4 Undervalued Large-Cap Stocks to Buy After Earnings

Susan Dziubinski: Hi, I am Susan Dziubinski with Morningstar. Every Monday morning I sit down with Morningstar Research Services 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. On your radar this week, Dave, are two main things, Treasury yields and earnings. Now the yield on the 10-year Treasury bond crossed 5% for the first time since 2007. Do you expect the yield to rise much further?

Dave Sekera: Good morning, Susan. Usually, I steer away from making those short-term predictions, but I will say, in this case, I don’t think the 10-year is really going to rise that much above 5%. There’s a couple of reasons for this. First, there are just a lot of technical factors that are hitting the bond market right now. For example, we still have the Fed’s ongoing quantitative tightening program. We also have higher-than-expected U.S. deficit financing needs right now. And also I’ve been hearing reports of a lot of foreign investors and central banks selling as well. And then just thinking about going forward, as the 10-year does rise further and further above 5%, I think you’d see a lot of new buyers really start emerging, including insurance companies and pension funds. The type of buyers I would see that as a very attractive opportunity to duration match their asset and their liabilities.

Plus, when it just gets above 5%, I just think a lot of people are going to really start seeing that as being much more attractive, especially in the corporate-bond market. I was taking a look this morning, the Morningstar investment-grade bond index now yields 6.25%, and our high-yield bond Index is all the way up to 9.4%. And then lastly, thinking about it from a fundamental longer-term perspective, our U.S. economics team is forecasting that the economy is starting to slow and that growth rate is going to slow for the next three quarters. While our base case is no recession, that combination of that and then also the expectation that inflation will continue to slow, I think that combination is going to give the Fed the room that it needs to start cutting short-term interest rates next year.

Dziubinski: What does this mean for the stock and bond markets, Dave? What should investors be making of this?

Sekera: For investors, I think now is a really great time to make sure you reevaluate the allocations in your portfolio, both between the percent that you have in fixed income as well as the percent you have in equity, but also in the duration in your fixed-income allocations. I think now is a good time to start extending that duration further out on the yield curve, lock in those higher rates. Part of the reason is that we do expect short-term rates, while they look high now, will start coming down next year. Our economics team is forecasting that the Fed will cut the fed-funds rate by 175 basis points over the course of 2024. And then from an equity valuation yield perspective, I think that will put a negative sentiment on the equity market over the next couple of months. I think those higher rates will be a headwind until the market really sees the economy bottoming out, probably middle of next year and beginning to expand thereafter.

Dziubinski: Let’s move on to earnings. This week, the companies reporting includes some big tech names and also some important companies from the real economy. Let’s start out with some of those tech heavy hitters. First up, our Microsoft MSFT and Alphabet GOOGL. What does Morningstar think of these stocks today and what will you be listening for?

Sekera: Starting off with Microsoft, the stock is currently rated 4 stars, although it’s only trading at about a 9% discount this morning. Some of the things to listen for here first is going to be Azure. That’s their cloud business. It’s been a key growth driver for that company for a while now. That growth has been slowing. I think there is a concern just how much that growth rate is going to continue to slow and how fast that’s going to slow. That will be something that we’ll be focused on. We’re also going to want to hear any outlook for their OpenAI and its Copilot powered solutions. Again, everyone’s very focused on artificial intelligence these days. And then lastly, I want to hear what their macroeconomic outlook is. Of course, they have a good view not just as far as what’s going on here in the U.S., but a good view as far as the economy more globally. Moving to Alphabet, that’s a 4-star-rated stock, trades at about a 16% discount to our fair value.

The first focus there is going to be on their advertising revenue growth. Specifically, I want to hear if they expect a slowing economy will pressure that advertising spending. And if so, how much? Again, artificial intelligence going to be top of mind by a lot of people. We’re going to hear what they’re doing with Bard, that’s their generative AI, and how they plan on monetizing that and when that monetization’s going to come through. And then lastly, their cloud business as well, we’ll will want to focus on their profitability, demand, and potential impact from AI on that. The thing is that AI, while it’s certainly a huge future growth opportunity here in the near term, it could require a lot of these companies to spend a lot more money on capex [capital expenditures] in the near term.

Dziubinski: We also have Meta META, Amazon AMZN, and ServiceNow NOW reporting this week. Run through those three names for our viewers, Dave.

Sekera: Sure. With Meta, that is a stock with a wide economic moat, and that stock was under just intense pressure in 2022. That stock, I believe, fell about 64% last year. But again, this one has really just been a phenomenal call by Ali Mogharabi. He’s the equity analyst at Morningstar that covers that name. He held steady with his fair value estimate, his long-term intrinsic valuation over the course of 2022 when the rest of the market was panicking. That stock had started this year as a 5-star-rated stock following about 160% gain. It’s now trading in that 3-star territory, pretty much right on top of our fair value. That means that we expect that investors today will end up earning its cost of equity over the long term. Turning gears here to ServiceNow. That’s a company that had long been one of the most attractive stocks in the technology sector, according to Dan Romanoff.

I know that he noted several times that he thought that company had just the best combination of growth, value, and a strong balance sheet as well, but that stock’s up 40% year to date. That one also now is a 3-star-rated stock, trades at about a 13% discount to fair value. And lastly, of course, Amazon, that stock being up 50% year to date, that again started the year with a 5-star rating. It’s now down to 3 stars, trades at about a 14% discount. We do rate that company with a wide economic moat. I’m going to be listening very carefully for their guidance on their outlook for holiday sales. I think that has a lot of implications, not just with Amazon, but across a lot of different companies in the retail sector. We also want to hear their outlook for AWS, that’s their cloud computing business; their progression for their advertising business; and of course any discussion on the incorporation of AI into their sales model.

Dziubinski: Let’s move over to talk about some real-economy stocks. What companies will you be watching this week on that front, and what do our analysts think of the stocks today?

Sekera: First I’m going to be watching 3M MMM. Now 3M is down 27% year to date. But 3M, you have to remember, they’re really focused on short-cycle products. And that company I think has been a bit of an early canary in the coal mine as to the slowing growth right here in the real economy. Now, I do have to note that 3M also does have a number of different legal issues that they’ve been working to resolve. First has been a liability for “forever chemicals” in drinking water. They also recently made a settlement for their Combat Arms earplugs, but we think both of those issues are already reflected in their valuation. That’s a 4-star-rated stock, trades at a 34% discount, the company yields almost 7% right now, and we do rate the company with a wide economic moat.

Now moving out on the sales cycle, we’ll be looking at Danaher DHR. That’s a 4-star-rated stock, trades at a 15% discount, but it only pays a little bit under maybe right around one half of a percent dividend yield, a company that we rate with a narrow economic moat. And they manufacture scientific equipment for life sciences and diagnostics. And I’d note that stock’s down 11% year to date. And then lastly, Illinois Tool Works ITW. That’s a 2-star-rated stock, trades at a 10% premium, has a 2.4% dividend yield, company we rate with a narrow economic moat. Now they manufacture specialized industrial equipment and this is going to be on the longer end of that sales cycle. And, of course, the longer end has held up much better than the short-cycle sales. There is some concern here. We’re going to start seeing that sales cycle start to impact them as the economy is slowing for the next couple of quarters. That would be one where I do have some concerns here. That stock is up about 2% year to date. But again, with that 2-star rating, we do think that it is slightly overvalued at this point.

Dziubinski: And then lastly, we have oil giants, Chevron CVX and Exxon XOM both reporting this week. What do Morningstar analysts think of these two stocks today?

Sekera: Now, generally, when we look at the energy sector overall, we do think energy is overpriced. We do think that the market is overextrapolating today’s high oil prices too far into the future. Here in the short term, we’ve had the OPEC supply cuts, the embargoes on Russian oil exports. The oil market is very tight today, but our team forecasts that over the long term oil prices will come down. And that’s going to be based on a combination of a couple of things. One, we do expect that new supply would be coming online as E&P companies look to take advantage of these higher oil prices and start drilling for new oil. And we also expect that over time, maybe later this decade, we would see oil demand start to taper off as electric vehicles become a higher percentage of new auto sales and other oil reduction programs go into effect.

For investors, though, that do want that exposure to oil, Exxon is one of our better picks. It’s a 3-star-rated stock, trades at a 6% discount, and has a 3.3% dividend yield. It is a company that we rate with a narrow economic moat. Now Chevron, actually they just announced this morning, they’re acquiring Hess HES, that does follow Exxon’s acquisition earlier this month of Pioneer. At this point, I’m going to withhold making any comments until our equity team can put together a pro forma equity valuation model here. But a focus of that call will certainly be on that acquisition they just announced.

Dziubinski: Got it. Let’s move on to some new research for Morningstar and that would be a Morningstar’s analysts take on earnings so far. Let’s kick things off with what Morningstar thinks of what we heard from regional banks. Any surprises or significant changes to our fair value estimates on the regional banks?

Sekera: Not too much in the way of surprises. And I’d say just generally when we’re looking at the regional banks, I think there’s really three key factors that the market has been focused on and that I’ve seen Eric [Compton, Morningstar strategist] write about in our notes thus far. First, it has just been net interest income, and I would say for the most part it looks like they’re mostly in line, a few may be slightly worse, than looking at loan-loss provisions and surprisingly, I think they’re generally better than expected. And then lastly, deposits. Of course, that’s certainly been in the news with all the regionals. For the most part, it’s stabilized and there’s a couple here and there that’ve actually even gained some deposits over the past quarter. Looking at our fair values, I don’t think when we increased our fair value on any. We did lower our fair value on a couple of them by that mid-single-digit percentage area. Now looking at the stock performance after earnings, most of them have been down anywhere from a little bit to a couple that are actually down double-digit percentages.

For those that are down only a little bit, I think that’s probably a good sign. I think that’s really just being down with the rest of the market. But a couple of these, taking a look at Zions ZION, that’s the one that really caught my eye. That stock just cratered. It was down 18% after earnings. And I know Eric’s noted that Zions is one of the banks that’s going to be facing the most funding pressure across the regional sector.

And I think the other thing that happened here is that management noted net interest income. They said it’s going to stabilize one year from now. That’s much longer than what we expect for the other regionals. We’re expecting the other regionals’ net interest income, it’s actually already starting to go up or it should start going up after the first quarter. And the other one here that caught my eye is Regions RF. That was down 12%. They did miss expectations. They noted that they had weak net interest income on higher funding costs. That is one that we did lower our fair value in the mid-single-digit percent area. Now we do think net interest income should begin to rebound in 2024, but again, that is one where the market certainly didn’t like what they saw.

Dziubinski: Got it. It’s been a busy couple of weeks for Eric Compton, he’s Morningstar’s lead U.S. bank analyst. Going beyond financial services to some interesting individual names that reported last week, let’s start with Tesla TSLA. I hear price cuts weighed on profits and margins, and the stock really took a hit.

Sekera: It did. We slightly lowered our fair value to $210 from $215 per share, and that was really just based on lowering our short-term margins as Tesla does ramp up the cyber truck production. Seth Goldstein, he’s the equity analyst who covers Tesla for us, he actually has really compared that to the ramp-up of what we saw happen with the Model 3. He does forecast the automotive profit margins will rebound over the next couple of years as they do scale up production of the cyber truck. But effectively, and more importantly, our long-term forecasts for Tesla are unchanged. After falling 15% last week, that stock now is trading right on top of our fair value. Again, it’s now rated 3 stars today.

Dziubinski: Now Netflix NFLX, on the other hand, had a really strong quarter. What did our analysts think there?

Sekera: It did have a very strong third quarter. We did increase our fair value up to $350 a share from $330. But we think the market is probably being overly optimistic here. We do expect that subscriber growth will moderate, and I think more importantly and more concerningly, what we could see is that we do forecast a significant increase in their cost of content spending in 2024. The stock does trade in that 3-star territory, but it is at a 15% premium to our fair value.

Dziubinski: And then AT&T T put up some improving cash flow figures and the stock rallied after earnings. Summarize what happened there.

Sekera: It did. That stock was up about 7% after earnings. I think that was a good day of trading for that company. And as you noted, they did increase their free cash flow. They also noticed some improving customer trends. Right now AT&T is rated 5 stars. It trades at a 33% discount to our fair value and pays a healthy 7% dividend yield. The other thing I’d note for investors is that later this week we’re going to see earnings coming out of competitor Verizon VZ. That also is a 5-star-rated stock, trades at a 40% discount, and has a 7% dividend yield.

Dziubinski: Let’s move on to the stock picks portion of our program this week. You’ve brought viewers four large-company stocks to buy after earnings, and the first stock of the week is a stock we actually just talked about, AT&T. Tell us a little bit more about what you like here.

Sekera: With AT&T, you have to remember a lot of investors had just been burned by AT&T over the past, not just a couple of years but really a couple of decades. And a lot of that was really due to just bad strategic acquisitions that management had made, way overpaying for a lot of those acquisitions. I still think there’s a lot of negative sentiment on that name. However, a new CEO did take over in July 2020, and we think the company is now moving in the right direction. We do think that AT&T is focusing on what they do best and really focusing now on improving shareholder value. Over time we do suspect that the market, as they see better and better numbers, we will start seeing that negative sentiment starting to fade.

Now a couple of things with AT&T. A few months ago there was some news out regarding environmental liabilities from lead in its cable sheathing. We think that’s probably greatly overexaggerated at this point, but more importantly, our longer-term investment thesis is that the wireless industry actually is going to start operating it more like an oligopoly going forward. They will compete less on price, and that’s going to allow margins to expand. And as that happens, I really think that you’re going to start seeing that stock move up to what we consider to be the long-term intrinsic valuation.

Dziubinski: Now your next two picks this week are from the financial-services sector. Your first is Schwab SCHW. Why do you like the stock?

Sekera: That stock is down 38% year to date, and a lot of that was, it just really got caught up in the downdraft of the banking sector. A lot of concern that it would lose deposits and it’s going to have to replace those deposits with higher-cost, short-term funding. And that has definitely happened to some degree, but we think to much less of a degree than what the market is pricing in. Looking at earnings this quarter, I think our team is starting to see some stabilization. Schwab is now starting to pay down some of that higher-cost short-term debt. I think the real takeaway here from Michael Wong, who covers that stock, is that over the medium to long term, he does expect to see some significant earnings growth just as that company begins to normalize. It’s currently rated 4 stars, trades at a 36% discount, and currently yields 2%. And it is a company that we rate with a wide economic moat.

Dziubinski: And then your next pick is Goldman Sachs GS. Why?

Sekera: Goldman stock has dropped 12% year to date, and there’s a couple of reasons for that. First, Goldman during the pandemic, I think it got too far away from its core competencies, that being investment banking, trading, and asset management. They tried expanding into more retail-type banking activities, and that just really has not worked for them. They’re now exiting those business lines and getting back to what they do best. Secondly, investment banking activity has been very slow for the past two years. We had a record-breaking activity in 2021, but that slowed down a lot. Yet, we actually think that that slowdown is probably behind us. We think that that banking activity has bottomed out and should start to tick up in 2024. That’s going to be a good tailwind for Goldman, a lot of the other investment banks as well, especially once they get rid of those other noncore businesses. That stock trades at an 18% discount to our intrinsic valuation, places it in that 4-star territory. The stock yields 3.4% right now, and we do rate Goldman with a narrow economic mode.

Dziubinski: And then your final stock pick this week is from the tech sector. It’s ASML Holding ASML.

Sekera: ASML is certainly not a household name, but it is a very important company in the semiconductor industry. They are the leader in photolithography systems, and that’s used to make semiconductors, essentially the equipment that they use in order to transfer light patterns onto the silicon chips. That’s then used to be able to make the individual circuits. Of course the semi industry we all know goes through boom and bus cycles. Currently, there’s just too much of certain types of semiconductors out there, and they need to bring, the semiconductor industry that is overall, needs to bring those inventory levels down to a more normalized level. We think the market right now is just looking at this oversupply, bringing their estimates down, but we think that the company over the long term, as that cycle goes and starts coming back up over the next couple of years, it should perform pretty well. It’s a 4-star-rated stock, trades at a 23% discount. I think it yields a little bit over 1%, but it is a company that we do rate with a wide economic moat.

Dziubinski: 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. Dave and I will be back live 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.