As stocks have rallied sharply, so have equity valuations, making it more difficult to find above-average growth prospects at reasonable prices. Analysts at investment banking, asset management, and wealth management firm Jefferies decided to look at beaten-down stocks for which they have buy ratings, but on which the Wall Street consensus is negative. After further analysis and screening, they produced a list of 13 stocks that they feel have significant unrecognized potential for gains.
Among those stocks are these ten, per Barron's: vehicle powertrain maker BorgWarner Inc (BWA), Michael Kors, Jimmy Choo, and Versace fashion brands owner Capri Holdings Ltd. (CPRI), telecommunications hardware maker CommScope Holding Co. Inc. (COMM), gold and copper miner Freeport-McMoRan Inc. (FCX), apparel retailer The Gap Inc. (GPS), money manager Invesco Ltd. (IVZ), grocery chain The Kroger Co. (KR), vacation property company Wyndham Destinations inc. (WYND), truck maker Paccar Inc. (PCAR), and medical testing company Quest Diagnostics Inc. (DGX). All except Paccar are trading more than 20% below their 52-week highs, are detailed in the table below.
10 Out-of-Favor Stocks
(Percent Below 52-Week High)
- BorgWarner, -21.3%
- Capri Holdings, -36.7%
- CommScope, -38.9%
- Freeport-McMoRan, -31.9%
- Gap, -25.5%
- Invesco, -33.9%
- Kroger, -21.4%
- Paccar, -4.4%
- Quest Diagnostics Inc., -23.0%
- Wyndham Destinations, -21.4%
Source: Yahoo Finance; pricing as of the close on April 11, 2019.
Significance For Investors
These stocks have price-earnings ratios (P/E) and consensus Wall Street analyst ratings below their five-year averages. However, as quoted by Barron's, Jefferies says that they do not intend "to merely surface some cheap stocks," but to "highlight stocks where we can quantify the Street's aversion" and explain their own bullish views.
The table below presents recent analysis by Goldman Sachs on the valuation of the S&P 500 Index (SPX) as a whole. They looked at nine different valuation metrics, and found that the index is now in the 80th percentile or higher versus history according to seven of them.
S&P Valuations Are Stretched
(Current Valuation in 80th Percentile or Higher vs. History)
- U.S. Market Capitalization vs. GDP, 98th percentile
- EV/Sales Ratio, 94th percentile
- Shiller CAPE Ratio, 89th percentile
- Price/Book Ratio, 86th percentile
- EV/EBITDA Ratio, 84th percentile
- Cash Flow Yield, 81st percentile
- Forward P/E Ratio, 80th percentile
Source: Goldman Sachs, "Where to Invest Now," April 5, 2019.
The median stock in the S&P 500 also is in the 80th percentile or higher compared to history on all these measures, except market cap to GDP and CAPE. These two are not applicable to individual stocks.
Below are four representative stocks, and why Jefferies recommends them.
BorgWarner: investors appear to be overestimating the demand for fully electric vehicles and underestimating it for hybrids.
Freeport-McMoRan: Jefferies' target price is $18 (+34.2% from the April 11, 2019 close). Jefferies sees the current price as a "trough" and anticipates a rebound fueled by "potential operational upside and leverage to a recovery in the copper price."
Gap: Price target $50 (+96.3%). The company plans to spin off its highly successful Old Navy brand, which emphasizes inexpensive basic apparel for a wide demographic. The Gap brand itself, meanwhile, has lost focus. Jefferies says that "initiatives are in place for core Gap brand improvement."
Capri Holdings: Price target $85 (+76.9%). Jefferies says "the category gets closer to bottoming and China sales likely will improve from stimulus/trade."
Goldman's analysis suggests that the market is at a precarious height. If a general selloff ensues, even the stocks listed above are likely to get battered, despite their own attractive fundamentals.