Although the broad U.S. stock market is trading near record highs, Goldman Sachs has found more than a dozen "beaten down stocks" that are trading at attractive discounts and thus are prime candidates for a rally, according to a recent research report. This group includes International Business Machines Corp. (IBM), Best Buy Co. Inc. (BBY), Morgan Stanley (MS), Flex Ltd., formerly Flextronics International, (FLEX), Conagra Brands Inc. (CAG), Carnival Corp. (CCL), Valero Energy Corp. (VLO), FedEx Corp. (FDX), Mosaic Co. (MOS), Archer-Daniels-Midland Co. (ADM), and Macy's Inc. (M).

Goldman indicates that investors who bought these stocks based on low valuations have seen them outperform stocks with faster-growing earnings recently. "While fundamentals will also determine the long-term trajectory of stocks, we use signals from options and credit markets to identify 20 value stocks from among those where our analysts' estimates show strong value scores," as Vishal Vivek, an equity derivatives associate at Goldman, wrote in a recent note to clients, as quoted by BI.

Key Takeaways

  • Goldman Sachs identified value stocks with upside potential
  • Several of them fell more than the S&P 500 in the past year
  • A wide range of industries are represented.

Significance For Investors

The stocks recommended by Goldman span a wide range of industries: computer hardware and software, consumer electronics retailing, financial services, technology supply chain services, food products, cruise lines, petroleum refining, shipping services, agricultural fertilizers, and department store retailing.

Through the close on Sept. 26, 2019, the S&P 500 Index (SPX) has delivered a year-to-date (YTD) gain of 18.8%. The respective gains for Goldman's picks are, per adjusted closing price data from Yahoo Finance: IBM, 30.8%, Best Buy, 29.3%, Morgan Stanley, 19.0%, Flex, 38.0%, Conagra, 48.7%, Carnival, -8.3%, Valero, 14.6%, FedEx, -9.0%, Mosaic, -31.3%, ADM, 2.4%, and Macy's, -45.9%.

Shares of cruise ship operator Carnival have tumbled by 15.9% since management issued lower profit guidance for 2019 on June 20, now trading where they were 20 years ago. On the positive side, Carnival offers a dividend yield of 4.2% that seems safe, given that the company has the strongest balance sheet than its two leading competitors, Royal Caribbean Cruises Ltd. (RCL) and Norwegian Cruise Line Holdings Ltd. (NCLH), per Barron's. Carnival also is cheap, with a forward P/E ratio of 9.4 times next 12 month earnings.

However, Carnival's share price sank by 8.6% on Sept. 26 alone, based on more negative guidance, per another report in Barron's. This is despite the fact that the company reported EPS of $2.63 for its fiscal 3Q 2019, up by 11.5% on a year-over-year basis (YOY) basis and better than the consensus estimate by 4.0%. Revenue was $6.53 billion, up by 11.8% YOY and beating the estimate by 6.0%.

Nonetheless, Carnival's market cap of $31.5 billion makes it a potential takeover candidate for an activist investor, the earlier Barron's report speculates, naming Warren Buffett's Berkshire Hathaway Inc. (BRK.A) or perhaps a private equity firm as possible candidates. With a market share of 47%, Carnival leads its industry, an oligopoly in which the top three companies combine for a concentration ratio of 80%. Buffett favors this sort of competitive moat, Barron's observes.

Indeed, the recent liquidation of venerable U.K.-based travel agency Thomas Cook Group “could be a modest near-term positive” for Carnival, as budget-minded consumers in the U.K. and Europe may seek "vacation/holiday options from stable operators," according to a research note from Wells Fargo, as quoted in a third report in Barron's. Chair Micky Arison, age 70, controls 18% of Carnival's stock.

Consumer electronics retailer Best Buy has defied skeptics about the future of brick-and-mortar stores. Revenue in fiscal year 2019 was $42.9 billion, while non-GAAP operating income was $2.0 billion, achieving goals set in 2017 for fiscal year 2021 two years ahead of plan, per the company's investor update on Sept. 25.

The update also indicates that Best Buy also has achieved $730 million in cost reductions, and that the target for revenue in 2025 is $50 billion. "Despite uncertainty surrounding potential tariffs, the Best Buy’s raising of guidance indicates that it believes it can weather whatever tariff situation results with minimal upset,” as Moody’s Vice President Charlie O’Shea observed in a note released in late August, as quoted in another Barron's article.

Looking Ahead

The performance of Goldman's picks is heavily dependent on continued economic expansion and bull market conditions. Should growth or the markets stumble, their picks may be unable to swim against the tide.