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5 Undervalued Stocks to Buy After They’ve Been Dumped

Plus, our take on the Fed meeting and our new fair value estimate for Nvidia stock.

5 Undervalued Stocks to Buy After They’ve Been Dumped

Susan Dziubinski: Hello and welcome to the Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday morning, I sit down with Morningstar Research Services’ chief US market strategist Dave Sekera to discuss what’s on his radar this week, some new Morningstar research, and a few stock picks or pans for the week ahead. Good morning, Dave. On your radar this week we have PCE figures coming out on Friday.

Remind viewers why PCE is an inflation figure that you watch closely.

David Sekera: Good morning, Susan. The Personal Consumption Expenditure Index is the Fed’s preferred measure of inflation. So while CPI and PPI are both important, certainly provide indications of where PCE is going to print when that report comes out. It’s the PCE report that the Fed is really relying upon when it’s going to determine what it’s going to do for monetary policy.

Dziubinski: What’s Morningstar expecting?

Sekera: Our US economics team right now looking for that headline figure of only 2.4% on a year-over-year basis for PCE. But, unfortunately, that core print is still going to come out on the high side. So, we’re looking for 2.8%. But I would say even more importantly is our US economics team does expect that inflation will continue to keep moderating over the course of the year.

Looking forward, when we’re projecting our core PCE for the fourth quarter of this year, we’re actually looking for it to get down to 2.2%. So, really close to the Fed’s long-term target for inflation.

Dziubinski: What could a too-high PCE reading mean for the market?

Sekera: Look out below. No, seriously, if it does come in hotter than expected, I would say that’s going to prompt the market, or really prompt the Fed, to stay on hold. And I think the market would realize that pretty quickly. So, at that point, if it’s hotter than expected, I don’t think we would see that reduction in the fed-funds rate for a while.

And I would think that if that happens, we could see the market give back a lot of those gains that we saw since Wednesday afternoon when the Fed came out; the market moved up on that relief rally and carried that momentum up into Thursday. So, again, if it does come in hotter than expected, I’d be very cautious of what the market might do.

Dziubinski: Let’s shift over to talking about some companies that are on your radar this week. McCormick, which is ticker MKC, will be reporting earnings, and Morningstar thinks the stock is fairly valued at this point. Why is this company one you’re watching?

Sekera: For the past five years, when I look at our valuation and look at where the market has traded, McCormick stock has been well into overvalued territory for a long time. The stock finally sold off last October, dropped down to our fair value estimate. So, at this point, it’s in that 3-star-rating territory.

It is a company that we do rate with a wide economic moat, meaning that we do think this company has long-term durable competitive advantages. We rate the company with only a Medium Uncertainty, and it pays a pretty decent yield. The dividend is about 2.4% right now. Personally, I’ve always liked McCormick. I’ve always thought that this was a very strong company.

I like their competitive positioning. Our analyst has noted that in the spice business, they have about 20% market share. That’s 4 times the next largest competitor out there. Of course, I would certainly prefer to see the stock trading at a greater margin of safety before I buy it. But at the same time, I wouldn’t be opposed to starting a position and maybe building a little bit here.

Looking at this as a stock that could be a pretty good core holding for some investors’ accounts. Having said that, I would certainly still keep dry powder here. That way if it were to sell off in a market downturn, then you still have the ability to buy some more and average down during a market pullback.

Dziubinski: Carnival Cruise Lines, which is ticker CCL, also reports this week. The stock’s having a tough 2024 and looks really undervalued ahead of earnings.

Sekera: A 5-star-rated stock that trades at almost a 40% discount to our fair value. It is a company that we do rate with a narrow economic moat, but for dividend investors, I would caution this one does not pay a dividend, and I don’t think it’s going to be paying a dividend here for quite a while at this point.

When I take a look at our coverage of the cruise lines, it is the most undervalued of the three. Norwegian Cruise Lines NCLH is a 4-star-rated stock. Royal RCL has actually had a pretty decent year. It’s now up into 3-star territory. But as you mentioned, CCL the stock has, I think, really taken a breather here the last couple of months.

But I would note it is still well over 50% from its October lows. I’ve talked to Jaime [Katz], who is our analyst who covers this one. And to some degree, I think our investment thesis is that the cruise lines are still recovering to some degree from the pandemic. Now, we are seeing passengers returning and pricing improving.

But when Jaime looks at the cost of cruises, and she compares that to land-based alternatives, she still thinks that these cruises are anywhere from 25% to 50% cheaper than those land-based alternatives. She does forecast over time that that discount will continue to keep tightening up, and that will improve margins over the long term.

And I think that’s a lot of our upside potential here.

Dziubinski: Let’s move on to some new research from Morningstar, starting with Morningstar’s reaction to last week’s Fed meeting. As expected, the Fed held rates steady, and it also indicated that three rate cuts are planned for some time this year. The market rallied on the news. What did Morningstar think of what Federal Reserve Chair Powell had to say after the meeting?

Sekera: For the most part, I didn’t hear anything new. I think Chair Powell really stuck to the same talking points. His answers were in line with exactly what he was talking about at recent congressional meetings. I think the big difference here is going to be between our view from our US economics team and what the Fed is currently modeling in in their dot plots.

I think that we have a much higher degree of confidence than the Fed has, that inflation will continue to keep moderating over the course of the year. While the Fed right now is looking at only three rate cuts for the federal-funds rate, our US economics team is holding to five cuts, so essentially looking at a cut not only at the June meeting but a cut at each meeting thereafter.

And the reason for that is that they’re looking at the rate of inflation slowing over the course of the year. But also we are modeling and projecting that the economy will continue to keep slowing as well. So, right now, we’re only looking for 1.5% GDP here in the first quarter.

That’s less than half of the growth rate that we saw in the fourth quarter last year. I think we’re still looking for that GDP to slow into the second quarter before it starts to reaccelerate in the second half of the year. I do think this is probably one of our largest nonconsensus calls at this point.

Dziubinski: You mentioned that Powell’s been consistent in his recent comments. Given that, do you think that the market rally will pick up steam again after the meeting?

Sekera: I think we already actually saw the relief rally started Wednesday afternoon and continued into Thursday. And to some degree, I think the market was just relieved that the Fed is still pointing to those three rate cuts, still pricing in that first cut to come here at the June meeting. And a lot of it is due to having those high CPI and PPE prints in January.

They moderated a bit in February but not enough to really give the market the confidence that the Fed was going to keep those three cuts. Now, as far as our market valuation goes at this point, the market is getting a little stretched. It is trading at a couple of percent above our fair value at this point.

And looking forward, it’s not that I’m expecting a big correction or anything, which, of course, can always happen. But I’m really looking for over the course of the year, more of a market rotation, looking for the market to move into those areas that have lagged and remain undervalued. Whereas things like the large-cap tech stocks, those have been what’s really driven the market over the past year and a half. Those have moved into overvalued territory, in our view.

Dziubinski: Let’s move on to some new Morningstar research about specific companies. And Dave, we have to begin with Nvidia NVDA. The company held its annual developers conference last week. What were some of Morningstar’s key takeaways from that event?

Sekera: The key takeaway is going to be the introduction of their new GPU, their new graphic processor unit, and of course, it’s those GPUs that are being used to build and train your AI models. And Nvidia products are by far the best products out there for AI right now. We just think that this new product that they have out there just widens their lead past their competitors at this point.

Dziubinski: Morningstar raised its fair value estimate on the stock by 25% after the event, and I think it’s at $910 per share right now, the fair value. So two questions here, Dave: Why that substantial hike, and what are the assumptions behind that valuation?

Sekera: It’s based on a number of different things. First, that new GPU, it does keep Nvidia well ahead of the competition. And at this point, I think that first-mover advantage that Nvidia has is going to last longer than I think what we originally projected. And then Nvidia also showcased how their chips are used by some of their partners.

We are looking at maybe some extension into new use cases that we hadn’t been looking at before, such as robotics and automotives. And then lastly, I think our analysts also just increase the amount of industrywide capex that we’re expecting to be spent on GPUs over the next couple of years.

So, again, when I look at our assumptions, the growth is still kind of mind-boggling. When I look at our financial model, we are expecting revenue, which already doubled last year to $60 billion, to double again to about $116 billion. Over the next five years, we expect revenue to go from $116 billion this year all the way up to $212 billion for fiscal-year 2029.

Taking a look at operating margins, they remain double what they had been historically. What’s that all mean for investors? Well, we’re looking at earnings this year. Our projection is $26.11 per share. Based on our fair value estimate, that’s about a 35 times P/E ratio for this year.

And for earnings next year, we’re modeling in $34.44. So, 26 times P/E, High P/E ratios but not necessarily that overexpensive for this kind of situation. Now, lastly, I want to try to put all of this in the context. What is the total addressable market here? I know AMD [Advanced Micro Devices] has forecasts of the total addressable market to be $300 billion for GPUs in 2027.

That compares to our forecast for Nvidia sales that year of $184 billion. Our revenue estimate is actually based on a pretty high market share, but a slightly lower total addressable market than AMD in that year. There actually still could even be additional upside to our fair value if the total addressable market is as high as AMD expects and Nvidia keeps that dominant market share that we’re currently projecting.

Dziubinski: Morningstar assigns Nvidia stock a Very High Uncertainty Rating. Explain to viewers what that means exactly.

Sekera: As much as we do think that there’s still upside potential here, there’s also a lot of downside potential. That Very High Uncertainty Rating means that we do think that there is just a very wide range of potential outcomes here. While it is just an amazing growth story, it’s really one of the most difficult in the market right now to make assumptions for not only just the long-term growth but even the short-term growth.

Right now, yes. Nvidia does make the best product out there for AI. They’re selling everything that they can make at pretty much whatever price they want to price it. First, I would think through how long you as an investor do you think that Nvidia is going to remain the leader before one of the competitors catches up.

Both AMD and Intel INTC are working to develop their own new products. But we also have some of the users of those products working to try and develop their own solutions as well. Alphabet GOOGL, Microsoft MSFT, and Amazon AMZN are also working on designing their own AI chips. Second, what is the dynamic for demand for AI chipsets?

Again, that is just how much demand is there for it today. But how much is that market growing and for how long? And at what point does supply start to catch up with that demand? I’d say there’s really just not much out there in the way of historical precedent. Analysts are certainly making their best estimates at this point, but certainly a wide range of possibilities over the next few years.

Again, now this is just my own opinion, but I do think that for some of these stories in artificial intelligence, I think you should try and keep your position sizes within those boundaries of what I consider to be some of the more speculative parts of your portfolio because there is just such a wide range of outcomes that could occur over the next couple of years.

Dziubinski: So much uncertainty around them. Also last week, Dave, we had the Department of Justice hit Apple AAPL with an antitrust suit, and the stock fell as a result. First, Dave, explain what the DOJ’s gripe is here.

Sekera: They’re suing Apple on antitrust grounds, essentially claiming that Apple is acting like a monopoly with certain parts of its businesses. Specifically, our analyst thinks that the DOJ is really focused on Apple’s core strategy of wrapping up customers into its ecosystem system, which I’d also note to some degree is also part of our wide moat rating assessment.

Dziubinski: What does Morningstar think of this suit? Any impact on our fair value estimate on the stock?

Sekera: Right now, we don’t foresee the suit resulting in a significant deterioration in either its ongoing business or its wide moat rating at this point. We do think that in our base case, Apple probably will have to open up its walled-off ecosystem to others. But essentially our analyst noted in his write-up that’s similar to what he expects is going to happen with the EU’s Digital Marketing Act.

So, no change to our fair value, still unchanged at $160 a share. But I would note, though, is that Apple stock has actually fallen enough year to date that it’s actually now moved into that 3-star territory after starting the year in that 2-star-rating range. In fact, it’s one of, if not the only large-cap tech stock that I can think of offhand that’s actually traded off thus far this year, while the rest of that part of the market is still on an upward trend.

Dziubinski: In other company news, Chipotle, which is ticker CMG, announced a 50-for-1 stock split and the stock popped on that news. Theoretically, Dave, why do stock prices often pop like this when a company announces that it’s splitting its stock?

Sekera: This really is, in today’s day and age, pretty much irrational behavior on the part of the market. When you have a stock split, the economic value of the company in and of itself doesn’t change. Your interest as a shareholder doesn’t change. Yes, you do have more shares, but each share is worth a smaller percentage of the company ownership.

Now, historically, stocks did go up in the past because when you had a stock split, it was usually because there was a liquidity issue. And, again, I’m showing my age here, but long, long ago when I started off in the business, a lot of stocks were often sold in 100-share lots.

So, if you’re trying to buy and sell shares that weren’t 100 shares, there was definitely a liquidity premium back then. But with the way trading technology is today, there’s no liquidity premium when you’re buying or selling your odd lot sizes, and there are no liquidity strains. Realistically, the only reason the stock was going up on the split is because historically stocks used to go up when they split because of those liquidity premiums.

Dziubinski: From a fundamental standpoint, what’s Morningstar’s take on the company and the stock today?

Sekera: Personally, I really like Chipotle’s food, especially the barbacoa. We do think there’s a long runway of growth ahead that we’re forecasting and putting into our models. I pulled up our model last night. We’re looking at a 15% five-year compound annual growth rate. That’s really a combination of looking for a 5% increase per year in same-store sales, looking for an annual growth rate of 10%, and new unit growth.

We’re looking for the number of units to double from 3,500 now to over 7,000 in 2032. And over that same time period, we’re looking for operating margins to expand. So, a great fundamental story here, but at the end of the day, the stock is just way too expensive. Taking a look at our 2024 earnings estimates of $49.43 per share, the stock’s like 59 times P/E right now.

This is one of those ones where I think it’s really kind of turned into more of a “what do you have to believe” kind of story as opposed to really a rational analysis of the fundamentals and the long-term outlook. Where does it put us today? It’s a 1-star-rated stock. It’s actually one of the more overvalued stocks in our coverage.

And the only other thing I’d note is that over the course of my career, purely anecdotally, but I’ve always found that I think the market tends to overpay for restaurant companies when they’re still expanding. But once that expansion starts to slow, look out below.

Dziubinski: Let’s stick with our food theme here, Dave. We have Unilever, which is ticker UL, announced plans last week to spin off its ice cream business. What does Morningstar think of that move and of the stock?

Sekera: We saw a small pop in the stock. And I think when we look at it, and I think we agree, that the market appreciates the focus that they’re putting on tightening up their portfolio and unlocking shareholder value here. It’s a 4-star-rated stock, trades at about a 3.8% dividend yield.

It is a company we rate with a wide economic moat and also has a Low Uncertainty. And I think this is just indicative of an ongoing trend that we’ve seen in the food business over the past couple of years where a lot of the food companies are starting to split some of their mature product lines from their faster-growing product lines in order to try and get better pricing from the market.

In this case, I probably wouldn’t be surprised to see if there are a couple more divestments yet to come from Unilever as they focus more on their higher-margin products in the household business and among the personal-item business. Now, overall, for investors looking for a core holding, specifically one with international exposure, I think this is one to take a look at.

Dziubinski: Then we also had some straggler earnings reports come out last week. Anything stand out to you on that front?

Sekera: There’s two I want to quickly review. First, is going to be General Mills GIS, and we talked about that one last week. Overall, I think last week was a pretty good week for the stock. Now, we did see a bit of a pop after earnings, and they did give back some of that afterward.

But at the end of the day, management maintained its 2024 guidance. Our analyst noted that he is seeing indications of stabilization, and the underlying business is expecting a good rebound in operating margins, which did increase by 220 basis points. It’s still a 4-star-rated stock, a stock that we rate with a narrow economic moat and a Low Uncertainty, and pays a 3.4% dividend yield.

And then the other one I want to highlight that we did talk about as well is Accenture ACN. Now, that stock dropped, I think, over 9% following earnings. And what happened here is management reduced its top-line and its margin guidance for the year. However, even after that selloff that stock is still overvalued and rated 2 stars.

Dziubinski: Let’s move on to your stock picks for this week. This week you brought us several stocks that were fairly valued coming into the new year but that have recently pulled back and are now in buying territory. The first pick on your list is Extra Space Storage EXR, which I don’t think is something we’ve talked about before.

This REIT is having kind of a tough year. Why is that? And what do you like about it?

Sekera: Real estate in general is still the most hated asset class on the Street. And it’s when I look at the Morningstar indexes, real estate’s the only sector that’s actually posted a loss year to date. And real estate is hit by two things. One, still just the high degree of uncertainty regarding urban office space valuations and where those are going, but also from the increase in interest rates.

Personally, I’d still steer clear of urban office space, but we do think the rest of the real estate sector has fallen too far. And my personal preference right now is playing some of these real estate companies that are going to be more defensive in nature. And, in this case, what we found is that historically, self-storage is considered a relatively recession-resistant sector.

Our fair value already incorporates a slowing demand for self-storage this year after some pretty strong growth the past couple of years. And last I saw, the stock was down 11% year to date. Now, like most of our real estate coverage, we rate it with no economic moat, but it does only have a Medium Uncertainty.

The stock trades in 4-star territory, has a nice healthy dividend yield of 4.6%. While not necessarily my favorite story in the real estate sector, I do think it does fit the bill for diversification within that real estate sector portion of your portfolio.

Dziubinski: Your next pick this week is Insulet PODD. The company’s Omnipod system is a popular choice for diabetics who require that continuous insulin therapy. But the stock’s down around 20% this year. What’s driven that performance and why is the stock on your picks?

Sekera: This is one I’ve really started paying attention to just more recently. It wasn’t a story that I knew in the past. And it is actually one of the more undervalued stocks in the healthcare industry in our coverage right now. A 4-star-rated stock that trades at I know I think slightly over a 30% discount to our fair value.

We rate with a narrow economic moat although I will caution they don’t pay a dividend at this point. Now, fundamentally, we think this company is actually still doing very well. Debbie [Wang], who covers this company, noted that it’s executed very well over the past year on its most recent product launch. So what’s happening here to some degree is I think the market is overestimating the potential for those new classes of weight-loss drugs, the Mounjaros and the Ozempics of the world, and how much those will end up reducing the number of diabetic new cases in the future.

So, with this company, about 20% of the new-patient starts are Type 2 patients for diabetes. And what Debbie said is that when she’s looked at the research here, what she finds is a weight-loss drug like Ozempic might delay the need for insulin management, but it doesn’t actually stop the progression of the disease. While it may push out from one year to three years the number of new cases for diabetes, it doesn’t change our forecast for double-digit growth with this company.

And then lastly, the other thing I like here is that Debbie Wang, who’s the equity analyst that covers the stock, she’s also written in her notes that she thinks this company could be an attractive buyout candidate from a company like Medtronic MDT or Abbott ABT. So, I think that also gives you some downside protection in the stock price from here.

Dziubinski: Starbucks SBUX is your next pick, and the stock’s having a really tough year. Why do you like it?

Sekera: I don’t know if you remember Peter Lynch. He’s the famous investor from Fidelity a number of years ago. And he always advised people, “Hey, invest in those companies that you know and whose products that you’re like.” Well, in this case, I’m going to disagree. I’m not a big fan of Starbucks coffee.

I much prefer Dunkin’ Donuts. But having said that, Starbucks customers are definitely a loyal bunch. I think they’re just as addicted to their caffeine as I am. And where we’ve seen Starbucks being under pressure over the past has really been in China and the Middle East. Of course, the Chinese economy has really failed to reaccelerate here in the short term.

But it hasn’t been enough to really affect our longer-term assumptions in this case. And so we do think that the stock has sold off too much. It’s a 4-star-rated stock, a company with a wide economic moat, a Medium Uncertainty, and a dividend yield of 2.5%. So, more than what you’re going to get in a lot of other stories. But maybe not as much as dividend investors would like. But I do think that this is one that’s probably sold off too much.

Dziubinski: Interpublic Group IPG is one of the Big Five global advertising companies, and the stock performance has been pretty sluggish this year. Why do you like it?

Sekera: First of all, if you remember back on our Feb. 26 show, we highlighted one of IPG’s competitors, Omnicom OMC, and that was one of our stock picks. Now, since then, Omnicom has risen. It’s now moved up into that 3-star territory, whereas IPG has lagged. So, this might actually be a good opportunity just to swap out of Omnicom.

Now that it’s trading in that fair value territory, you’ll move that into IPG. It can have a lot of the same dynamics impacting IPG as what we think will impact Omnicom. IPG is a 4-star-rated stock, I think about a 15% discount to fair value, a company we rate with a narrow moat, although a High Uncertainty, and pays a pretty decent dividend at 4%.

I think what’s weighed on the stock here is IPG has a pretty heavy client concentration in telecom and technology. Those are two areas that we think in the ad business were under pressure last year. But we do expect that to improve over the course of this year. So, similar to Omnicom, our long-term investment thesis here is that we do think that over time the larger agencies are going to benefit the most.

They’re the ones that are able to provide complete advertising solutions to their clients for both traditional and digital advertising. I’m having a tough time here. Need a little more coffee, I guess. So, as clients are allocating more ad dollars to their digital campaigns, these larger agencies this year will be able to provide better pricing to their customers because they’re large enough to be able to negotiate better deals.

And then lastly, I would just note, any time we have an election year, especially a presidential election year, we’re going to see a lot more spending on ads. And usually that is a good year for the ad stocks.

Dziubinski: Last pick this week—Dave, have some coffee—is Xcel Energy XEL. Insurance companies are suing Xcel based on allegations that the company’s equipment might have started the Smokehouse Creek wildfire in the Texas Panhandle. So, the stock is, of course, taking a hit. But you think there’s a buying opportunity here? Explain that.

Sekera: I think this is one where if this is something that you’re interested in, go to Morningstar.com, pull up our research here and read through what, Travis [Miller] has written on it. Essentially what Travis has done is he’s incorporated an assumption into his forecasts of a 50% probability that the company will be responsible for about $1 billion worth of costs.

Now, based on how much the stock pulled back, we’re estimating that the market is pricing in a $5 billion worth of costs. So, we expect potential liabilities here will probably be somewhat limited. I think, fortunately to some degree, the fires have been in relatively sparsely populated areas. And the other difference here with this company versus some of the others that have been under pressure from potential fires that they have potentially started is that Texas doesn’t have a strict liability standard.

So, the company is only going to be responsible for those liabilities if the courts determine that its equipment was not maintained properly. And then any payments, of course, certainly could be pushed out several years into the future. And to some degree, it might also be covered in part by Xcel’s insurance. It’s a 4-star-rated stock, it trades probably around a 13% discount, narrow moat, Low Uncertainty, and a 4.2% dividend yield.

I think the market is giving you an opportunity on this one. The market, I think, is being overly conservative with what they think the potential liabilities are going to be compared to what our estimates are.

Dziubinski: Well, 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. 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, and have a great week.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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