While the P/E for the S&P 500 soared in the past 5 years, today there are more than 3 times as many constituents with P/Es below 10. Among the 67 such stocks as of June 30, these 8 may be especially attractive: Bank of America Corp. (BAC), Goldman Sachs Group Inc. (GS), CVS Health Corp. (CVS), Lennar Corp. (LEN), Kroger Co. (KR), Delta Air Lines Inc. (DAL), PVH Corp. (PVH), and United Rentals Inc. (URI).
Significance For Investors
There is a record wide valuation gap between favored and disdained stocks, whether measured by P/E ratios or price to book (P/B) ratios, per analysis by JPMorgan cited by Barron’s. Low interest rates have led investors to pursue higher returns with riskier growth stocks, while index investing has reduced the impact on stock prices of company fundamentals. Both trends hurt value stocks, JPMorgan observes.
During the past 12 calendar years, value stocks lagged the market by about 2 percentage points annually, according to investment management firm Grantham, Mayo, & van Otterloo (GMO), co-founded by bearish market pundit Jeremy Grantham, per the same report. Value stocks beat the market by an average of 1.1 percentage points annually over the preceding 20 years.
CVS Health had a recent forward P/E of just 8.1 times estimated earnings, per Bloomberg data cited by Barron’s. The future of health insurance in the U.S. is a politically contentious issue, and this will weigh on CVS’ Aetna insurance unit through the 2020 presidential election. Aetna enjoys fast growth in Medicare Advantage plans, and slower growth in more profitable employer plans. Additionally, CVS appears ahead of target in cutting $750 million of annual costs at Aetna by 2020.
Walk-in MinuteClinics are in 1,100 of the 9,900 CVS stores, almost equaling the number of for-profit hospitals, per another Barron’s article. CVS Caremark is among the three leading pharmacy benefit managers (PBMs), which negotiate lower drug prices for group health plans. Caremark generates about $5 billion in annual pretax profits, but this can drop to about $3 billion if its profit margins fall in line with other players in the drug supply chain, according to Lance Wilkes, an analyst with Bernstein cited by Barron’s. Secrecy in PBM pricing deals is drawing scrutiny from Congress.
Goldman Sachs, a longtime leader on Wall Street, had a recent forward P/E of just 8.5 times projected earnings. Low interest rates, weak bond trading profits, scandals, and investigations are recent negatives.
Goldman is expanding beyond investment banking and securities trading, ramping up more stable consumer businesses such as lending through its Marcus unit and wealth management by acquiring United Capital Financial Partners. Cleared by the Federal Reserve to return $8.8 billion to shareholders over the 12 months, up from $6.3 billion currently, Goldman hiked its dividend from 85 cents to $1.25 per share.
Value investors, among them Warren Buffett, bet on mean reversion, by which stock valuations and returns eventually revert to long run averages. This requires patience, and that has been tested sorely over the last 12 years. When value investing finally makes a comeback, and whether the stocks mentioned above will enjoy rebounds in the near future, remains anybody’s guess.