In the first piece that I wrote on the subject of finding undervalued stocks in the S&P 500 based on low valuations, I initially believed that opportunities would be few-and-far between. However, it appears that there is actually a large number of companies that are trading at astonishingly low valuations in relation to the rest of their sectors, which spurred me to write another post on the subject.
Where to start?
In the first piece I covered the Consumer Goods sector as one of the most overvalued sectors in the S&P 500. But what about the most undervalued?
One of the most undervalued sectors in the market is Energy. According to 27 year historic valuation averages. Specifically, one of the most sold-off sectors in the market right now is the oil & gas drilling & exploration sector. Currently, the oil & gas drilling & exploration sector currently trades at a average P/E ratio of 16.6 and price to book value of 2.5. The sector offers an average dividend yield of 3.2% and trades at a price-to-free-cash-flow ratio of 38.
So, are there any good stocks on offer in the sector?
Yes, in fact one of the cheapest stocks in the sector is the world’s leading oil & gas equipment producer, holding 60% of the market: National-Oilwell Varco, Inc. (NYSE:NOV). National Oilwell currently trades at a TTM P/E ratio of 12.3, far below the sector average. In addition, the company trades at a forward P/E ratio of 10.5 and a price to book ratio of 1.4 — once again, both below the sector average. Unfortunately, the company trades at a price-to-free-cash-flow ratio of 86, and only offers a dividend yield of 1.5%, both below the sector average. However, as National-Oilwell Varco, Inc. (NYSE:NOV) is a market leading company and is trading at such a low earnings multiple in comparison to the rest of the sector, the low yield can be overlooked.
The second company that trades at a relatively low valuation in relation to its sector is oilfield services provider Baker Hughes Incorporated (NYSE:BHI). Currently, Baker Hughes trades at a TTM P/E of 16.5, which is around the same as the sector average. That said, the company is trading at a forward P/E ratio of 11.1 and a P/B ratio of 1.2, both below the sector average. Baker Hughes offers a 1.3% dividend yield, once again below the sector average; but the company’s low valuation offsets the low dividend.
You could be mistaken for assuming that National-Oilwell Varco, Inc. (NYSE:NOV) and Baker Hughes Incorporated (NYSE:BHI) are trading at low valuations because they are not going to grow this year. But in fact the opposite is true. National Oilwell’s earnings are predicted to grow a staggering 24% this year, while Baker Hughes’ earnings are expected to grow by around 33%.
Out of the S&P 500 oil & gas equipment and services sector, both National-Oilwell Varco, Inc. (NYSE:NOV) and Baker Hughes Incorporated have some of the lowest forward P/E ratios:
| Forward P/E | |
|---|---|
| Oil & gas equipment and services sector average | 12.6 |
| National Oilwell Varco | 10.5 |
| Baker Hughes Incorporated | 11.1 |
Major chemical producers
Another sector which offers some stock that are undervalued relative to the rest of the sector, is the S&P 500 major chemical producers sector.
Currently, the major chemicals sector trades at an average TTM P/E ratio of 21.1, and a price-to-book value of 11.7. In addition, the sector offers a average dividend yield of 2.6% and the sector trades at an average price-to-free-cash-flow ratio of around 100.
So, where is the value in the sector?
Well, firstly it would appear that the world renowned The Dow Chemical Company (NYSE:DOW) is actually one of the cheapest companies in the sector right now. Dow currently trades at a low TTM P/E of 14.6 and P/B ratio of 2.3, both of which are below the sector average. In addition, the company offers investors a dividend yield of 3.9%. However, The Dow Chemical Company (NYSE:DOW) does trade at a price-to-free-cash-flow ratio of 154 –way above the sector average.
Elsewhere, Eastman Chemical Company (NYSE:EMN) currently looks expensive, trading at a TTM P/E ratio of 20.3 – although still below the sector average. That said, the company is trading at a forward P/E ratio of 10, a P/B ratio of 3.5 and a price-to-free-cash-flow ratio of 61, all below the sector averages. However, the company only offers investors a 1.7% dividend yield, about 1/3 below the sector average.
Both The Dow Chemical Company (NYSE:DOW) and Eastman Chemical Company (NYSE:EMN) have the lowest forward P/E ratios in the sector, and despite their low valuations, their earnings are expected to grow rapidly over the next few years:
| Forward P/E | EPS Growth 2013 | EPS Growth 3-YR Predicted (compounded) | |
|---|---|---|---|
| Major chemicals sector average | 12.8 | ||
| Dow Chemical Company | 11.7 | 214% | 46% |
| Eastman Chemical | 10 | 114% | 24% |
Conclusion
Although the market may seem overvalued and uncertain to some investors right now, by using the most simple of valuation methods, it is possible to identify some stocks that are still undervalued in relation the rest of their sector. The Dow Chemical Company (NYSE:DOW), Eastman Chemical Company (NYSE:EMN), National-Oilwell Varco, Inc. (NYSE:NOV) and Baker Hughes Incorporated (NYSE:BHI) are all trading at discounts to their sector valuations and offer good opportunities for profit as the valuation gap closes. Moreover, each company is strong and is forecast to grow earnings rapidly over the next year or so.
Fool contributor Rupert Hargreaves owns shares of National Oilwell Varco. The Motley Fool recommends National Oilwell Varco. The Motley Fool owns shares of National Oilwell Varco.
The article Finding Undervalued Stocks in the S&P 500 originally appeared on Fool.com and is written by Rupert Hargreaves.
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