, right now they’re feeling the pinch of Europe and emerging markets in (especially China for CAT). Because of this they’re always subject to the occasional stock price dip. That’s why Caterpillar Inc. (NYSE:CAT) is trading nearly $10 below their previous 52 week high and why Ford has been stuck in the teens for years.
The six month outcome for these businesses is unclear, but they’ve shown over the decades that their stock prices tend to go up in the long-term. So own these stocks, don’t rent them.
Despite the headwinds, both companies are expecting strong growth over the next two years, so buying at these value prices might be perfect timing. I like that they sport attractive valuations, growth and they will pay you a dividend yield just under 3% to wait for the good times to roll.
In a perfect scenario, you could be buying at a lull just before a nice growth upswing, as international conditions stabilize.
