5 Stocks to Buy if You’re Concerned About US Market Valuations

Susan Dziubinski: Hello, and welcome to The Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday morning, I talk with Morningstar Research Services Chief US Market Strategist Dave Sekera about what investors should have on their radars, some new Morningstar research, and a few stock picks or pans for the week ahead. So, good morning, Dave. Anything on radar this week on the economic front?

David Sekera: Hey, good morning Susan. Really not much as far as like what I consider to be market-moving economic indicators. I’ll keep an eye on new-home sales and durable good orders, especially the durable good order in light of the better than expected retail sales number last week. But it’s interesting. I still think the economy is running at a much hotter rate than what we originally anticipated earlier this year.

In fact, I just checked again this morning. The Atlanta Fed GDPNow is running at 3.4%. So again, a lot hotter and a lot higher than I think pretty much anyone would have expected. But really it’s all about earnings this week.

Dziubinski: Well, then let’s turn to earnings, Dave. Talking about some companies reporting, starting with Tesla. So what are you going to be listening for here?

Sekera: Well, first of all Tesla already announced earlier this month their third-quarter deliveries, 463,000 vehicles, which is a 6% year-over-year increase. So I talked to Seth on this one. He’s the analyst that covers the stock. And I know he’s going to be watching to see if that higher growth rate is able to then boost their auto segment profit margins.

He’s also going to listen for any updates on the new lower-priced vehicle that’s set to enter production next year. Now to me, I think that’s probably like the next main potential catalyst for this stock. And then also of note, we did leave our fair value estimate unchanged following the Robotaxi event earlier this year.

Dziubinski: Now 2024 has really been a year of fits and starts for Tesla stock. It’s down more than 10% so far this year. So is the stock attractive today?

Sekera: I wouldn’t consider it attractive. It is rated 3 stars. Our fair value estimate is $200 a share. So one of those stocks, especially in light of just how volatile this stock can be. I think if you want to get involved in this one, you probably want to wait to see if it trades down where you can buy it at a larger margin of safety from its long-term intrinsic valuation.

Dziubinski: Now we also have chipmaker Texas Instruments reporting this week. So what do you want to hear about here?

Sekera: I think people are going to really be listening to their guidance very carefully. In my own opinion, I think there’s probably greater risk to the downside here. Now, the reason being that ASML guidance last week indicated that semiconductor capex spending was slowing at Samsung and Intel. So the question to me is: Is that really idiosyncratic to just those semi chip manufacturers, or is it really going to be more broad than that?

Are we really seeing a capex spending slow at all the traditional commodity and the semiconductors across the board or really just those two?

Dziubinski: Now, how does Texas Instruments look from a valuation perspective heading into earnings?

Sekera: We think it’s actually overvalued at this point. It trades at a 13% premium to fair value. So that’s enough just to put it into that 2-star territory.

Dziubinski: Now we also have ServiceNow reporting earnings this week. And the stock looks about fairly valued heading into earnings. So why is ServiceNow on your radar?

Sekera: I talked to Dan Romanoff. He’s our equity analyst, last Friday, just to get a read from him of what he’s thinking here. And he just highlighted: ServiceNow in his opinion is really one of the best enterprise software companies who’s currently really implementing AI in their existing business model. He also noted they just have very good operational momentum.

He thinks that they’re really running ahead of the pack there. In his view, he just saw really no reason to expect the company won’t at least meet if not beat their expectations for earnings. He also expects an in line to better than expected guidance. Now it is a 3-star-rated stock, but I have to caution ‚it’s getting to the top of the range of the 3-star to really nearing that 2-star range.

So my opinion is I probably wouldn’t look to buy here. But then again, I also wouldn’t be selling stock at this point. I think this is probably one of those ones where you can let it run for a while above the fair value before you look to maybe sell and need to try and lock in gains.

Dziubinski: We also have several key telecom players reporting this week in Verizon, T-Mobile, and AT&T. So broadly, what do you expect to hear about from this group?

Sekera: Generally, I think we’re just still looking for ongoing improvement in their operating margins, looking for that to support our thesis that the US wireless industry is transforming more into an oligopoly, where, going forward, we still expect they’re going to compete less on price. But I also want to hear if they’re going to give any indications of how demand has been for the iPhone 16.

Dziubinski: Now, these stocks have all rallied tremendously during the past 12 months. So do any of them look attractive ahead of earnings?

Sekera: Yeah, I mean, this has been really a sector that’s run up a lot more than I think people would have expected. T-Mobile is up the most. It’s up about 55% over the trailing 52 weeks. Now that’s run up to the point where it’s trading at a 17% premium above our fair value. So that’s a 2-star-rated stock.

AT&T is up the second most. That was up 51%. That’s enough now to put it into that 3-star territory. It’s only trading at a 5% discount but still an attractive yield at 5%. And then Verizon has actually lagged to the upside. It’s up 43% compared to the other two. So at that point, it’s still a 4-star-rated stock, trades at a 17% discount to fair value, and has over 6% dividend yield.

So that would be the one that we would still look to advocate for today.

Dziubinski: Now we also have a trio of big names in defense reporting this week in RTX, Lockheed Martin, and Northrop Grumman. So what are your expectations here?

Sekera: Well, unfortunately, with all the ongoing geopolitical conflict, I’m expecting earnings probably should be pretty good. Should expect to see the backlog continuing to build. So probably good expectations coming out of all three of these stocks.

Dziubinski: And how about the valuations on these stocks heading into earnings? Are there any opportunities here?

Sekera: At this point, I would say most of them are pretty fully valued, if not getting to be overvalued. Year to date, Lockheed is up 35%. It’s enough to put that in 2-star territory. Trades at a 22% premium to our fair value. RTX, we actually recommended that stock. The first time we recommended was July of our 2023 show.

That’s up 50% year to date. That’s also now almost a 2-star-rated stock. Trades at a 6% premium. Northrop, that’s up 13% year to date. So it’s still slightly undervalued but again at a 6% discount. A 3-star-rated stock. Personally I hope the market’s overextrapolating the short-term growth here too far into the future. If you are looking for a defense play, I would just highlight Huntington Ingalls. That stock is essentially flat year to date. It’s a 4-star-rated stock at a 19% discount. But I would caution expectations here, based on the production of what the company makes, they make large naval vessels. Those are going to be subject to long-term contracting. So they’re not going to benefit in the short term from the ongoing conflict. But for a long-term investor, that’s the one that we think has the best intrinsic value today.

Dziubinski: Moving on to some new research from Morningstar. US Bancorp saw a nice bump in its stock price after earnings last week. So why, Dave? What did management have to say that impressed the market?

Sekera: Yeah, I think it’s really just a combination that the stock is undervalued and they reported pretty solid third-quarter results. They’re seeing that interest income growth. They’re seeing an expansion of their net interest margin. Management also solidified their guidance for 2024 for net interest income to come in at the high end of their previous guidance.

Plus, when you take a look at that guidance for 2024, we’re expecting to see more than 100 basis points of operating leverage in the fourth quarter.

Dziubinski: Now, we’ve talked a lot on The Morning Filter about US Bank because it’s been Morningstar’s favorite stock among the US banks. So did we make any changes to the stock’s fair value estimate after earnings? And is it a still a buy from Morningstar’s perspective?

Sekera: At this point, there’s no change to our fair value. Came in line with our expectations. In fact, it just moved into that 3-star-territory from 4 stars, trades at a 7% discount, but it still has a pretty healthy yield at 4%. It’s probably the last of the US regionals, I think, that’s still trading at much of a discount to our fair value.

Dziubinski: All right. So let’s talk next about two tech names that released earnings last week and that performed very differently after their reports. That’s ASML and Taiwan Semiconductor. Now you already talked a little bit about ASML. So let’s start with that one. The stock finished the week down 14% after it accidentally reported earnings early. So what the heck happened here?

And how do you accidentally release your earnings early?

Sekera: Well, I mean as far as it goes for accidentally releasing your earnings early, I haven’t heard any actual explanation of why it happened. In my guess it’s probably was just human error. They probably just programed the other wrong date into their system when they uploaded the press release for when it was supposed to get released.

As far as what happened here, revenue and earnings were just fine. But ASML provided much weaker than expected guidance for next year.

Dziubinski: Now, as you noted there was sort of this big and unexpected shift in terms of revenue guidance and margin guidance at ASML. So what was the explanation for that?

Sekera: They lowered their revenue guidance to be between 30 to 35 billion euro. It was 30 to 40 billion euro beforehand. So they brought that top end of the range down. But they also cut their gross margin guidance for 2025 to a range of 51% to 53%. The previous target was 54% to 56%. And then also of note, their third-quarter earnings were pretty weak.

They only came in at 2.6 billion euro versus expectations of 5 billion euro. So we’ll get better clarity as earnings season progresses. Our best bet at this point is that orders from Intel probably pulled back pretty significantly. Intel recently postponed the opening of one of its fabs. Also, we just have to note there’s a lot of customer concentration in the chip equipment manufacturing.

There’s only a handful of big buyers. And so when you see things like memory chips having a downcycle, that can really disproportionately impact the equipment manufacturers.

Dziubinski: Morningstar trimmed its fair value estimate on ASML a bit, and it looks like the stock is undervalued, according to Morningstar’s metrics. But what say you, Dave? Is ASML an opportunity today?

Sekera: It is a 25% discount to our fair value, which places it in the 4-star category. Only has a 1% dividend yield. It is a company we rate with a wide economic moat, although a high uncertainty, being in the technology sector. So our equity analyst has called it out as being undervalued. And I think this is just a good example of some of the things we’ve talked about in the past, as far as building into a position.

This is probably a pretty good example that, if you want to start building a position, probably start with a partial position. That way, if we do see the stock trade down any further, you can dollar-cost average into it and be able to buy more stock at lower prices.

Dziubinski: Well, let’s focus on some brighter news, and that was Taiwan Semiconductors earnings report last week. The stock really rallied after earnings. And interestingly Taiwan Semi is ASML’s largest customer. So comment on that.

Sekera: We actually estimate that Taiwan Semi accounts for about a third of the sales for ASML. And then Samsung and Intel each account for about 10% of each. So considering just how well Taiwan Semi is doing, I think that really just shows how much pressure both Intel and Samsung are under right now.

Dziubinski: So let’s get down to what Taiwan Semi had to say that drove that stock rally. What did management say that the market got so excited about?

Sekera: Third-quarter results were much better than we anticipated. Revenue was up 13% sequentially from last quarter. And both gross and operating margins improved about 5 percentage points each from the prior quarter, coming in at 57.8% and 47.5%, respectively. And then taking a look at guidance, fourth-quarter revenue guidance is to grow 11.6% sequentially.

Gross margin guidance was coming in marginally higher sequentially at 58%. And then operating margin still holding up at 47.5%. So having said all that, though, our change—we actually didn’t make any changes, I’m sorry—to our long term assumptions, so our fair value is unchanged following those results.

Dziubinski: So, given that we didn’t change the fair value after earnings, do shares look undervalued after the rally?

Sekera: So year to date when I look at the stock, it’s up 93%. So at this point it’s only trading at a 7% discount to fair value. Puts it in 3-star territory. Typically I would just like to see a greater margin of safety from its intrinsic value before it really garners much more interest from us.

Dziubinski: Netflix also reported last week, and sales growth was strong, margins expanded, and subscriber growth slowed, but that was expected. Morningstar raised its fair value estimate on the stock by 10%. Is Netflix a buy after earnings, Dave?

Sekera: Not according to our analyst team. Now following the results, we did bump up our fair value to $550 from $500 per share. But even after that, it’s still a 2-star-rated stock, trading at a really big premium to our fair value. We still think the market is probably extrapolating this short-term growth too far into the future.

Our analytical team noted that they think some of Netflix’s markets are probably pretty close to approaching saturation. And we expect a much more moderate margin expansion going forward. In fact, when I take a look at our financial model: Over the next five years, we’re only projecting a 11% compound annual growth rate for the top line 22% compound annual earnings growth rate.

But yet the stock trades at about 39 times 2024 earnings.

Dziubinski: All right. It’s time to move on to the picks portion of our program. And this week, our picks were inspired by comments that two viewers made after the Sept. 30 episode of The Morning Filter. As a refresher, the picks in that particular episode were the ADRs of undervalued, high-quality Chinese companies, and viewers asked for some undervalued ADRs of Canadian and European companies.

And that’s just what Dave has brought us today. His first pick this week is Nutrien. So give us some key stats on this one, Dave.

Sekera: Nutrien is a Canadian company, and it’s the world’s largest crop nutrient company by capacity. And within those crop nutrients, it is the world’s largest potash producer by capacity. One of the largest nitrogen fertilizer producers globally. And it’s rated 4 stars. Trades at a 32% discount, has a 4.5% yield. A company we rate with a narrow economic moat, and that’s really going to be based on the cost advantages that they have in their underlying businesses. However, it is a company that we rate with a high uncertainty.

Dziubinski: Nutrien stock is having a pretty tough year. So give us a little bit more flavor on Morningstar’s thesis for the company.

Sekera: First of all, I wanted to give a little bit of background as far as what’s happened here with the fundamentals. So when you take a look at the charts, I just note that corn, soybean, and wheat prices—they’re all skyrocketed in 2021 and into 2022. And that was really just because we had an increase in global demand following the pandemic. We had droughts in many areas of the world and, of course, also all of those supply chain disruptions. So to take advantage of those high prices, farmers significantly increased the amount of usage of fertilizers in order to be able to maximize their yields at that point in time. Now, since then, prices have plunged all the way back down to prepandemic levels, in some cases even lower.

So, of course the farmers have pulled back on their fertilizer usage as well. Looking forward, we’re actually projecting 2024 to be the cyclical low for both volumes and for prices to start rebounding going forward more toward those historically normalized levels. Moving back to Nutrien, its potash business accounts for 44% of EBITDA.

And I would note here that we think production costs are in the lower half of the curve for that part of the business. So, even when prices are at cyclical lows, they’re still actually generating profits in that part of their business. Now the other part of their business, like the nitrogen business, I believe that’s 39% of their EBITDA, production costs there are in the middle to the lower end of their cost curve.

And the low crop prices weighing on fertilizer prices are at cyclical lows. So we expect growth is going to rebound. We’re looking for an increase in 6% in the top line next year and probably to increase by inflation or maybe a little bit more than inflation thereafter. And we forecast 2024 will be the low for their earnings at $3.63 a share.

We’re looking for the company’s earnings to be 391 next year and up to 413 in 2026. So when you look at that stock right now, it’s trading at pretty modest multiples. Only trades at like 13 times our 2024 earnings estimates and only 12 times next year’s.

Dziubinski: Now your second pick this week is another Canadian company, Toronto-Dominion Bank. So first run down some of the key data points on this one.

Sekera: Toronto-Dominion is one of the two largest banks in Canada by assets. I believe it’s got like number-one or number-two market share most of its retail operations. And then number-two market share in its business banking in Canada. Currently rate the stock with 4 stars, trades at a 12% discount, has a pretty healthy yield at about 5.25%.

We rate the company with a wide economic moat based on its cost advantages. They have a low-cost deposit base, We think excellent operating efficiency, and pretty conservative underwriting. And it’s a company we rate with a low uncertainty.

Dziubinski: Now there’s been a cloud around Toronto-Dominion Bank stock this month as the bank announced that it will be paying around $3 billion in penalties for its failure to have proper anti-money-laundering practices in place in its US operations. And as part of that settlement, regulators are also expected to place an asset cap on the firm’s US business. So given that news, how is this a pick?

Sekera: Well, I would just have to note following that news, there was no change to our fair value. The amount of the fine was close to what our analysts had already included in their projections. And I’d note, at this point, the bank has set aside enough to cover the size of that fine. Taking a look at the balance sheet, it’s well capitalized. Their common equity Tier 1 ratio is 12.8%. And last quarter, just looking at our notes here, they reported relatively strong loan growth and increasing that interest margin. So fundamentally looks like it’s still on the right path.

Dziubinski: Rogers Communications is the largest wireless service provider in Canada. It’s also your third pick this week.

Sekera: Rogers is a 5-star-rated stock, trades at a 31% discount to fair value and a 3.8% yield. The company we rate with a narrow economic moat based on its efficient scale and cost advantages and have a Low Uncertainty Rating on this company.

Dziubinski: Now, what’s Morningstar’s take on Rogers Communications business?

Sekera: It is Canada’s largest wireless services provider, but in addition, it also has a fixed line network that covers two thirds of Canada. Now, the other two main Canada competitors are BCE and Telus And unlike the US, where we expect oligopoly-like conditions, we actually see more competition in Canada. So a company called Quebecor is now going to be competing on a national level going forward.

So our investment thesis here is that Quebecor will generally keep price levels lower throughout Canada. But we don’t think that they’re going to be able to price at enough of a discount to really take a significant share from those big three incumbents. Quebecor itself is just going to have to continue to invest enough in its network to keep up with the big three.

Looking at our financial model here—again relatively conservative top line growth assumptions of only 3% on average over the next five years. But we are looking for pretty good margin expansion to drive a 13% earnings growth. Stock trades at only 11.5 times earnings versus our fair value, which places the stock at 17.5 times earnings.

Dziubinski: We’ll go across the pond for your final two picks this week. British American Tobacco is your first pick there. And boy that’s an attractive yield on this stock.

Sekera: Generally when you talk tobacco companies, they do generally have pretty high dividend yields. The reason being that at this point they’re typically run to maximize those cash returns. In this case, the dividend payout ratio is 75%. Right now, it’s a 4-star-rated stock, trades at a 31% discount to fair value, has an 8.6% dividend yield.

And it is a company we rate with a wide economic moat.

Dziubinski: Now British American Tobacco is the second-largest tobacco company by volume. But given the decline in tobacco consumption worldwide, what’s the case for the business today?

Sekera: Cigarettes do account for 80% of its revenue, yet cigarettes are in a long-term secular decline. We expect volumes will probably decrease anywhere from 3% to 5% on average per year. Generally, tobacco companies try to increase their prices enough every year to offset those volume declines.

So what they’re doing right now is they are using that other part of their cash that they don’t pay out as dividends to try and generate more revenue from what they consider to be next-generation products. And those next-generation products are what they call nicotine delivery systems. And they include things like nicotine pouches, heated tobacco, and vapes.

When I take a look at our financial model here: We’re forecasting no top line growth over the next five years, a little bit of your operating margin expansion to be able to drive 5% earnings growth. And our fair value is really only 11.5 times 2024 earnings.

Dziubinski: And then your last pick this week is pharmaceutical giant GSK. Run down the metrics for us.

Sekera: GSK is a 4-star-rated stock. Trades at a 28% discount. Has a 4% yield. Company we rate with a wide economic moat based on its patents, economies of scale, and distribution network, and a company that we rate with a medium uncertainty.

Dziubinski: GSK announced earlier this month that it had agreed to pay as much as 2.2 billion to settle the majority of lawsuits in the US courts involving claims that Zantac, which GSK manufactures, causes cancer. So have concerns about these settlements been weighing on the stock?

Sekera: GSK stock did get hit pretty hard in mid-2022 due to that product liability from Zantac. However, at that point in time, we thought the market was just greatly overestimating the potential liability. Now the settlement, when it came in, it was a little bit higher than we thought but pretty much still within the range of our expectations.

So taking a look at our note in our write-up here, there was just no change to our fair value. And in fact, we actually think this is a positive for the stock. It should remove the overhang that had been over that stock for the past two years now. And I think that’s going to allow investors really to go back to focusing on the fundamentals, really reviewing not only their product portfolio, but taking a look at their pipeline that we think investors today under appreciate.

Dziubinski: Talk a little bit more about the business at GSK, Dave.

Sekera: As a UK company, it is still one of the largest global pharmaceutical companies out there globally. They have a portfolio of drugs across a couple of different therapeutic—sorry, I need a little bit more coffee here today just to keep myself going.

So taking a look at their product portfolio, it spans several different therapeutic classes including respiratory, cancer, and antiviral. a couple of different vaccines, although I would note they were not involved in the mRNA vaccines from the other pandemic for covid. Looks like they’re also in the midst of launching a traditional RSV vaccine that we think has multibillion-dollar potential.

But really GSK faces probably some of the lowest amount of near-term patent losses across the pharmaceutical sector. We think that sets the company off just for pretty steady growth over the next three years. And we think the stock is just very attractive here as it trades at only about 10 times 2024 earnings.

Dziubinski: Thanks for your time this morning, Dave. Viewers who’d like more information about any of the stocks Dave talked about today can visit Morningstar.com for more details. We hope you’ll join us for The Morning Filter 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!

Got a question for Dave? Send it to themorningfilter@morningstar.com.