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2 Low PE Stocks You Will Love: Discover Financial Services (DFS) and Northrop Grumman Corporation (NOC)

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Investors have always shown their love towards low PE stocks. These beaten-up stocks have their price lower relative to net worth and maintain a lower PE in comparison to other industry peers. Investor ideology behind investing in a low PE stock is that it offers them the best bargain for an asset that is likely to gain in the future. Though this strategy paid off in 2012 for investors who laid their bet on the S&P 500’s lowest PE stocks of 2011, there is no guarantee that this strategy will pay-off going forward. My idea of picking up the low PE stocks is to go a bit further and test them on the grounds of their long term performance. I have analyzed three stocks, Magna International Inc. (USA) (NYSE:MGA), Discover Financial Services (NYSE:DFS) and Northrop Grumman Corporation (NYSE:NOC) that have lower PE’s in comparison to industry peers and applied the “long term feasibility test” on each of them. I feel that Magna and Discover are undervalued and have potential to grow while Northrop is fairly valued at the current price level. (Read my other coverage on low PE stocks here.)

Discover Financial Services (NYSE:DFS)Let’s analyze these stocks in detail.

Name of Company Price Earnings Ratio (P/E)
Magna International Incorporated 8.89x
Discover Financial Services 8.78x
Northrop Grumman Corporation 8.79x

Magna International Incorporated

Recently Magna announced its guidance for the year 2013. The company expects to achieve total sales of ~$31.3 billion in FY13. Although half of its revenue is projected to be generated from the North American region, it has increased its focus towards the other parts of the world as well. Almost 40% of the growth in the Production sales segment for the next two years is to be contributed from ROW.  In FY13, it shall generate ~$2.2 billion from the Rest of the World (ROW) region. To achieve this desired growth it has plans to open 14 new facilities in the next two years. In addition, the Chinese market for light vehicles is also growing that will help the company to generate ~$2 billion by 2014 which is double its current revenue from the country.

Coming over to the revenue generated from the European region, the sluggish economy has dragged the region’s profitability. As a counter measure, Magna has deployed restructuring initiatives transferring part of its production capacity to the lower cost Eastern Europe. For the same purpose, in December 2012, it acquired ixetic Verwaltungs GmbH, a Germany-based manufacturer of automotive vacuum, engine and transmission pumps for ~$399.3 million. In 2013 this acquisition is expected to generate ~$400 million in the form of revenue and will help in increasing the production sales of the region. Along with some recent tailwinds in the region also came from operational improvements in specific under-performing facilities and by achieving price increases on selected contracts.

Discover Financial Services

The stock of Discover Financial Services showed some weakness post the announcement of the Master Trust Credit Card Data. The “net charge-off rate” increased by 29 bps month-over-month (m/m) to ~2.31% in December, 2012. Even after a mixed bag of credit card data, I feel that the future endeavors of the company will help it attract more card holders. The company currently has 50 million cardholders. The company’s biggest marketing investment of 2013 is the new “IT” card. The card provides the combination of some solid features such as cash back, foreign transactions, pay-by-phone, and over-limit facilities without any fees charged. It will serve as Discover’s flagship card for customer acquisitions. The card had been successfully tested in four markets in the summer of 2012. While current plans call for a sizable investment behind the card, if the performance and returns are not according to expectations, management will be able to quickly reduce the spending. I expect a mid-single digit growth rate in total credit card loans, which will be ~$48.99 billion by the end of 1Q13.

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