While the stock market’s plunge in recent months has lowered valuations of more than 20% of S&P 500 index companies to a price below 10 times next-four-quarter earnings estimates, only a fraction of those look like real bargains, as outlined in a recent Barron’s story. Associate editor Jack Hough looked at stocks with single-digit P/Es, which have also recently received new buy ratings from analysts. He concluded that four companies are better positioned to outperform than the rest, including AT&T (T), DXC Technology (DXC), Mylan (MYL) and Morgan Stanley (MS).
4 Low P/E Bargains
- Mylan; 5.7x next-four-quarter earnings
- DXC Technology; 6.6x
- Morgan Stanley; 8.3x
- AT&T; 8.7x
Mylan is another company that has been hard hit by a combination of broader industry and market headwinds, as well as company specific news. In August, the Food and Drug Administration (FDA) approved a generic EpiPen competitor from Teva Pharmaceutical Industries (TEVA), adding to pessimism around Mylan’s purchase of Swedish drug maker Meda in 2016.
Wells Fargo Securities analyst David Maris viewed the risks as fully priced into Mylan stock, upgrading shares to outperform in November. He noted that Mylan recently traded at a 10% discount to Teva relative to projected earnings, compared to the recent five years, in which it had traded at an average 10% premium. In light of prospects for an approval for a new generic competitor to GlaxoSmithKline’s (GSK) asthma treatment, and expectations on Wall Street for 10% EPS growth in 2019, Wells argues that Mylan looks inexpensive.
Barron's Hough notes that not all stocks trading at a low P/E ratio are attractive, including Macy’s (M) at 7.3 times, which sells goods that are subject to intense price competition, as well as American Airlines Group (AAL), facing its own sector risks. Others like General Motors (GM), at 5.6 times forward earnings, typically trade with a single P/E.
Morgan Stanley, which has seen its stock fall into correction territory, down nearly 22% over the past 12 months, could make a comeback as earnings return to stability, according to Wells Fargo analyst Mike Mayo.
As wealth and asset management bring in an estimated 48% of total profits this year, up from 34% in 2010, there should be less risk of any big earnings surprises from the bank, wrote Mayo. A shift away from relying on trading has helped with earnings stability.
The analyst views the broader U.S. banking sector as undervalued, highlighting domestic firms’ ability to steal share from European banks in the capital markets space. Mayo, who rates Morgan Stanley at outperform, has a $60 price target on the stock, implying a near 45% upside. Potential positive tailwinds include an expected boost in earnings guidance during its fourth quarter earnings report, cost cutting reductions – particularly the elimination of retention bonuses – and a boost from the release of bank stress tests by U.S. regulators in June.
Shares of AT&T have sharply underperformed the broader market in the recent period, down 17.6% over 12 months compared to the S&P 500’s 7.1% decline. Meanwhile, the communications services provider boasts a 6.7% dividend yield.
Last month, Cowen analyst Colby Synesael upgraded shares of AT&T to outperform from market perform, indicating that he views the dividend as safe after hearing the company’s 2019 strategy and guidance at an analyst meeting in November. He expects shares to gain roughly 16% over 12 months to reach a target of $36, highlighting the importance of higher free cash flow from improvements to core profitability.
On the more bearish side, it’s worth mentioning that AT&T has been a chronic underperformer in a disrupted media landscape, burdened by its massive debt load from its recent Time Warner deal. While the firm is set to launch its own streaming service late this year, reducing the content it sells to industry leader Netflix Inc. (NFLX) and others, the move may not be enough to offset heavy paid-TV losses.
Meanwhile, Morgan Stanley is one of many big banks whose profits are slowing sharply - when you exclude tax cut - and has simply failed to rebound big as many had hoped. In light of these negative headwinds, low P/E multiples may be justified.