5 Undervalued Stocks to Buy Before They Rise Further

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Every Monday morning I sit down with Morningstar Research Services’ chief US market strategist Dave Sekera to discuss what’s on his radar this week, some new Morningstar research, and a few stock picks or pans for the week ahead. Good morning, Dave. You have a few economic reports on your radar. In fact, we have both the CPI and the PPE releasing this week.

Remind viewers how these two inflation measures differ from each other.

David Sekera: Good morning, Susan. I can’t believe it’s already been a month since that last CPI report. It feels like we were just talking about it, actually. But taking a look at the two. PPI, that’s the measure of inflation at the producer level, where CPI is the measure of inflation at the consumer level. So, essentially the prices that are actually being paid by individuals.

Now, as a reminder, CPI last month it did actually price, or print, you know, much higher than what the market had expected. Our economics team came out with an article quickly thereafter telling investors not to panic. You know, the CPI was boosted by a couple of different things like shelter and healthcare, which have different weightings and calculations as compared to the personal consumption expenditures index.

And of course, that’s the one that the Fed watches. And then later in the month, last month, your PCE did come out and it was in line with expectations. According to our economics team, we still expect that inflation remains on that long-term downward trend.

Dziubinski: What’s the market expecting for each of these measures this week?

Sekera: The consensus for CPI on a year-over-year basis is 3.1%, and that would be unchanged from last month. But taking a look deeper at the core CPI on a year-over-year basis, the consensus is for 3.7%. And I know that’s our expectation from our economics team as well. And that would be down from 3.9% the print last month.

And then as far as PPE goes, you know, we expect that to be flat from last month and core PPE to also be on a slow downward trend.

Dziubinski: The market will also be digesting some retail sales numbers this week. What’s Morningstar watching for in these numbers?

Sekera: The projection from our US economics team is for three tenths of a percent increase on a month-over-month basis in February from January. That’s actually a pretty good improvement from the negative eight tenths of a percent that we saw last month. But it is actually slightly lower than what the consensus is, which is currently five tenths of a percent.

Dziubinski: Moving over to earnings, a few companies report this week that you’ll be watching. First up is Adobe ADBE. Why is this one that you’re watching and what does Morningstar think of the stock ahead of earnings?

Sekera: We actually think it’s pretty fairly valued. It’s a 3-star-rated stock. Our fair value estimate is $610 per share. It puts it in the bottom of the range that we consider to be fairly valued. Now, I do think that it could be volatile after earnings. And I think when you look at the charts here on the stock, you’ll see in 2020 and 2021 the stock actually had soared during that disruptive tech bubble.

When the pandemic had first started, we then saw that stock correct to the downside in 2022. In fact, it dropped into that 4-star territory. Now, over the past 52 weeks, the stock has done very well. It’s back up 60% since then. In fact, that puts it kind of near its highs. I think the company’s probably going to need to post both pretty good results on the top line as well as on the margin line in order to keep that stock up here or have any other upward movement at this point.

Dziubinski: We also have two discount retailers reporting this week, Dollar Tree DLTR and Dollar General DG. Why are you watching these two companies and what do we think of the stocks heading in earnings?

Sekera: A little similar to Adobe here. Both of these stocks did rise quite a bit in 2021 and 2022. They did end up going all the way up into that 2-star territory, so we did see a selloff in the second half of last year. Now, those stocks have bounced a bit off of the bottoms here.

But at this point, Dollar Tree is still a 2-star-rated stock, and Dollar General is now in that 3-star territory. So as far as results here from a top-line perspective, I suspect that they’re probably going to both be under pressure to have much revenue growth. They do serve the lower-income customers and, of course, the lower-income have been under the most pressure from inflation over the past year to year and a half.

And then from a margin perspective, again, I expect them to be under pressure. Of course, they do have a tough time putting through their own cost increases to consumers. I think for valuations really to start moving up from here, you would actually need to see those operating margins start to expand as inflation starts to slow.

Dziubinski: Let’s move on to some new research for Morningstar, starting with some company-specific research. Last week, Target, ticker TGT, reported decent earnings and margin improvement for the quarter, and the stock rallied. What did Morningstar think of the results and how does the stock look today?

Sekera: That stock actually had a really good day after earnings. the stock surged now much higher and as you noted specifically on those higher margins. Now, the reason the margins were higher is that Target has a much more normalized level of inventory this year compared to last year. They didn’t have to resort to the same kind of deep discounting that they did last year, which of course, then pressure their margins.

However, we only raised our fair value estimate relatively modestly. The operating margin did come in at 5.8%. Now, we’re already modeling in margin on a long-term basis to expand. We’re looking for that long-term margin to be about 6.5%. At this point, we didn’t see any reason to lift our longer-term assumptions any higher.

And in fact, our longer-term assumptions are already higher than management guidance. Also note here that with Target we rate the company with no economic moat. So, again, we don’t see the company having a long-term durable competitive advantages and really not having any kind of edge above some of the other retailers. I think we’re pretty comfortable with our long-term assumptions here.

With the price where it is now, it does put that in that 2-star territory, and it’s trading at a pretty healthy 28% premium above our fair value.

Dziubinski: Two companies benefiting from the rise of AI reported last week, and those were Broadcom, which is ticker AVGO, and Marvell Technologies, which is ticker MRVL. We raised our fair value on Broadcom after earnings came out. Let’s start with that one.

Sekera: Even after bumping up our fair value, it’s a 2-star-rated stock and trades at a 20% premium to our fair value. And the increase in our fair value really accounts for a couple of different things. But one, I would say it’s really mostly because of an increase in projection for their AI-related business. However, when we look at the rest of their businesses, they’re still experiencing weakness in those other lines.

Based on where the stock is trading, the market’s pricing in, we think, about $50 billion worth of chip business over the course of the next five years. And when I look at that, compared to our forecast, we’re only looking for $30 billion of that increase over that same time period. And as a point of reference, that AI revenue this quarter was a little over $2 billion.

So, that really puts it only at a $10 billion run rate. So already on some pretty strong growth assumptions for the AI business there. In fact, our projection assumes that from the current run rate, it’s got to more than triple in order to get to our run rate, much less what the market is pricing in.

Dziubinski: Then turning to Marvell, the stock was down pretty substantially after earnings. What happened there? And is there a buying opportunity here?

Sekera: Well, the short answer is no. We don’t see this as being a buying opportunity at this point. Similarly, Marvell also got a boost from its AI products that are used in data centers. But that was actually more than offset by weakness in some of their other areas—enterprise, consumer, telecom, and so forth.

And this quarter, you know, guidance implies almost a 20% sequential decline from last quarter, and that’s well below our forecast. Marvell did fall 11%, but even still, it’s at a 24% premium to our fair value, a 2-star-rated stock.

Dziubinski: Let’s move on to some new research around CrowdStrike, which is ticker CRWD. Morningstar raised its fair value on the stock by 36% after the company reported earnings, and that’s a really substantial increase. Why the hike?

Sekera: Unfortunately, I just think that we failed to understand the true long-term potential of this company, and I think we really missed the ball on this one, to be perfectly honest. If you remember back in June 2022, I published an article on the cybersecurity industry and why we like the fundamentals of cybersecurity as much as we do.

And much of that article still holds true today. On our show in February 2023, we recommended CrowdStrike stock. The stock was about $110 a share back then. It’s now well up over $300 per share. So, following earnings, our equity team kind of went back to the drawing board, really reevaluated their long-term assumptions.

They substantially increased their long-term growth prospects. And really the two reasons here are, one, just increased adoption of CrowdStrike’s newer offerings that are really taking hold. And secondly, its expansion from their traditional endpoint business into other areas, which has also been working out well for them.

Dziubinski: After that pretty big boost to fair value, does the stock look like a buy?

Sekera: At this point it puts it into 3-star territory. So, again, an area that we believe is fairly valued today. so not necessarily that we think it’s a buy because it’s undervalued. But at the same point, I would expect that for long-term investors here, you will end up at least earning the other company’s cost of equity over time.

And I’d note with as much as the cybersecurity industry overall has run up over the past year. In fact, all of our cybersecurity coverage right now is in that 3-star area.

Dziubinski: Now Albemarle, which is ticker ALB, surprised the market last week when it announced plans to issue convertible preferred shares, and the stock plunged on that news. Walk viewers through the details of the offering and the rationale behind it.

Sekera: They priced slightly over a $2 billion mandatory convertible preferred. And the stock did tank on that. I think it dropped about 18% that day. Now, a large part of that selloff is just going to be because of the arbs out there, the convertible arb players selling that stock in order to use that as a hedge against going long the mandatory convertible preferred underneath.

And then the other part of it, too, is that these are mandatory convertible preferreds. So, when this matures they will convert into equity. So, there is a natural dilution there as well. But I would say the stock has bounced a bit. I think it’s regained about a third of that selloff at this point.

Dziubinski: After the terms of the offering were announced, Morningstar reduced its fair value estimate on the common stock by about 8% to $275. Why?

Sekera: Again, it just gets back to it is exactly what it sounds like, a mandatory convertible. So at maturity, it converts into the common stock. And, of course, there is a range at which it converts depending on where that stock price is at that point in time. But based on our assumptions and how much dilution there is for the existing stockholders today, that was the reason for bringing that fair value down.

Dziubinski: How does the price of the common stock look today? What do we think of it?

Sekera: Our price today is $275 a share. That is a decrease from 300 a share prior to the offering. But it still leaves that stock deep in 5-star territory. In fact, I think the stock is about half of our fair value estimate today. And I just note the kind of the investment thesis, the synopsis here is that lithium prices were in a bubble back in 2021 and 2022, they popped in 2023. We think those prices are bottoming out here. Overall, we think that the amount of lithium that’s going to be produced over the course of the next decade is going to lag the amount of demand out there. We think it’s going to be undersupplied and that will keep lithium prices well above the marginal cost of production at least through 2030.

Dziubinski: Let’s talk about some new research from you, Dave. Your stock market outlook for March, which viewers can access via a link beneath this video. Specifically, let’s look at the market through the lens of the Morningstar Style Box, starting with a look at the valuations of growth stocks versus value stocks. How do things look?

Sekera: The market overall, with as much as it’s rallied this year, is now starting to trade a couple of percent above our fair value when we look at all of the stocks that we cover and put together that composite. And as you note, when we do break it down into the Morningstar Style Box, growth stocks right now are trading at about a 10% premium, whereas value stocks, which have lagged, are still trading at a 9% discount.

Dziubinski: Has that valuation gap between growth and value stocks widened or narrowed during the past few months?

Sekera: It’s been widening out, and it’s been widening out here for quite a while. At the end of 2022, growth stocks were undervalued, and they’re actually more undervalued than the value category. But when I look at the returns here, growth stocks rose 38.5% in 2023, and they’re up almost another 7% year to date. That does put growth in that premium to fair value. Now, when I look at the value category, that only rose 12% in 2023, and it’s only up about 4.5% year to date. So, value stocks are still trading at a pretty deep discount compared to our fair value.

When I look at the spread between the two, it’s not the greatest that the spread has ever been. That actually had peaked in August 2020, but since the end of 2010, when I calculate the current spread versus where it’s been historically, it’s only been this wide or more only 6% of the time.

Dziubinski: Why has this gap persisted, Dave? Is it simply because of the ongoing outperformance of growth stocks?

Sekera: For the most part, it really is due to that outperformance in growth. And specifically, I would say it’s actually the technology sector, which is now one of the most overvalued sectors in our view. In fact, technology was one of the more undervalued sectors at the beginning of last year. And even when I think about growth and when I think about tech, the biggest gainers specifically have been any of those companies that are even remotely tied to artificial intelligence.

And with as much as they’ve risen at this point, most of those stocks are well into fair value territory, pretty fully valued. And some of them are even getting pretty extended now moving into that overvalued territory.

Dziubinski: Moving over to market capitalization, we continue to see large caps trading at less attractive valuations than small caps. How large is the gap, and here, too, is that gap widening or tightening?

Sekera: Currently, large-cap stocks are trading at a 4% premium to our fair value, whereas mid-cap stocks are trading at a 5% discount. But small-cap stocks have really lagged behind in their returns. Those are now trading at a 20% discount to our fair value.

Dziubinski: Similar question here, Dave. Is the gap largely the result of the underperformance of small-cap stocks compared to large-cap stocks?

Sekera: It is. When I look at returns over the past year, large-cap stocks were up 30% last year. They’re up another 8% year to date through last Friday. Mid-caps were only up 16% in 2023 and only up 6% year to date. And small caps were a little bit better than mid-caps last year, up 20%. But this year they’re lagging. They’re only up 2%.

Dziubinski: Given how valuations look across the style box, how would you suggest investors position their portfolios today?

Sekera: Well, just from a broad equity exposure, I would still remain fully invested in equity at whatever your target allocation in your portfolio is. It’s not to the point that I would look to underweight equities today, but within that portfolio, I would look to overweight value stocks, whether you want to do that on an individual stock basis or using ETFs or mutual funds. In order to pay for that overweight in value, I’d look to underweight core and growth stocks.

Then from a capitalization basis, I would still look to overweight small caps. That is where we do see the best long-term value, as well as a slight overweight in mid-cap stocks because they are still slightly undervalued but not nearly to the degree as small caps. And, again, in order to pay for those overweights, the area that I’d look to underweight would be the large-cap space.

Dziubinski: We’ve reached the crowd-pleasing part of our program, Dave, your picks for the week. Your picks this week are all growth stocks with price momentum, but they still look undervalued, according to Morningstar. Your first few picks are from the healthcare sector, with the first being Veeva Systems, which is ticker VEEV. The stock is up about 35% since mid-November. Why do you like it?

Sekera: I think these stocks are just a good indication that even within areas of the market that are getting overextended and overpriced, there’s always going to be individual stocks that are undervalued. And in this case, I also look for those stocks that look like they’re having some pretty good momentum here in the short term, as well as, you know, being undervalued.

Veeva is an interesting company. It’s a leading supplier of cloud-based software and solutions for the life sciences industry. The stock is currently rated 4 stars, trades at a 16% discount, and it is a company that we rate with a wide economic moat. So, again, just a good growth stock with a good price momentum. And when I look at our most recent analyst note, I would just say fourth-quarter results were slightly ahead of expectations.

We did make a slight increase to our fair value. So, it appears that the company is executing well right now. A couple of things that our analyst highlighted were that they did report some new customer wins as well as had some successful new product launches. So, I think good momentum here, both technically in the stock price as well as fundamentally in the underlying company.

Dziubinski: Now, your second pick this week is another name from healthcare. It’s ResMed, which is ticker RMD. The stock is also up well over 30% since last fall. Tell us about it.

Sekera: This is a stock that actually kind of was a little bit under the radar for me as a is not a stock that I knew before I did the screen. But ResMed is actually one of the largest global respiratory care companies, primarily for the treatment of sleep apnea. Two thirds of their business is here in the US. Stock is currently rated 4 stars, 27% discount. The company that we do rate with a narrow economic moat. When I think about the long-term outlook here and look at our forecast, I would just say that we are seeing an increase in the diagnosis of sleep apnea. And over time that company should benefit from the aging population as well as the increase in obesity rates.

Dziubinski: Crispr Therapeutics CRSP is up more than 100% since since fall. But you think that stock still has legs. Why?

Sekera: It’s still rated 4 stars. It does trade at a 34% discount. I will note here that it is a company that we rate with no economic moat, but the company has focused on using gene-editing technology specifically for genetically defined diseases. And our economic our equity team here notes that they think that this is probably one of the better companies that provides long-term investors who have a pretty high risk tolerance—again because it is still in the startup stage—really with a pure-play exposure to what they consider to be relatively novel gene-editing technology.

They also noted here that 2024 is going to be a pivotal year for this company. They are rolling out the commercialization efforts for a drug that has been approved for treating sickle cell disease.

Dziubinski: Moving off healthcare, your next pick is WK Kellogg KLG, which is the cereal business that was spun out from the former Kellogg business. The stock is up more than 40% since fall but shares still look undervalued. What’s driving performance and why do you like the stock?

Sekera: Still, in our view, a very undervalued stock. It’s deep in that 5-star territory, trades at a 46% discount to our fair value, and also know that pays a very healthy 4.4% dividend yield. As you noted, Kellogg itself did split up into two businesses last year. So you have Kellanova, which is the ticker K, and that’s the higher-growth snacks-oriented part of the business.

And then WK Kellogg is the slower-growth, traditional cereal business. When that stock did split up, I think the WK Kellogg stock was orphaned. Essentially a lot of people that owned Kellogg as the consolidated entity looked to sell the WK Kellogg stock off. It was a small-cap stock, and it was a slower-growth business that I don’t think a lot of people had very much appreciation for.

In fact, the stock immediately fell about 50% once it was free to trade. A small-cap stock, I mean, small in the small-cap universe, only $1.2 billion in market cap. And I think it really just fell below the radar of most institutional money managers. There was no sponsorship in the name. So, that’s why we saw that free-fall, you know, early on.

Now, when I look at the charts here, I do think some of the institutional money managers in that small-cap space are probably now starting to pay attention to the company. I think they’ve been doing their due diligence. It appears to me that with kind of the price momentum that we’ve seen here, it does look like we’re probably starting to see some accumulation by the institutional investors.

Dziubinski: Then your last stock pick this week is Chart Industries GTLS. The stock’s up about 25% since the end of January but still looks very undervalued, according to Morningstar. So tell us about it.

Sekera: So, a 4-star-rated, 28% discount company that we do rate with a narrow economic moat. Interesting company. It makes cryogenic equipment for storage and distribution for both industrial gas as well as and LNG, so liquefied natural gas. And as we know with everything that’s going on in the world today, LNG is just a large growing total addressable market for this company.

We also think that there’s opportunity for margin expansion here. I like it both from a top-line as well as a bottom-line perspective. And having talked to our equity analyst, his main takeaway is that he thinks consensus estimates remain just far too low for 2024. So, this is one both with that good valuation as well as some good underlying fundamentals that we think could continue some good momentum this year.

Dziubinski: Well, thanks for your time this morning, Dave. Viewers interested in researching any of the stocks that Dave talked about today can visit Morningstar.com for more analysis. We hope you’ll join us again next Monday at 9 a.m. Eastern, 8 a.m. Central. In the meantime, please like this video and subscribe to Morningstar’s channel. Have a great week.