5 Cheap Value Stocks to Buy that Look Like Bargains—For Now

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. You have several things on your radar this week, Dave. First are a couple of economic reports: the preliminary fourth-quarter GDP and the December Personal Consumption Expenditures. Now, why are these two economic reports the ones you’re focusing on this week?

Dave Sekera: Good morning, Susan. Of course, the market’s focus is really on earnings this week and next, but there’s going to be a lot of focus on those two economic indicators as well. Everyone is also very focused on, “What is the Fed going to do?” What is their monetary policy going to be, and when are they going to start cutting interest rates? The question there is, is the Fed going to stay higher for longer, or are they going to begin to cut rates here in March?

Now, our own opinion is still that we think they’re going to begin to cut here in March, but if you look at the market-implied probability, the market’s really not that confident anymore. That market-implied probability was as high as 80% of a cut a week ago. It’s now down to about a 50/50 probability. So GDP and PCE are really kind of two of the most important indicators for the economy and for inflation, and I think both are going to heavily influence the Fed’s thinking on monetary policy, so depending on where those numbers could come out this week, I think that could drive a lot of market volatility.

Dziubinski: Let’s probe on that a little bit. What could come out of these reports that might impact the market either to the upside or to the downside?

Sekera: As far as GDP goes, if the economy is actually running hotter than expected, I think you’d see a bit of a market selloff. I think traders would interpret a stronger economy, meaning that the Fed is not going to start cutting rates, and they’ll start keeping things higher for longer. Conversely, if it is weaker, then the markets could rally. That would then support easier monetary policy. And as far as inflation goes, if that’s hotter than expected, then I do think you see a market selloff there. The market will then price in that higher-for-longer monetary policy, but if inflation does continue to moderate, I do think you get a rally on that as the market will price in those rate cuts.

Dziubinski: As you mentioned, earnings season is starting to heat up this week, and so you’re going to be watching that. Let’s walk through a couple of reports in particular you’re looking at. We have both Verizon VZ and AT&T T reporting this week. What are you going to be listening for there? And what does Morningstar think of these two stocks ahead of earnings?

Sekera: I wanted to highlight those two because I think you and I have talked about those and have highlighted them a number of times over at least the last several months. Both are still 4-star-rated stocks, they trade at about a 40% discount to fair value, and their dividend yields are just under 7% at this point. So, the thesis here is that the wireless business going forward will start to act more like an oligopoly. They’ll compete less on price, and that will then allow margins to rise.

I recently talked to our equity analyst Mike Hodel, who covers these two names, and he mentioned he is starting to see some early indications of that. A couple of things he mentioned were it’s becoming harder for new clients to qualify for new cellphone discounts. They’re seeing fewer free new add-ons when they do sign up for different plans, and he also noted, too, that both of them are spending less on capex [capital expenditures] in their network investments, so again, that should allow margins to rise. I think, on this call, he’s going to look for additional indications that we are starting to see that transition to more of an oligopoly.

Dziubinski: We also have Procter & Gamble PG reporting this week. Why is this one that you’re keeping an eye on and what does Morningstar think of the stock today?

Sekera: Well, we do think that stock is a touch overvalued. It’s a 2-star-rated stock and it trades at a 10% premium to our fair value. Now, this is one where the stock call really isn’t a call on the company or expecting any weakening fundamentals. In fact, we do think it is a very strong company. We rate it with a wide economic moat. We just think that the market valuation is just a little bit too high. So specifically here, I’m going to be listening for indications of the strength of the consumer. For example, are consumers still trading down to private-label from branded goods, and are consumers still buying in smaller package sizes? But I also want to hear their own indications on inflation and pricing, specifically for P&G. Are they able to raise prices enough in order to keep up with inflation, or are they going to see their margins continue to be under pressure

Dziubinski: United Airlines UAL reports this week and would you expect holiday travel is going to have a positive impact on United results? Is there an opportunity here from Morningstar’s perspective?

Sekera: Personally, I’m always just very leery of investing in airlines. These are the kind of stocks you don’t necessarily want to buy as a long-term investor. You can rent them in the short term when they’re undervalued, but at this point, we don’t think that they’re undervalued. In fact, we think all of the airlines, to some degree, are actually overvalued. Now, as you mentioned, holiday travel was probably pretty robust, and maybe you’ll see a couple of good earnings reports here. But with the long-term, intrinsic valuation of a company, one season in and of itself isn’t going to have that large of an impact on how we value a company.

And so, at this point, margins and earnings for the airlines, they’ve looked pretty good for the past two years. But again, we rate all of these companies as no moat. We don’t think that there are competitive advantages that you can build in the airline industry. So, as travel rebounded the past couple of years from the pandemic, demand outstripped supply. We saw good earnings, we saw good margins, but over time we do expect that those margins will come down, really, as we just see competition normalize over time.

Dziubinski: Netflix NFLX reports this week, too. Netflix is, of course, the leader in streaming today, and Morningstar raised its fair value estimate on the stock by quite a bit in late November. How does the stock look heading into earnings?

Sekera: We think the stock is overvalued. It’s at a 17% premium to our intrinsic valuation, which puts it in that 2-star category. Now, again, the stock call here isn’t a call on the fundamentals of the company. Netflix is doing very well right now. New subscriber growth has been increasing, and that’s due to a couple of different things. One, they did have that crackdown on password sharing. We also saw that new ad-supported subscription business. Things from a fundamental point of view, have looked pretty good, but if you look at the stock price, we just think that it’s gotten ahead of itself. Now, my own personal concern here is that you could see that stock sell off if the company doesn’t beat consensus by enough, or especially if management were to come out and provide any kind of guidance that would disappoint the marketplace.

Dziubinski: And then, lastly, on the upcoming earnings front, we have one of the “Magnificent Seven” reporting this week. It’s Tesla TSLA.

Sekera: Tesla trades within fair value territory. It’s a 3-star-rated stock. Of course, with Tesla, the value of Tesla is really in its assumed growth rate. It’s not just the number of cars that it produces today, but how many cars you think it’s going to produce in the future over the next decade, and so I do think that that’s a stock that always has the potential for some pretty high volatility. So Tesla’s covered by Seth Goldstein, and I read through his note, and here’s some of the things that he’s expecting.

He is looking for the profit margin to be slightly lower, and that’s really due to the ramp-up of the Cybertruck, although some lower raw material costs should help partly offset the margin pressure there. Based on his current forecast, he does think that profit margin pressure will end up subsiding here later in 2024, probably somewhere in the midteen area. On the call, Seth is hoping to hear some of management’s plans about launching a new affordable vehicle platform for both sedans and small SUVs. And when he thinks about what Tesla needs to do to be able to reach our forecast to be able to produce 5 million vehicles per year by 2030, they really need to have a vehicle in that affordable vehicle platform.

Dziubinski: Let’s move on to some new research for Morningstar, and that’s our take on bank earnings. Let’s start with the big banks, Dave: JPMorgan Chase JPM, Bank of America BAC, Wells Fargo WFC, and Citi C. What’s your one big takeaway from what you heard from the big names?

Sekera: And even more important than the earnings and the guidance, what I was really listening for was what were the banks doing with their loan-loss reserves? My concern had been if the banks were ratcheting higher their loan-loss reserves, that might indicate that the banks were preparing their balance sheet for a recession. Fortunately, that is not what we’re seeing. Generally, at loan-loss reserves, I think were in line or within the expectations of our equity research team. Now, I’d note we did see some increase in the reserves for commercial real estate, specifically for urban office space. But, in our view, that’s not surprising, and in fact, the amount that they raised didn’t raise it to the degree that it impacts any of our valuations today.

Dziubinski: Let’s talk a little bit about what you thought of what each of the banks had to say, and are the stocks of any of them looking attractive today?

Sekera: Generally, the results were in line with our expectations. I don’t think there were any material changes to our fair value. Now, I would note Citi’s earnings, in and of themselves, were a little disappointing to our team, but they did note that the guidance that Citi provided offset some of that disappointing earnings. Now, we still think that Citi is a long-term value play. The key for Citibank is that it does need to execute on its plans for its expense reduction going forward, but the thesis here is that we do expect that the stock will accrete upward. It does trade at a pretty deep discount to its tangible book value. The stock’s currently at a 20% discount to our fair value. As far as the others, Wells Fargo is a 4-star-rated stock. It trades at an 11% discount, and then both JP and Bank of America are 3-star-rated stocks.

Dziubinski: We saw the regional bank’s report last week, too. Any surprises there, and which ones might look attractive after earnings?

Sekera: It was a really busy week for our financials team. I know they were definitely burning the midnight oil going through all of these reports and updating their models. We cover eight different regionals that reported last week. Now, in the regionals, six of those are rated 4 stars, very undervalued, and two of them are currently 3-star-rated stocks. So, there might be some slight updates to our fair values here and there, but again, our team doesn’t expect any significant or any material changes in our fair values.

Taking a look at some of these stocks, the two I’d highlight are first, U.S. Bank USB. It’s a 4-star-rated stock. That’s really been our go-to stock for the regional banks for people looking for exposure there. It currently trades at a 19% discount to fair value and has a 4.8% dividend yield. Then, for investors who are able to take a little bit more risk in their portfolio, I would highlight Truist TFC. It’s a 4-star-rated stock. It trades at a 25% discount and has a 5.6% dividend yield. So the play here is it’s really going to do well if we do see declining long-term interest rates, which is currently what our forecast is. It does have one of the larger amounts of losses embedded in their hold-to-maturity book, so the thesis here is that as long-term interest rates decline, those losses in that hold-to-maturity book would then quickly dissipate.

Dziubinski: OK, so U.S. Bancorp and Truist. Let’s move on to the picks portion of our program. Now, in our last episode, Dave, you talked about how attractive value stocks looked coming into the new year, especially when you compare the valuations to those of growth stocks and core stocks. Is that still looking the case a little bit into January?

Sekera: No. That’s definitely still the case today, that value stocks are the most attractive part of the market by category. If I look at returns, year to date, the Morningstar US Market Index is up just over 1.0% year to date, and that’s really been driven by core stocks. So, the Morningstar US Core Index is up 1.5%, and that’s been driven by both Alphabet GOOGL and Meta META. Both of those stocks make up a very large portion of that index, and that’s where those stocks are located today.

If we look at the growth index, that’s essentially unchanged on the year, and the value index is down a little bit under 1% today. When we look at the valuations of the different categories, the value categories are undervalued by 10%, whereas both core and growth are fairly valued—core probably starting to get a little bit overextended at this point. So in our view, based on those valuations, we do think now is a good time for investors to remain overweight in the value category, and to pay for that overweight, I’d look to underweight both growth and core stocks today.

Dziubinski: This week you’ve brought us five undervalued value stocks to buy that you’ve selected from our analysts’ first-quarter list of 33 undervalued stocks to buy. Your first stock pick this week is ExxonMobil XOM. Why?

Sekera: The energy sector is actually one of the more undervalued sectors at this point. Energy was down slightly in 2023, while the rest of the market was up about 26%. As far as the global major oil producers, Exxon is our top pick there. The investment thesis is: Our forecast is we’re looking for production to grow modestly for the next couple of years. We also look for profitability to increase over that same time period as we’re expecting a mixed shift into some higher-margin-producing fields. Exxon Mobil stock is a 4-star-rated stock. It trades at a 20% discount to our fair value. It pays a 3.9% dividend yield, but I’ll also note that they have just a huge dividend stock buyback program outstanding as well.

Dziubinski: Next on your list is Hasbro HAS this week. What’s to like here?

Sekera: Hasbro stock is rated 5 stars. It trades at a 42% discount to our fair value, and it currently pays about a 5.8% dividend yield. It is a stock that we do rate with a narrow economic moat. Hasbro is covered by Jaime Katz, and she’s noted that she thinks that there’s just too much negative sentiment on this name in the marketplace today. Hasbro has been fundamentally under some short-term pressure. She’s noted some weak discretionary demand, the impact from entertainment-related strikes over the past couple of quarters, and then rightsizing among the inventory channels for the retailers. But we think that investors are overextrapolating these near-term fundamental pressures too far into the future. Over time, as the inventory rightsizing goes back to normal, we no longer have the impact of those strikes, and we get back to more of a normalized demand environment, we do think that there’s a lot of upside for investors here.

Dziubinski: Illumina ILMN is your next pick this week, and we talked about Illumina several times last year, and the stock disappointed. Why do you still like it?

Sekera: This is one where we just have to admit this is a name that we’ve been long and wrong, but we do still think it is significantly undervalued. For people who do have an interest in Illumina, I’d suggest and go watch our video from Dec. 26. That’s when you and I kind of provided some more detail on some of the winners and losers of stocks that we had highlighted last year. So, I’ll give you a not-so-quick synopsis for people who are interested in Illumina. The stock is 5 stars, it’s almost a 40% discount to fair value, and we do rate the company with a narrow economic moat. Here’s the story: A couple of years ago, Illumina reacquired Grail, which is a company it had formerly owned but had spun out back in 2016.

Now, Grail is currently testing a product called Galleri, and that is a test that can test for up to 50 different types of cancers in one blood draw. If Gallery is approved, we think that’s just a game changer as to when cancer can be detected and you can start treatment. Now, the problem is that Illumina closed the acquisition before they got approval from the regulators, and now the company’s being forced to divest Grail. Now, in the meantime, the legacy Illumina business has been under some pressure; some of the results have been weaker than we’ve expected. So, between the regulatory actions and some weaker results, a lot of investors just don’t want to be involved in this situation today. Now, most recently, Illumina prereleased its fourth-quarter results, and those results were slightly stronger than what we expected.

Plus, at the same time, they did announce that they’re going to divest Grail in 2024, so right now they’re just deciding what they think the best way is to do so. In our view, we think a spinoff to existing shareholders will provide the most economic value to shareholders today. Once the spinoff occurs later this year, I suspect that’s going to help unlock the economic value that we see here. It’s going to do a couple of things. One, it just removes that regulatory overhang that we currently have. Plus, I think it allows investors to be able to own the piece of the business that they want. For example, some of the investors prefer owning the legacy testing and supplies business, more of that steady-Eddie business, whereas other investors are going to want to invest in the upside of Grail’s product Galleri. I’m really hoping that’s going to be the catalyst for the stock this year.

Dziubinski: Your fourth pick is APA APA, which is a midsize exploration and production company. Unlike Illumina, I don’t remember us ever talking about this name before, so tell us about it.

Sekera: This is another story stock at this point. It’s a 4-star-rated stock, it trades at a 47% discount, and has a 3.3% dividend yield. Now, I will caution this is a stock that we rate with no economic moat, but it’s a catalyst-driven situation. APA has a joint venture with Total in Suriname, and they’ve announced that there is evidence that there’s a very large oilfield or large oil play that the joint venture has found, and we think it’s very likely that it’s going to be a very large discovery and that it will progress to the development stage.

So, the cautionary part of it is none of this has been officially sanctioned by the companies at this point. We do think a final investment decision is planned for the end of this year, and if they do move forward with this oil play, we’ll see oil production starting in 2028. This stock is covered by Stephen Ellis. In his view, this is also potentially a game changer for this company. This play, he thinks, could double the firm’s production in the next 10 years, but when he looks at our valuation and he looks at our model, he doesn’t think that the market is including this in the current stock price, so to some degree, it looks like a free option to us for this play in Suriname.

Dziubinski: Your final pick this week, Dave, is another stock we’ve talked about before on the program. It’s Entergy ETR. Remind viewers why you like this one.

Sekera: I’ll just keep this one short and sweet. We’ve highlighted this one a number of times. Essentially, our U.S. economics team does forecast that long-term interest rates are going to subside this year and next. I think that’s going to be a good tailwind for the utilities sector, and this stock is a 4-star-rated stock. It trades at a 13% discount to fair value, a pretty decent dividend yield at 4.6%, a company that we rate with a narrow economic moat, and according to our utilities team, Entergy is just the company that they think has the best combination of growth, valuation, and yield in the utilities sector today.

Dziubinski: Well, Dave, thanks for your time this morning. Viewers interested in researching any of the stocks that Dave talked about today can visit Morningstar.com for more analysis, and 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, and have a great week.