If you ask me, just having a low price to earnings (PE) ratio doesn’t make a stock cheap. Nor does simply having a declining stock price, or trading at a 52 week low make a stock cheap.
All of those numbers matter, but they’re how you measure a value; they’re not the reason value is created. To me, what creates value is when the collective market decides to “write a story” on a stock despite the facts. And despite what the naysayers think, these three stocks truly are as cheap as they look.
Boring is beautiful
I often wonder why Cisco Systems, Inc. (NASDAQ:CSCO)’s stock seems perpetually stuck in neutral. This maker of networking and communication technology has a truly dominant market position, and seems to outperform quarter after quarter.
The first quarter of 2013 was no exception, as Cisco Systems, Inc. (NASDAQ:CSCO) again beat earnings ($0.51 to $0.48) expectations and grew earnings in excess of 10% year over year. Year over year growth, is no small feet for a company of Cisco’s size! In addition to a good quarter Cisco Systems, Inc. (NASDAQ:CSCO) pays a healthy dividend of 3.22%. So why does the stock look so cheap, with a P/E of 12 and a PEG ratio of just 1.27, these days?
My opinion is that Cisco has become International Business Machines Corp. (NYSE:IBM). The “market storyline” is that mature tech companies like Cisco Systems, Inc. (NASDAQ:CSCO) and International Business Machines Corp. (NYSE:IBM) shouldn’t have their growth and cash flows fairly valued. When you’re in tech growth and gobs of cash are a given (says Mr. Market), so unless you’re “unexpected” the market doesn’t care–for now. But that’s where the value lies.
There was a time when Cisco Systems, Inc. (NASDAQ:CSCO) was a new, fast growing, tech company and traded at a multiple that reflected the quality of the business. But once Cisco (and International Business Machines Corp. (NYSE:IBM), etc.) stopped being “sexy,” and once the double-digit growth cooled, the stock lost its premium. Today Cisco, and many names in “old tech,” trade at multiples befitting utility companies.
Sure, Cisco Systems, Inc. (NASDAQ:CSCO)’s days of hyper-growth are long over but it still has a great competitive edge due to the scale of its business and the 18% returns on equity that come with it. When you combine Cisco’s market position, its dividend, and the fact that the earnings are still growing–the stock looks cheap.
iCan’t believe it’s so cheap!
So is Apple Inc. (NASDAQ:AAPL) the next Cisco or International Business Machines Corp. (NYSE:IBM)? Has the market decided to treat it like a utility? How else can we even try to explain the fact that Apple Inc. (NASDAQ:AAPL)–which was once Mr. Market’s darling–trades at P/E of just 10? Factor in that the company has a return on equity of 33.34%, and a healthy dividend, and it seems analysts are expecting a much darker tomorrow than today. That’s the only rational explanation for the disconnect in Apple Inc. (NASDAQ:AAPL)’s fundamentals.
But when you step back from the negative headlines and worry, it’s easy to see that there’s still time to take a bite out of this one.
Apple Inc. (NASDAQ:AAPL) is receiving negative sentiment from nearly every analyst, but this can actually be a good thing. Apple just had a decent quarter, and stocks that perform well–especially as analysts jockey to be “negative first”–ultimately rally. Bottoms in stock prices are made when every last bull has turned negative, despite good fundamentals. I think we’re close with Apple.
Further, Apple Inc. (NASDAQ:AAPL) is answering its critics. Earnings didn’t fall off a cliff. They raised the dividend, now at 2.7%, and are using their cash to buy back loads of stock. Best of all, the company seems at the beginning of a refresh cycle amongst their product lines, and new product categories could be coming as well. Perhaps that’s why Apple still has a PEG ratio of just 0.55. Think about that. Even with all the negative headlines, the pundits and analysts are still projecting growth.
When you combine the lowered expectations, with great valuations, and the growth prospects, there’s just too much good in Apple Inc. (NASDAQ:AAPL) to pass up. It seems to be low hanging fruit, indeed.
Value: This one’s in the bag
Over the past year Coach, Inc. (NYSE:COH) has been a case study in Mr. Market’s negative story telling. The market just won’t let the facts of Coach get in the way of a good story. The story is the much hyped tale of Coach, Inc. (NYSE:COH)’s demise. With the growth of competitor Michael Kors Holdings Ltd (NYSE:KORS) and Coach’s exposure to Europe, this “stodgy” luxury maker of foot wear, accessories, and (of course) handbags fell suddenly out of style. That was, until the facts (and a strong earnings beat) got in the way of the story.
Coach, Inc. (NYSE:COH) beat on earnings in the most recent quarter by $0.04 ($0.84 vs $0.80) and grew handily over last years $0.77. The primary areas of new growth (Men’s, Asia) were right on track, which helps calm many of the fears regarding Coach, Inc. (NYSE:COH)’s demise. With one bad story squashed, don’t fall for the next bad story: that Coach is no longer cheap at these levels, near $60.
Sure, since reporting earnings the stock has been on a small run, but it’s still well shy of its 52 week high. I think what people don’t understand is that the stock should never have been knocked down so far. Coach, Inc. (NYSE:COH)’s business is simply stronger this year than it was last year, and until it surpasses its 52-week high, it’s cheap. A lot of people just don’t realize the overwhelming brand moat that Coach has in its handbags, leading to returns on equity north of 50%. The fact that wonderful handbags are synonymous with the word Coach creates a brand habituation amongst customer that’s invaluable. If Coach, Inc. (NYSE:COH) is successful in either expanding this brand moat into new markets or growing Men’s wear, its current PEG ratio of 1.3% will be the cheapest we see for a while.
There’s multiple ways for Coach to win, and it has the wind at its back. Buy this one on any dips, it will look wonderful on you.
What really makes a stock cheap
Finding cheap stocks really requires us to question authority. We need to question the authority of financial media, analysts, and pundits of all types. The truth is that these people are paid to predict the future, which is impossible, so they usually follow the consensus.
When that consensus is negative news, a good company can see its stock hammered even as the underlying company does well.
Not every stock that has negative headlines will be a value, in fact, most won’t. But when you find stocks like these, with negative headlines and superb growth prospects, you should consider buying.
The truth is, no matter how scary the “story” seems, sooner or later the facts matter.
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