5 Stocks to Buy With Solid Fundamentals and Upside Potential

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 plans for the week ahead. Well, good morning, Dave. We have a slew of economic reports coming out this week, and I think it’s six of the 10 largest companies by market capitalization also report earnings this week. So could we see some volatility in the market as a result?

David Sekera: Hey good morning, Susan, and happy fall. Yeah, between earnings and economic indicators I definitely think we could see some Halloween tricks and treats in the market this weekend. And of course we also could see traders really start to position themselves this week for the impending US elections the week thereafter.

Dziubinski: Let’s walk through this week day by day. On Tuesday, we have both Alphabet and AMD reporting earnings. Alphabet looks undervalued according to Morningstar heading into earnings, and AMD is about fairly valued. So what will you be listening for with these two companies?

Sekera: Well, as you mentioned, Alphabet is undervalued. It trades at a 22% discount to fair value, puts it in the 4-star territory according to our scale. Now fundamentally I think the company is still hitting on all cylinders. We just think the market’s probably overpenalizing the stock for some regulatory issues. Now, I doubt management is going to be able to say anything meaningful regarding the DOJ antitrust case, so we’ll be listening more just for fundamental factors, really, what’s going on with search performance, digital ad spending, their ongoing efforts to monetize YouTube, and then some updates in the cloud business and just how fast that’s growing. Over at AMD, that’s a 3-star-rated stock. That’s pretty close to fair value. We’re going to be listening for commentary on their efforts regarding their own AI products.

Now, over the long term, we do expect that AMD will end up being the number-two player in AI semiconductors. But for now, Nvidia still has just a huge advantage over AMD and everybody else for that matter. Otherwise we’ll be looking for commentary on their traditional server business, especially because it sounds like AMD is still taking additional market share away from Intel.

Dziubinski: Now, on Wednesday, we have earnings reports from Eli Lilly, Microsoft, and Meta Platforms, as well as third-quarter GDP numbers. So let’s start with the earnings there. Morningstar thinks Eli Lilly is really overvalued today. So why is it so overvalued, and what will the market be listening for?

Sekera: Yeah, it’s one of the more overvalued stocks under our coverage. It’s a 1-star-rated stock I believe it trades well over a 50% premium to fair value. So Eli Lilly—it’s all about the growth of Mounjaro and Zepbound. That’s their two weight loss drugs. Now this quarter there are several different potential positive catalysts for the stock.

This quarter, I think they’re expected to release data from a head-to-head study against Wegovy in obesity. That’s one of the competing drugs there. And the Morningstar equity team expects Zepbound is probably the more potent of the two drugs. So that will give them some additional leverage when they negotiate with pharmacy benefit managers and may end up providing some preference from the physicians that prescribe those drugs as well.

Maybe some updates on the timing of the launch of using their drugs to address sleep apnea as soon as later this year. That would actually be a good way for Lilly to get coverage of their drugs for obese patients with Medicare. Now, my understanding is that Medicare won’t cover drugs specifically for obesity, but obesity and sleep apnea have very significant overlaps.

But overall, when we look at kind of the long-term expectations of what the market is pricing in, versus our own model, we think the market is just pricing in too much growth for too long. In the years ahead, we expect that there will be much greater competition in this specific type of drugs, and that will end up pressuring volume and pricing in the years to come.

Dziubinski: Now, what about Meta Platforms and Microsoft? How do these two stocks look heading into earnings, and, again, anything in particular you’re going to want to hear about from these two companies?

Sekera: Yeah Microsoft in our view is looking pretty good. It’s a 4-star-rated stock. Trades at a 13% discount. And in fact it’s one of only a few large-cap growth stocks in the tech sector that are still trading at a discount to fair value. As one of the largest global tech companies, I’m going to be interested in any outlook that they have on the global economy as well as the US economy.

Looking at their individual business lines, any color on their gaming business as we go into the holiday season. Now, to me, that’s probably not necessarily meaningful to the overall valuation of Microsoft in and of itself, but I’ll be interested in that, thinking about how the holiday season is shaping up for other companies this year.

Be listening for any commentary on how the PC channel is doing, whether or not they see that normalizing. Of course, we had that big pull forward a number of years ago from the pandemic, and then once that happened that pulled forward a demand, and so we saw that a slump. So we’re looking for that to start recovering probably in the short term.

And then on their enterprise system, you just really expect that to be business as usual with very strong growth coming out of Azure. Taking a turn here to Meta. Meta is a 3-star-rated stock. Trades almost right on top of our fair value. I think we as the market are going to be listening for any update on capex spending, specifically on generative AI. I’d really like to hear from them, more specifically, on how and when they think they’re going to be able to monetize that spending. I think that’s really probably the big question for Meta. Other than that, just an update on growth in digital ads. You know, they had a big benefit from ad spending and Temu and Shien over the past couple of quarters.

So the question is: Will that growth continue to keep up or are we going to start seeing that starting to slow?

Dziubinski: Now let’s pivot over to those quarterly GDP numbers. Could there be any surprises there that could affect the market this week?

Sekera: I think so, and I think the bigger risk here is potentially to the upside. When I take a look at the Atlanta Fed GDPNow figure, I think that’s running at 3.3%. Now if it were to print there, that’s actually sequentially higher than the 3% print we had last quarter. So that would be a surprise to us. That’s higher than consensus and our own forecasts.

Now having said that, there may not necessarily be a huge market reaction. At this point, when GDP comes out, depending on which month within the quarter, you’re looking at that news as overall one to four months stale at this point. So I think most investors are already looking for that strong GDP print. So I don’t think that would necessarily cause a lot of market volatility.

Dziubinski: Now moving on to Thursday. That brings us the September PCE number and earnings from Apple and Amazon. So this is a really big day. So first let’s talk PCE. Given that the CPI number that came out earlier this month was a little higher than expected. What could either a higher or lower than expected PCE number mean for the markets this week?

Sekera: Yeah, and this one, I think the risks to the market’s if PCE comes in higher than expected. Now of course the Fed’s 50-basis-point cut was predicated on a combination of moderating inflation and weakening labor markets. So if inflation were to come in hotter than expected, I think that would really call into question just how much and how fast the Fed would be able to continue to cut rates.

And at that point, I think the market would be very unhappy to see that hotter inflation coming in. Now, on the opposite side, if we had a low print, while that could be beneficial to the market, I don’t really think that would end up impacting the markets all that much. I think the market really is going to be much more focused on earnings this week, and that would really overwhelm the impact of any moderating inflation that we would see.

Dziubinski: All right. Let’s talk about Apple and Amazon then. Apple looks about 25% overvalued, according to Morningstar, as it heads into earnings. While Amazon looks about fairly valued. So do you expect any drama around either of the stocks this week?

Sekera: Well, we shall see. I mean, Apple would be the one that I’m going to be a lot more concerned about. I think there could see some risk to the downside here. And it’s really just based on our view of valuation. It’s a 2-star-rated stock. Trades at a 25% premium. And of course this quarter the entire focus is really going to be on the launch of the iPhone 16.

The real question to the market is: Will Apple’s AI efforts in Apple intelligence drive a huge wave of new handset upgrades or not? So we’re going to also want to hear from them some color as far as their expectations for shipments for the holiday season. The fourth quarter or calendar fourth quarter anyways is their strongest season of the year for sales.

So if that were to disappoint, I could imagine seeing the stock get hit pretty hard. Amazon, on the other hand—3-star-rated stock. Does trade a little bit below our fair value, but not necessarily enough to be in that 4-star territory. Thinking about their business here, on the retail side, the business should be pretty solid, pretty near expectations.

Now we will listen for a commentary on the retail side as far as the state of the consumer. We have seen some shifts going on there. People buying fewer discretionary items online, buying more food and staples. So want to hear if that trend is still ongoing or not. Their advertising business—we’re expecting pretty good strength here especially as we head into the holiday shopping season.

And then lastly, AWS, their AI platform. We’re expecting that revenue there should still be accelerating. So we’re going to want to hear about their capex spending programs to support the growth in that business.

Dziubinski: And then we wrap up the week on Friday with October payroll numbers and earnings releases from ExxonMobil and Chevron. September payroll numbers were surprisingly strong, so any thoughts on what October’s numbers might hold?

Sekera: But I’m going to caution investors really be careful when that number prints this week. Now to be honest, I don’t exactly know how payrolls are calculated. I’m not an economist. I’ve never really dug into it. But there’s a number of different things going on. Like you have the Boeing strike that could end up making some changes to these numbers, which may not necessarily be indicative of what’s really fundamentally going on with the job market.

So I’d be cautious with this one when it comes out. I think the consensus numbers have a pretty wide dispersion here. So again, we’ll watch for it, but I’ll wait to hear from Preston as far as what he thinks once he’s able to dig into the underlying numbers.

Dziubinski: Now, Exxon and Chevron are no longer really the heavyweights that they once were in the index, but they’re still representative of Big Oil. So are there opportunities with either stock ahead of earnings?

Sekera: I think so. Now Chevron is now the more undervalued of these two stocks. It’s rated 4 stars. Trades at a 15% discount. Nice healthy dividend yield at 4.3%. And of course Exxon, we’ve talked about that one for a long time. That’s been pretty much my go-to stock for oil exposure. It’s moved up enough it’s now in 3-star territory.

Still does trade a 11% discount to fair value with a 3.2% dividend yield. So I wouldn’t argue against it if you wanted to buy that stock. But based on their valuation, Chevron is the more undervalued of the two right now.

Dziubinski: All right. So that’s our week ahead. It’s time to move on to some new research from Morningstar. Tesla’s stock soared last week after earnings, and the company’s margins expanded during the third quarter, and management offered up an improved 2024 outlook. So what did Morningstar make of the report, Dave?

Sekera: Well, as you mentioned, Tesla was able to expand their margins on better operating leverage based on a higher number of vehicle deliveries this past quarter. And that’s really in contrast to the first half of the year where margins were under pressure. So when I read through our notes here, Seth writes that he thinks that that probably means that first half of this year will be the low for their margins.

We did raise our fair value a little bit by 5%. That increased forecast was just slightly higher in near-term deliveries and higher 2024 gross profit margins. And then we also did raise our outlook for the energy generation and storage segment. We are still seeing a pretty strong demand for utilities scale batteries. Now, overall, management affirmed its timeline for the new affordable vehicles to enter production in the first half of 2025.

It sounds like that, with incentives, the price for those vehicles will come in below $30,000. In my view, I think that would be a very good positive catalyst. Now we won’t see a huge number of deliveries of those cars in 2025 as they ramp up. It’s really much more of a 2026 event. But I think those low-priced vehicles is really going to open up a whole new demographic of new-car buyers coming into Tesla.

Dziubinski: So then even after the fair value boost, though, the stock still looks overvalued after that rally, right?

Sekera: Yeah. I mean, that stock shot up, I think, 22% on Thursday, another 3% on Friday. So where that stock is trading, last I checked, is about $269 a share. So that’s well over our $210 fair value estimate.

Dziubinski: Starbucks also kind of surprised the market, reporting earnings ahead of schedule last week—evidently wanting to get that bad news out of the way. And as expected, results were weak. What did Morningstar think of the report?

Sekera: As you mentioned, earnings were really pretty weak. In my own mind, the biggest surprise was that store traffic in the US fell by 10%. That’s a huge decline in just any one individual quarter, but that’s now the third sequential quarter that foot traffic has declined. So that led to pretty weak revenue of only 9.1 billion. Our estimate for that was 9.4 billion.

Earnings per share was only $0.80. That’s compared to our estimate of $1.05 per share. So really the key takeaway according to Sean, who covers the stock for us, is that all of the new solutions that are really outlined by the new CEO that they brought in are going to likely require higher near-term operational and capital investment that’s going to result in lower near-term earnings power.

Now, typically in a situation like this, I would expect a stock like that really to just fall off a cliff after a report like this. But when I look at them, the charts here, that stock really held in there much stronger than I would have expected. I think that’s really a testament to the confidence the market has and are placing in the new CEO here.

So overall, it’s a 3-star-rated stock. Our fair value is $95 a share. And again, as long-term investors, it’s not really going to be based on what we’re seeing here in the short term, but based on really our long-term expectations for cash flow for the company. But personally, I’d probably wait to see if the stock did pull back and fall any more before getting involved.

Dziubinski: Now we have some new research on a few tech companies that reported last week, starting with IBM. Now, IBM stock, interestingly, is up more than 60% during the past 12 months. But the stock fell about 6% after earnings. And Morningstar’s analyst called management’s fourth-quarter outlook “bleak.” So what’s going on here?

Sekera: Overall, kind of when I think about the markets over the years that I’ve been involved in the markets, I think this is just like a lot of stocks that got caught up during the tech bubble back in the year 1999 and 2000 that really shouldn’t have been caught up back in the tech bubble at that point in time.

And I think IBM has been caught up now in the artificial intelligence trade. But according to our analyst, we just don’t think the amount that it’s going to benefit over time from its growing AI business will be enough to offset the legacy technology business, which continues to keep feeling like it’s shrinking and shrinking every year.

In our view, the stock is significantly overvalued at this point. I think you mentioned that it was up was at 60% this year. It’s now trading over a 60% premium to fair value. So again puts it well into that 1-star territory.

Dziubinski: Texas Instruments offered solid results but an unimpressive forecast. So Morningstar held its fair value estimate on the stock at $175. So, what’s notable over at Texas Instruments, Dave?

Sekera: I think this is a case that results came in better than what were originally feared. Now the stock had fallen after ASML had reported poor earnings the week before. So the market was very cautious going into this one. And I’ll also mention, too, that when we look at the fundamentals here, the quarter was probably not necessarily that great, but the quarter was saved by high-single-digit sequential growth in the automotive revenue segment, thanks to pretty healthy momentum from Chinese electric vehicles. Now looking forward to the guidance for next quarter was what I considered to be pretty mediocre. They guided sales to be down 7% sequentially. Management noted they said that they thought that was in line with normal seasonal patterns, but that would also be down 6% year on year.

Now when I look at earnings, I think the guidance was $1.18. That’s really at the midpoint. Based on where the company’s performed thus far this year, our analyst noted that at that earnings guidance, margins would need to dip this quarter. It’s a 2-star-rated stock. Trades at a 15% premium.

So if it’s one that you want to take a look at, put it on your watchlist, continue to follow it, but not one that I would get involved in at this point.

Dziubinski: And then lastly, ServiceNow reported earnings last week. And Morningstar’s analysts said it was “another epic quarter.” Morningstar raised its fair value on the stock by 7%. So what’s to like here, Dave?

Sekera: Well, we think ServiceNow, when we look at all of the companies in the enterprise software space and what they’re doing in AI, ServiceNow is actually one of the best to actually implementing AI in its product offerings. So really that’s the reason to watch this one and why we’ve seen such good momentum in the stock and our own fair values.

And it looks like there’s really just very good operating momentum. And I think it’s really going to stay ahead of the rest of the pack as far as implementing AI in its products.

Dziubinski: So after that fair value increase, ServiceNow stock still looks about fairly valued. So is it fair to say that this stock is a good one for a watchlist?

Sekera: Exactly. It’s rated 3 stars. Very close to our fair value at this point in time. So one that if you put that on your watchlist, maybe if we do see a market pullback here and it gets kind of caught up with a market pullback and falls enough to move into that 4 star, that’d be definitely one I would highlight for investors.

Dziubinski: All right. Well it’s time to move on to our stock picks for the week. The market hit new highs not long ago and is looking stretched. But as you’ve noted before Dave, because of market tailwinds you think investors should maintain their equity allocations. So before we get to the picks, can you briefly remind viewers what those tailwinds are?

Sekera: First of all, it’s just moderating inflation. Morningstar’s US economics team not only expects inflation to moderate over the next couple of months, but going into next year, we’re looking for inflation on average to fall actually below the Fed’s 2% target. Also taking a look at our US economists forecast, and we still think that we’re in kind of a multiyear decline in long-term interest rates.

Now, we did have a brief blip up here over the past month or so with the 10-year going up. But over the long term, we do expect long-term interest rates will turn down and head down next year and into 2026 and maybe even to 2027 as well. Of course, we’ve got the Fed easing monetary policy.

But it’s not just the fed. You’ve got the ECB also easing monetary policy in Europe. And of course over the past couple of weeks we’ve seen a huge wave of fiscal stimulus and monetary policy programs being unleashed in China—of course, the second largest by GDP in the world. So again, a lot of tailwinds which could keep the market at what I consider it to be relatively elevated valuations. But it could keep those stock prices up there until earnings really catch up to where they should be.

Dziubinski: All right. Given that backdrop, your picks today are all undervalued stocks from companies with strong fundamentals and solid underlying businesses that should be able to withstand volatility in the short and intermediate term. And your first pick this week is Verizon, which actually reported earnings last week. So walk us through the numbers on Verizon, Dave.

Sekera: Verizon is a 4-star-rated stock. Trades at a 22% discount to fair value. Has a 6.3% dividend yield. It’s a company that we rate with a narrow economic moat and a medium uncertainty. Now, I would note on the face of it when you look at Verizon’s reports, they actually looked pretty poor from a GAAP basis.

And the reason the results looked poor is because they took a very large charge, $1.7 billion, for severance costs. They are reducing headcount. Looks like they’re trying to bring it down under 100,000 from 117,000. But again this is really just going to be a one-time charge. So when we think about the long-term valuation for this company, we’re really going to exclude that from kind of our future free cash flow estimates.

Other than that I would say the results were just fine. The wireless service revenue came in, I think, at about 2.7% increase. They added over 81,000 wireless customers. Adjusted EBITDA increased by 2.1%. So again, not like they were knocking it out of the park, but just very good solid numbers for this company. Now the other thing that I think also got the market’s concern is that they guided towards higher capex spending for broadband and fiber over the short term.

But overall, when I look at the results here and even when we include that higher capex spending in the short term and really think about what it will do for the business over the long term, in our view, it all actually really just supported our long-term investment thesis here.

Dziubinski: Now, of the big telecoms here in the US, Verizon is the one that still looks undervalued. So what’s the market missing here?

Sekera: Yeah I mean they’ve all run up pretty strong over the past 52 weeks. And of course Verizon is the one that’s lagged the most. But we think the market’s actually getting it wrong here. Long term, we expect the wireless business in the US is going to continue to keep acting more and more like an oligopoly, meaning that they will compete less on price over time.

That’s going to allow those margins to continue to keep expanding. We’ve seen that over the past couple of quarters, and we expect the company will have just slow but steady service revenue growth, probably pretty solid cost control. Again, talking about like the severance costs that they have in order to reduce their headcount. And then what we’re also seeing too is probably a drop in phone upgrade cycle.

So that’s going to allow them to expand their EBITDA margins modestly. And when I look at the valuation of the stock, it only trades at 9 times our 2024 earnings.

Dziubinski: Now your second pick this week is Kenvue. So give us the headline metrics on this one.

Sekera: So Kenvue is a 4-star-rated stock. Trades at a 13% discount. Has a 3.6% dividend yield. A company we rate with a wide economic moat and a medium uncertainty. The economic moat is really just based on their intangible assets, very strong brand reputation, very good customer loyalty here. But based on their size, they do have a cost advantage from significant economies of scale.

Taking a look at the stock, just to give you an indication of where trades, it’s a little bit under 20 times 2024 earnings and 18 times our earnings estimates for 2025.

Dziubinski: Now Kenvue stock was up last week after reports that activist investor Starboard Value had taken what many were saying is a sizable stake in the company. So what’s Morningstar’s take on the company today?

Sekera: For those of you that aren’t familiar, it is a spinoff from Johnson & Johnson’s consumer products division. Following the spinoff, we expect that the company is going to be able to better allocate capital to prioritize growing its own consumer brands. While they were still part of JMJ, I think a lot of the money that they made actually was getting siphoned off there in order to spend on drug development. Over the long term, when we think about the aging population, the premiumization of consumer healthcare products, a lot of growth in emerging markets, I think that all provides very good tailwinds for Kenvue’s wide product portfolio. And as you mentioned, we now have an activist investor here, so obviously they see a lot of value just like what we have seen. Now of course the stock after it moved up isn’t as undervalued as it was. But still, 4-star-rated stock that we think looks pretty attractive here.

Dziubinski: Now your third pick this week is the stock of a company we already talked about today and that’s reporting this week. And it’s Microsoft.

Sekera: Yeah 4-star-rated stock. 13% discount. Not one for dividend investors. under a 1% dividend yield. But again wide economic moat, medium uncertainty. Their moat here is going to be primarily based on switching costs but also some network effects and some cost advantages as well.

Dziubinski: Now Microsoft isn’t necessarily a screaming buy when compared to some of your other picks. So what’s your case for the stock today?

Sekera: Well, again with Microsoft today, it’s all about the growth in their Azure business, specifically the growth they’re getting from artificial intelligence. Now Azure earlier this year has already been growing very rapidly. But that growth had actually been constrained by capacity. So this quarter we’re going to be looking for just how much more capacity they’ve been able to add, how much more they’re going to be able to add here in the short term.

I know our analyst team is expecting growth in Azure to have actually accelerated and increase as the rate of pace goes up in the second half of this year and into next year. Taking a look at the stock: It’s not overly expensive. Trades at about 28 times our 2025 earnings estimate. But it is a company that we expect kind of that low to mid double-digit growth on average over the next five years.

Dziubinski: Now Medtronic is your next pick. Give us the highlights.

Sekera: Sure: 4-star-rated stock, 19% discount to fair value, 3% dividend yield. Company we rate with a narrow economic moat and a medium uncertainty. And their moat really is just going to be based on the intangible assets as they have patents on all of their intellectual property. And of course, there are probably also some switching costs here that support that moat.

Dziubinski: Now, Medtronic stock has had a pretty nice run the past few months relative to its industry. So what’s Morningstar’s thesis here?

Sekera: Well, again, for those that may not know Medtronic, it is the largest pure-play in medical-device maker. We think it’s actually one of the better positioned medtech companies for the continued aging of the baby boomer generation. They make medical devices for chronic diseases, including pacemakers, defibrillators, heart valves, stents, insulin pumps. So again, a company we rate with a wide economic moat and a medium uncertainty.

Taking a look at our model here. we’re looking for a little bit better than inflation or revenue growth, 4.5% compound annual growth rate over the next five years, but with some operating leverage, their earnings growth probably will be about 9% as a compound annual growth rate over the next five years. So pretty solid growth rate.

Taking a look at the valuation of the stock—only trades at 16.7 times our earnings estimate for 2024 and 15.5 times our earnings estimate for next year.

Dziubinski: And then your final pick this week, Dave, is Devon Energy. Really nice dividend yield on the stock. And I think Devon was among the first energy companies to adopt a fixed plus variable dividend policy, too.

Sekera: Yeah. Now we’ve seen that in other areas of the world, that variable dividend policy. Typically US stocks always had a very fixed payout range. But I think in this case it makes a lot of sense, specifically in the energy sector where profits can swing a lot over the course of the year and from year to year as part as oil prices might spike or retreat. So in this case, it looks like they do have a somewhat small but a steady, constant dividend. And then to that they’ll either increase their dividend based on if they have higher cash flows than expected.

Now taking a look at this one, our fair value estimate corresponds to an enterprise value/EBITDA multiple of only 4.2 times and 3.8 times based on our 2024 and 2025 model. From our earnings perspective, it trades at just under 7 times our 2024 earnings estimates. So I think it’s one that from a valuation basis it just looks very undervalued.

Dziubinski: And then why is the stock a pick, Dave?

Sekera: It’s really just that, first and foremost, to me it’s all about the valuation. Four-star-rated stock, 18% discount, 5.1% dividend yield. Company with a narrow economic moat and a medium uncertainty. And that narrow economic moat, in this case being a basic materials company, is going to be based on their cost advantages. When we calculate what we expect their breakeven oil price to be, it’s just under $36.50 a barrel—well below our estimated marginal cost of production for the sector overall. And secondly, I just like generally energy and oil stocks in your portfolio. I think it just provides a good natural hedge against any other geopolitical risk or if inflation were to make a comeback at some point.

Dziubinski: All right. Well, 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 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.