Back to top

Image: Bigstock

Sometimes, Valuation Is the Most Important Consideration

Read MoreHide Full Article

It isn’t every day that all the major indexes take a nosedive. But it’s only to be expected when both the bulls and bears continue to air their views with logic and facts. For every positive view encouraging investment in XYZ stock, there is also a negative view, discouraging such investment. So what do investors do when they’re sitting with their free dollars and hoping for more?

As may be expected, the unemployment rate (non-farm payroll) rose from their historical lows of under 4% in March, shooting up to around 15% in April. But it has been coming down since then, dropping to around 11% in June, according to the Bureau of Labor Statistics, a positive indicator for consumer spending.

Yes, the situation is still worse than it has been in a long time, particularly considering that recent spikes in infection rates have increased fears of a second wave. And nobody knows if that will spur a second lockdown.

The good news is that if there isn’t a second wave leading to another lockdown, most segments of the market will normalize by next year. But therein lies the problem as well. Because this slowdown isn’t market related, any attempt to predict what will happen through the rest of the year necessarily includes some risk.

So while we continue to invest in stocks that promise growth or those that have gained from the new normal, we can supplement the risk in there by investing in some stocks that are obviously undervalued. Here I’m highlighting three Zacks Rank #1 (Strong Buy) or Zacks Rank #2 (Buy) stocks on the basis of their P/E, PEG, P/CF, P/S and P/B ratios-

Canadian Solar Inc. (CSIQ - Free Report)

Ontario, Canada-based Canadian Solar is a vertically integrated manufacturer of silicon ingots, wafers, cells, solar modules (panels) and custom-designed solar power applications. Its production facilities in Canada, China, Indonesia, Vietnam and Brazil design, manufacture and delivers these products and solar system solutions for both on-grid and off-grid use.

Canadian Solar operates in the Solar industry, which is in the top 25% of 250+ Zacks classified industries. Historically, the top 50% have outperformed the bottom 50% by a factor of more than 2 to 1.

The company is expected to grow earnings 22.8% in 2020 and 11.4% in 2021.

On the basis of its price-to-forward 12 months’ earnings (P/E) ratio, the shares are trading at a multiple of 7.82X, relatively close to its median value of 6.80X over the past year indicating room for upside. The S&P 500 is of course trading at its annual high of 22.7X.

The P/E to earnings growth (PEG) evaluates the P/E on the basis of earnings growth potential, and is therefore a more robust indicator of value. A PEG ratio of 1 is considered a fair valuation with anything above that indicating overvalued earnings growth. Hence CSIQ’s PEG of 0.26X indicates that the stock is significantly undervalued on the basis of its earnings growth.

But since earnings are derived after providing for non-cash and one-time expenses, it allows room for manipulation. So we may get a clearer picture from a valuation based on the company’s operating cash flow, i.e. before these items are deducted (stocks in a capital intensive industry would generally have high non-cash expenses in the form of depreciation). So a price to operating cash flow (P/CF) ratio should be as low as possible to indicate undervaluation. In this case, the P/CF of 2.23X is below the median value over the past year unlike the S&P 500, which is close to its annual high of 22.62X. So the shares are undervalued.

The price-to-forward sales for the current year of 0.41X is close to its annual high of 0.42X. The S&P 500 is at its annual high of 3.39X.

The price to book value of 0.89 in itself indicates that the stock is trading below its book value and is therefore undervalued. And right now, this is close to its median value of 0.81X over the past year. The S&P 500 is trading close to its annual high of 4.52X.

Upside is indicated on four out of the five considerations.

Office Depot, Inc. (ODP - Free Report)

Office Depot is one of the leading providers of business services and supplies, products and technology solutions to small, medium and enterprise businesses, through its fully integrated business-to-business distribution platform of 1,307 retail stores, online presence, and dedicated sales professionals and technicians.

The Retail-Miscellaneous industry, of which Office Depot is a part, is 31st out of 250+ Zacks-classified industries (top 12%), which therefore improves its upside potential.

The company is expected to grow earnings 9.0% in 2020 and 0.9% in 2021.

On the basis of P/E ratio, the current value of 4.63X is below the median value of 5.19X, indicating undervaluation.

Its PEG ratio of 0.70X indicates that the shares are undervalued.

The P/CF ratio for this stock indicates significant undervaluation as its current value of 2.36X is well below its median value of 3.25X over the past year.

On a P/S basis the shares are trading at their median value of 0.11, which in itself indicates fair valuation. However, given that the S&P 500 is trading at its annual high, there appears to be room for upside.

Its P/B ratio of 0.51X is below its median value of 0.54 over the past year, indicating undervaluation.

The stock is undervalued on all considerations, indicating upside from these levels.

Teva Pharmaceutical Industries Ltd. (TEVA - Free Report)

Headquartered in Petach Tikva, Israel, Teva Pharmaceutical Industries Limited is a global pharmaceutical company that develops, manufactures, and markets both branded and generic drugs, as well as active pharmaceutical ingredients (APIs) in North America, Europe, Latin America, Asia and Israel. Teva’s generic product portfolio includes tablets, capsules, liquids, ointments, creams, liquids, injectables and inhalants.

Teva operates in the Medical-Generic Drugs industry, which is in the top 24% of 250+ Zacks-classified industries. This improves its chances of upside.

The company is expected to grow earnings 3.3% in 2020 and 4.9% in 2021.

Its valuation based on P/E shows upside potential, as the stock is trading at 4.41X, which is relatively close to its median value of 4.07X.

Its PEG ratio of 0.79X indicates that the shares are undervalued.

On the basis of P/CF, the current value of 13.06X is below the median value of 13.71X, indicating undervaluation.

On the basis of P/S, the current value of 0.73X is midway between the median value of 0.62X and the high of 0.87X, indicating upside potential.

Its current P/B ratio of 0.84X in itself indicates undervaluation. It is between its median and high values of 0.72X and 0.98X, respectively.

All criteria indicate upside.

Conclusion

One factor to always keep in mind in volatile markets is the valuation. Because the best companies often end up getting overbought with true potential opening up in other areas.

 

5 Stocks to Soar Past the Pandemic

In addition to the companies you learned about above, we invite you to learn about 5 cutting-edge stocks that could skyrocket from the exponential increase in demand for “stay at home” technologies. This could be one of the biggest buying opportunities of the decade.

See the 5 high-tech stocks now>>


In-Depth Zacks Research for the Tickers Above


Normally $25 each - click below to receive one report FREE:


Teva Pharmaceutical Industries Ltd. (TEVA) - free report >>

Canadian Solar Inc. (CSIQ) - free report >>

Office Depot, Inc. (ODP) - free report >>