Stocks Are Undervalued – Week in Review

Stocks Are Undervalued – Week in Review

Stocks Are Undervalued

The bear growled this past week as the S&P 500 Index skirted the (-20%) threshold. But then came Friday, and markets bounced back, much to investors’ relief. The Index is still technically in a correction, although that may change next week if more bad news arrives. However, according to Stock Rover*, the Nasdaq and the Nasdaq 100 are clearly in a bear market. I have pointed out recently that some tech stocks are down much more. In general, stocks are now undervalued, and some deals are to be had. However, investors should still expect more volatility.

Why Markets Recovered on Friday?

Over the past several weeks, we have covered the reasons why the stock market is struggling. The reasons include inflation, high oil and gas prices, the resurgence of COVID-19 in China causing excessive lockdowns, and the conflict in Ukraine.

However, three days ago, a positive number about inflation was reported, indicating slowing. The US Bureau of Labor Statistics said that the CPI grew by only 0.3% in April 2022, or 8.3% in the past 12 months. The 0.3% was the lowest since August 2021, and the 8.3% value showed a decline from March 2022. Notably, prices for energy, used cars, and apparel declined.

Before this, the stock market was arguably continuing its downward trend on the expectation of worsening inflation. In addition, there was positive news that China would ease its lockdowns allowing factories to reopen and global supply chains to function normally again. Lastly, the conflict in Ukraine is not abating, but at the same time, it seems to be heading to a protracted phase and not expanding like some feared and may not impact inflation as much as expected.

However, the bottom line is if inflation is peaking and trends down, the US Federal Reserve will not need to be as hawkish and aggressive with their interest rate increases.

Stocks Are Undervalued

Stocks are now undervalued. Last week, Morningstar highlighted that many stocks were trading below their fair value estimate. Dividend growth and income stocks like Starbucks (SBUX), T. Rowe Price (TROW), BlackRock (BLK), Microsoft (MSFT), Intel (INTC), Gilead Science (GILD), Emerson Electric (EMR), Medtronic (MDT), and Merck (MRK) are all undervalued according to them. Note that I own several of these stocks and added to existing positions this past week.

The list of articles below highlights some of these stocks.

Despite the bounce back in the stock market, many stocks are still down substantially YTD. A helpful map from finviz plots companies by market capitalization, sectors, industries, and year-to-date (YTD) performance. More defensive sectors and industries like telecom, drug manufacturing, consumer defensive, and utilities are performing relatively well. Aerospace is performing well due to the conflict in Ukraine. Energy is up because of high oil and natural gas prices.

If investors examine the forward price-to-earnings (P/E) ratio, the picture becomes more evident. Many companies are trading at low valuation multiples. In addition, dividend growth stock categories are trading at their lowest valuation from March 2020 to May 2020. However, bear in mind that not all stocks are undervalued, but there are many to choose from now.

Quoting Warren Buffett,

Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.

Uncertainty actually is the friend of the buyer of long-term values.

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.

Although not all investors have capitulated, many are now on the sidelines, and it is probably time to be contrarian, at least in my opinion.

Final Thoughts on Stocks Are Undervalued

Recent market volatility and poor earnings from some high-flying growth stocks have punished the markets. However, many of those stocks benefitted from strong pandemic tailwinds but now face headwinds. Second, other growth stocks were unprofitable and bid up to excessive valuations. Third, some high-quality stocks with long-term dividend growth have declined in the market downturn. For instance, Lowe’s (LOW) is down from its 52-week high of about $263 per share and is now at ~$194 per share, trading at a multiple of ~14.5X. Lowe’s is a Dividend King too. Investors should focus on these high quality stocks in their research.

The Stock of the Week

Today we highlight Quest Diagnostics (DGX), a clinical laboratory testing company. The company is one of two large third-party testing services competing with many hospitals’ in-house testing. We highlight the company since the stock price is down, and it is a Dividend Contender with 11 years of dividend increases. According to Stock Rover*, the stock price is down about (-17.2%) year-to-date (YTD). Simultaneously, the dividend yield went up to about 1.94%. The payout ratio is very conservative at 18.4%. The stock is below the 200-day exponential moving average (EMA) but above the 50-day EMA. The forward P/E ratio is about 15X at the lower end of its 10-year range. However, one risk is the stock may face some headwinds in 2022 as testing revenue declines. Stock Rover* gives the stock a high overall rating.

Dividend Increases and Reinstatements

Search for a stock in the list of dividend increases and reinstatements. This list is updated weekly. In addition, you can search for your stocks by company name, ticker, and date.

Dividend Cuts and Suspensions List

The dividend cuts and suspensions list was most recently updated at the end of April 2022. As a result, the number of companies on the list has risen to 551. Thus, well over 10% of companies that pay dividends have cut or suspended them since the start of the COVID-19 pandemic. The list is updated monthly.

Three new additions indicate companies are experiencing solid profits and cash flow in April.

The new additions were Gouverneur Bancorp (GOVB), Bridge Investment Group (BRDG), and Western Asset Management (WMC).

Market Indices

05/14/22

Dow Jones Industrial Averages (DJIA): 32,196 (-2.14%)

NASDAQ: 11,805 (-2.80%)

S&P 500: 4,024 (-2.41%)

Market Valuation

The S&P 500 is trading at a price-to-earnings ratio of 20.34X, and the Schiller P/E Ratio is about 31.68X. These multiples are based on trailing twelve months (TTM) earnings.

Note that the long-term means of these two ratios are 16.0X and 16.9X, respectively. 

The market is still overvalued despite the recent market correction and rebound. Earnings multiples more than 30X are overvalued based on historical data.

S&P 500 PE Ratio History

Shiller PE Ratio History

Stock Market Volatility – CBOE VIX

This past week, the CBOE VIX measuring volatility was down about 1.5 points to 28.87. The long-term average is approximately 19 to 20. The CBOE VIX measures the stock market’s expectation of volatility based on S&P 500 index options. It is commonly referred to as the fear index.

Yield Curve

The two yield curves shown here are the 10-year US Treasury Bond minus the 3-month US Treasury Bill from the NY York Fed and the 10-year US Treasury Bond minus the 2-year US Treasury Bond from the St. Louis Fed.

Inversion of the yield curve has been increasingly viewed as a leading indicator of recessions about two to six quarters ahead, according to the NY Fed. The higher the spread between the two interest rates, the higher the probability of a recession.

Economic News

The US Energy Information Administration, in its May 2022 Short-Term Energy Outlook (STEO), estimates that US crude oil production will average 11.9 million bpd in 2022 and increase to 12.8 million bpd in 2023, exceeding the record average production of 12.3 million bpd set in 2019. The STEO assumes that US GDP will grow by 3.1% in 2022 and 2023. Despite the production increases, the EIA expects Brent crude prices to average $107/bbl in the second quarter of 2022 and $103/bbl in the second half of 2022. The average Brent crude price is expected to drop to $97/bbl in 2023.

The Labor Department reported a slight increase in initial jobless claims for the week ending May 7th. The seasonally adjusted initial claims were reported at 203,000, increasing 1,000 from the previous week’s upwardly revised level. The last week’s initial claims value was revised from 200,000 to 202,000. The four-week moving average, which smooths out volatility was 192,750, an increase of 4,250 from the previous week’s revised average. Continuing claims were reported at 1.343M, down 440,000 from the last week’s upwardly revised level. The continuing claims 4-week moving average was 1,385,000, a decrease of 32,750 from the previous week’s revised level. This number is the lowest level since hitting 1,374,250 in January of 1970.

Thanks for reading Stocks Are Undervalued – Week in Review!

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Published at Sun, 15 May 2022 04:00:00 -0700