5 Undervalued Stocks to Buy After Earnings

Susan Dziubinski: Hi. I’m Susan Dziubinski with Morningstar. Every Monday morning I sit down with Morningstar’s chief U.S. market strategist Dave Sekera to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead. Dave, the big thing on your radar this week is earnings. A lot of mega-cap companies report this week. What might that mean for the market?

Dave Sekera: Good morning, Susan. I think it could introduce some heightened market volatility this week and that’s really just based on two factors. So first, just based on the size of their market cap alone, large swings in those individual stocks can just have an outsize impact on the overall market. And secondly, the commentary and outlook that those companies provide during their call, that often sets the tone across their respective sectors. So, if either earnings and/or guidance are different than what the market expectations are coming into this week, we could not only see big moves in those individual stocks, but across their entire respective sectors as well.

Dziubinski: Let’s go through some of the notable tech and tech-related companies that are scheduled to report. On Tuesday, I think we have Microsoft MSFT and Alphabet GOOG. What are you listening for there?

Sekera: All right. Well, first off, Microsoft is a 3-star-rated stock. It’s had quite a run thus far this year. So it’s only trading at an 8% discount to our fair value at this point. Now I’d say most importantly for Microsoft this quarter is going to be how that Azure business is doing. That’s really been a key driver for Microsoft for the past couple of quarters. Now growth there has been decelerating, and any further slowdown there could pressure that stock. I think we also want to hear more about their strategy regarding artificial intelligence. Of course, that’s been in the headlines the past couple weeks, but really specifically about open AI and their co-pilot powered solutions. And then lastly, we will certainly focus on their macroeconomic commentary and their customer demand outlook.

Alphabet, the parent of Google, is a 4-star-rated stock and that trades at a 32% discount to our fair value. And I want to hear what their views are on how the impact of artificial intelligence could impact their search business as well as details regarding their own AI strategy. Otherwise I’ll be listening to hear if any kind of economic outlook is having an impact on advertisers, specifically at their YouTube division. And then lastly, I just want to hear details regarding their traffic acquisition costs. There’s certainly been a lot of reports and news headlines that Alphabet might be having to renegotiate both with Apple AAPL as well as Samsung. There’s reports that Samsung might move to Bing. So those traffic acquisition costs guidance there certainly will be important this quarter.

Dziubinski: Then midweek, we’ll be hearing from Meta META and Amazon AMZN. What are your expectations?

Sekera: Meta’s a 4-star-rated stock. Trades at an 18% discount. And Meta has really had a huge runup this year. It’s up I think about 77% year to date. I do think that in the short term with the stock up that much, any disappointment could certainly send that stock down after earnings. And I think there’s really three main things the market’s going to be listening to here. So first, commentary regarding their advertising revenue and trends will be at the forefront; I think people are going to want to hear about the progress on their expense-cutting programs; and then any updates on any outstanding regulatory issues.

Dziubinski: And Dave, what about Amazon?

Sekera: Amazon is a 4-star-rated stock. Trades at over a 20% discount to our fair value. Now similar to Microsoft, Amazon Web Services has also been a key growth driver for the company. So, I think what the market is going to be looking for is, has the growth rate at AWS continued to slow? And if so, by how much? Now the other key growth driver for Amazon is its advertising business. Now that has also slowed, but our equity analyst thinks it’s holding up better than the advertising at Meta or Alphabet. And then lastly, just want to hear an update for retail sales trends. Have they begun to accelerate or reaccelerate in this case? I know our expectation from our research team is that they’re expecting in-line or better results there as well.

Dziubinski: And then we have a couple of big oil names reporting later in the week, Exxon Mobil XOM and Chevron CVX. What are you expecting to hear there?

Sekera: Sure. So, both of those are rated 3 stars and trade pretty close to their fair value estimates. Now I do expect that they’re going to have a pretty strong quarter. Oil prices have remained pretty high as well as OPEC has announced production cuts. However, I think both stocks being already pretty fairly valued and really that’s just because oil prices, while we do think that oil will remain high here in the short term, we’ve held to our longer-term oil forecast, that oil will fall toward $55 a barrel. And really what that is, that’s our long-term estimate where we see the supply and demand curve intersects with the cost of marginal new oil production.

Dziubinski: Dave, let’s pivot over to some new pieces of research from Morningstar on three big names that reported last week, Tesla TSLA, Netflix NFLX, and J&J JNJ. Let’s talk about Tesla first. Morningstar reduced its fair value estimate on the stock from $225 to $215. Walk us through that change and whether we think Tesla’s a buy today.

Sekera: Well, first I’d note that following the sellout that we saw, Tesla stock’s actually moved back now into that 4-star territory. It trades at a 23% discount to our fair value. Now as you mentioned, we did reduce our fair value by $10 to $215 a share, but I think that the market reaction actually overreacted following the earnings. So, when I think about the reduction in our fair value, that really is just reflecting higher short-term margin compression as the company in the short term here is pursuing a volume over unit profit strategy. And so partially offsetting this is how we—and again, taking a look at our notes from our equity analysts here—is we did increase our outlook for the energy generation and storage segment and that reflects higher growth as Tesla builds out a new facility in China.

And while we did reduce that short-term outlook, the long-term view is unchanged when I think about the base case for the automotive division. We still forecast that Tesla will be able to deliver five million vehicles by 2030 annually. And we also do think that their cost reduction programs and their fixed-cost leverage will drive long-term profit margin expansion. Actually more specifically, we do forecast that their automotive gross profit margins will increase over time to 29% from the low 20% range that we’re seeing this year.

Dziubinski: We maintained our fair value estimate on Netflix after that company reported. Walk through Morningstar’s analysis here.

Sekera: Netflix stock trades pretty close to our fair value and is a 3-star-rated stock and I’d say this is actually probably one of the quietest, most eventful quarterly earnings that I can remember out of Netflix in a long time. Now, the stock did slide a little bit after earnings. It recovered a little bit more the next day, but when I look at what they reported, yes, they’re net sub additions we’re a little short of our forecast. We expect that’ll be offset over time and that revenue will increase as Netflix continues to expand on its password-sharing crackdown.

So, considering how volatile Netflix stock can be over time, personally I would look for a greater margin of safety before I look to buy that stock. In this environment, we just see a lot of better, more undervalued opportunities for investors elsewhere.

Dziubinski: And lastly, let’s talk about Johnson & Johnson. We reaffirmed our current fair value estimate there, but our analyst did note that drug pressures are mounting for J&J. So what’s going on?

Sekera: J&J is another 3-star-rated stock. Trades pretty much right at fair value. Now the results for the quarter in and of themselves were pretty much inline with our expectations, but our analyst did note that we believe that patent losses and slower new drug losses will weigh on the longer term drug outlook. Now having said that, I would note that it is a wide-economic-moat-rated stock and that wide economic moat rating is really derived from its drug innovation and its pipeline, and that I think does help support our long-term evaluation.

And when I think about J&J stock in and of itself, I do think it’s appropriate for investors looking for a Low Uncertainty stock that pays a relatively high dividend. It’s about a 3% yield right now, but again, I still think that I would look to buy stocks at a greater margin of safety and in the healthcare space, we do see other opportunities out there such as GlaxoSmithKline GSK.

Dziubinski: Let’s move on to the picks portion of our program this morning, Dave. This week you’ve brought us five undervalued stocks you like after earnings. The first stock on your list is Citigroup C. Now this bank has been a top pick from our analyst for a while. What’s the story here?

Sekera: Well all the mega banks have reported and generally I’d say earnings and guidance were either in line to slightly better than expected. And really the biggest takeaway from the big banks is that while generally they have increased their loan-loss reserves, those increases really are just bringing those loan-loss reserves up to maybe slightly higher than historical norms. So, at this point, I would say the banks really aren’t preparing for a really deep or long recession. They’re not looking for a surge in defaults or bankruptcies. And so that to me is giving me a pretty good comfort looking at this area and I think also supports our economic view looking forward. Among the big banks, JPMorgan JPM is a 3-star-rated stock so that’s pretty much trading right within that fair value range, Bank of America BAC, a little on the undervalued side at 4 stars, and Wells Fargo WFC is a 5-star stock, but our preference here is still Citibank.

Citi’s a 5-star-rated stock, trades at a 33% discount to our fair value, and also pays about a 4% dividend yield. In fact, it’s kind of one of the best ideas in the value category that we have across our coverage. And part of the reason is that I would note that Citi does trade at a very large discount to its tangible book value. And in my view, from a value stock perspective, now that discount that tangible book value provides both downside production as well as upside potential. So, we’re really not projecting that much in the way of earnings growth with Citi, but we do expect that over time it will be able to earn its cost of capital, and that stock will then appreciate up toward that book value. Whereas all the other mega banks all trade at a premium to their book value right now.

Dziubinski: Your second stock pick of the week is another bank, U.S. Bancorp USB. Our analyst called the earnings report average and expects that we’ll shave our fair value estimate on the stock by a dollar or two. What do you like about the stock?

Sekera: Well, we are still waiting for a lot of the other regional banks to report, but generally U.S. bank reports were generally in line with results. Now we did lower our full year revenue guidance a little bit here due to lower expected net interest income, but more importantly I think here the real story is at the deposit base and the funding costs are roughly tracking in line with what we would have expected. So, the stock’s currently rated 5 stars, trades at an over 40% discount to our fair value estimate, and pays a 5% dividend yield.

So our thesis among the majority of the regional banks that we cover is that yes, they are under stress from declining deposits. They do have some stress from their real estate exposure, but we do think that stress will be manageable. Now having said that, I will caution investors. One regional bank that we do have some concern on is First Republic FRC. We had lowered our fair value estimate there to $3 a share after it had reportedly lost 40% of its deposits earlier this past quarter.

Dziubinski: The next name on your stocks of the week is Charles Schwab SCHW. There was nothing really eventful in the company’s earnings report, and its balance sheet and client base seemed fine, but our analyst expects a near term decline in earnings and then a longer term uptrend and maintained our $70 fair value estimate.

Sekera: I’d note Schwab is of one of a handful of stocks that we had highlighted earlier that we do think that they have enough of a different business model and do have enough other ways to fund themselves other than deposits that, even after the Silicon Bank failure, we’re very comfortable with these stocks and with these companies going forward. So, as you mentioned at Schwab, first-quarter earnings really didn’t show any signs of really balance-sheet distress or any client attrition. Yes, some higher costs as investors have been moving some of those deposits into higher-yielding money market funds, but we’re leaving our $70 fair value unchanged following the earnings report. The stock’s currently rated 4 stars and trades at a 23% discount.

Dziubinski: Let’s move away from financial-services stocks. Your next pick is actually Delta DAL. Like the many other airlines, Delta has been enjoying some tailwinds.

Sekera: Following earnings, we did leave our $60 fair value estimate unchanged. The stock’s rated 5 stars, and I think it trades at over 40% discount to our fair value. We do forecast strong bookings for the busy summer season and an improving cost picture in the second half of 2023, but also in my mind I think Delta’s just a good play on consumer behavior normalization and even more specifically the return of the business traveler as we do see a rebound in business travel this year and next.

Dziubinski: And then the last undervalued stock on your list this week is a tech name. It’s ASML ASML. The stock’s up about 60% since it’s low last October, but it’s still undervalued, according to our metrics.

Sekera: It is. The stock slipped a couple percent but then rebounded right the next day. And I think really what’s going on there is the market is somewhat concerned that the latest round of export restrictions to China could impede the company’s ability to sell certain types of semiconductor tooling into China. The earnings in and of themselves were ahead of our expectations. Management did reiterate its outlook for 2023 revenue to be up 25% year over year. But we also think that this is also a good play on the long-term growth in artificial intelligence as ASML’s equipment is used to make those specific type of AI chips. The stock’s rated 4 stars and currently trades at a 17% discount to our fair value.

Dziubinski: Well thanks for your time this morning, Dave. Be sure to join Dave and I live on YouTube every Monday morning at 9 a.m. Eastern, 8 a.m. Central. And while you’re at it, subscribe to Morningstar’s Channel. Have a great week.