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National-Oilwell Varco, Inc. (NOV), The Dow Chemical Company (DOW): Finding Undervalued Stocks in the S&P 500

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.

National-Oilwell Varco, Inc. (NYSE:NOV)

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?