5 Undervalued Stocks for Contrarians to Buy

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Every Monday morning, I sit down with Morningstar Research Services’ chief U.S. market strategist Dave Sekera, to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead. On your radar this week, Dave, well, there’s not a whole lot, is there?

Sekera: Hello. Good morning, Susan. From an economic point of view, not a lot of metrics coming out. From an earnings point of view, should be pretty quiet as well. I mean, for the most part, we’re past second-quarter earnings. It looks like there’s a couple of off-cycle reports coming out. And we’re still a couple of weeks before third-quarter numbers are going to come out. Looking at the calendar here, from an economic-metric point of view, I’m probably going to be watching core PCE later this week. But to be honest, based on the Fed commentary last week, I think it’s probably going to be pretty close to being in line with expectations.

Dziubinski: We do have a couple of companies reporting that may be of interest to viewers. The first is Nike NKE, which Morningstar thinks is pretty significantly undervalued. What’s been going on with the stock, and why do we think it’s undervalued?

Sekera: Nike’s stock right now is a 4-star-rated stock, trades at about a 33% discount to our fair value, yields 1.2%, and it is a company that we do rate with a wide economic moat. When you take a look at the longer-term chart here, the stock really surged during the pandemic. Of course, we had that huge shift in spending to goods and away from services. Consumers were just flush with cash from stimulus checks. But we think that the stock overshot in 2021. Looks like it got over $170 a share. Our fair value, at that point in time, was only $128. Since then, that stock has now round-tripped. It’s back to prepandemic levels. But according to our fair value, we now think it’s actually overshooting to the downside. It’s dropped to about $91 a share. Our fair value at this point in time is $136.

I think, in the short term, the market here is very concerned about consumer strength. Of course, we’ve got higher oil and gas prices. Later this fall, we have the resumption of student loan payments and, of course, higher interest rates. But also, there’s a lot of concern about weakness in the Chinese economy. And China is where Nike’s been really its fastest-growing market. On the expense side, it’s fallen. Let’s see, the operating margins here have fallen 280 basis points, with marketing and other costs having increased. But looking forward from here, I think our forecasts are relatively modest. We’re projecting only really a 5% top-line growth. We are looking for a rebound of about 60 basis points in the operating margin. And over the next five years, we’re only looking for a little bit over 6% average top-line growth, and for the operating margin only to slowly rebound. In fact, it doesn’t even reach 2021 levels until 2028.

Dziubinski: Costco COST also reports this week. Now, here’s a stock that Morningstar thinks is quite a bit overvalued. What’s the story here?

Sekera: With Costco being the third-largest retailer in the United States, personally, I think there’s a lot to like about the company. In fact, we do rate it with a wide economic moat based on its cost advantages. It’s a solid business model, fundamentally strong underlying numbers here. But according to our analysis, it’s really just a matter of valuation at this point. The stock is rated 2 stars and has a 24% premium to our fair value. Of course, it does have a wide economic moat, but a little bit under a 1% dividend yield. And when I look at our numbers here, our fair value, I mean it looks like it’s trading at about a forward PE of almost 30 times right now. That would put it in the same kind of grouping as growth and other technology stocks, not other retailers.

Dziubinski: Well, the stock might be overvalued, but that rotisserie chicken at Costco is surely a bargain.

Sekera: That it is.

Dziubinski: Let’s move on to some new research from Morningstar. Morningstar’s healthcare team released some new research last week, focusing on the investment opportunity around managed-care organizations, or MCOs. Before we start, Dave, explain to viewers what MCOs are and give us some examples of maybe the larger publicly traded MCO stocks.

Sekera: Well, for the most part, they’re really just the healthcare insurance companies. The largest include names like UnitedHealth UNH, Elevance ELV—now, that’s formerly known as Anthem; people might know Elevance more by their brands like Blue Cross Blue Shield—and Humana HUM rounding out the three largest. But the thing is, it’s really that they’re no longer just healthcare insurance companies. The MCOs have expanded into a lot of different areas. For example, a lot of them now also have their own pharmacy benefit manager programs, or PBMs. And PBMs, of course, manage prescriptions, and they negotiate prices with the pharmaceutical companies. And they’ve also expanded directly into healthcare services themselves. This was an interesting point I’ve learned here is that, for example, UNH is actually now the leading caregiver in the United States. It’s even larger than hospital chain HCA HCA.

Dziubinski: Let’s talk about some of the key takeaways from this new research on MCOs. The one that jumped out at me is, “Wow, some of these MCO stocks look really cheap.” Why is that?

Sekera: There are a number of different reasons. And to some degree, the industry really can be kind of difficult for a lot of investors to analyze. Plus, the industry’s gone through a lot of change over the past couple of years. There’s been a lot of merger-and-acquisition activity in this space, both horizontally as well as vertically. And of course, there’s always concern about how changes in politics could negatively impact the industry. Most recently, the stocks have been under pressure. There are a lot of headwinds here in the near term. Underlying fundamentals are getting tougher. In fact, we expect the industry will experience some slow growth in 2024 and 2025 before it starts going back to more of a normalized rate thereafter.

When we dig through the fundamentals, I think one of our biggest concerns right now is in the Medicaid market. During the pandemic, a substantial number of people were insured by Medicaid. We saw a lot of growth there. But what happened was that the government also wouldn’t allow anyone to get kicked off of Medicaid, even if people didn’t qualify. And of course, with the pandemic behind us, that’s now changing. A lot of states are starting to evaluate whether or not people really qualify for Medicaid. And so we do forecast there will be a number of people that get kicked off. There will be lower coverage there. So, I think a lot of people are really overestimating the impact that could have on these stocks for the long term.

Dziubinski: How competitive is the MCO industry? Does Morningstar think that some of the MCOs have built competitive advantages, or what we’d call economic moats?

Sekera: We do rate each of the different MCOs with a narrow economic moat, so that means that we do think they’re going to generate returns on invested capital over the weighted average cost of capital for at least the next 10 years. And it’s based on two different moat sources: cost advantage and network effect. So on the cost-advantage side, it’s interesting from an industrywide, nationwide scale. The healthcare insurance market is really not very concentrated. But what the larger MCOs do is they really focus on building scale within local markets, and within those local markets, that scale allows them to be able to negotiate better pricing with the healthcare providers, who, of course, want to be on those larger networks that have more potential clients.

And then looking at the PBMs, they do have scale advantage. The larger they are, the more they’re able to negotiate lower prices with the pharmaceutical companies. And then lastly, taking a look at the network effect here, insurance customers, like ourselves, we want to be on the largest networks with the lowest amount of costs. And the providers, of course, they want to be able to provide discounts on those larger networks with the greatest number of potential patients. So, you kind of have a beneficial cycle there between the supply and the demand in the local markets.

Dziubinski: What’s Morningstar’s investment case for MCOs today? These stocks look cheap, but is there a catalyst on the horizon that could unlock the value of these names?

Sekera: It’s possible, but I don’t think that’s the story here. I think the story here is having to be able to look through these short-term pandemic-led disruptions. At this point, I would say we’re not really relying, necessarily, on a hard catalyst for these stocks. Now having said that, there are some possible catalysts that could be coming up. This fall, we’ll start hearing from the companies on their investor days. We think they’ll probably give some guidance for 2024. And because so many of these stocks have been beaten up, and we have a lot of negative sentiment, any positive indications there could give the stocks a short-term lift.

And then also specifically for CVS CVS and CNC [Centene CNC], both of these companies scored very low in the Medicare star ratings last year. So, when the updated ratings come out, if those scores improve, that would certainly help those two stocks out, in the short term. But more likely, I think it’s going to take time for investors to become more comfortable with the business models and for the fundamentals, not only to bottom out but start trending upward as well.

Dziubinski: It’s time for the picks portion of this week’s program. This week, Dave, you’ve brought us five undervalued stocks for contrarians. They’re all from the healthcare sector. And they’re all looking at pretty sizable losses over the past 12 months. And they’re all also covered by the same Morningstar analyst, Julie Utterback.

Sekera: Just as a side note, I think Julie’s a great example of the depth and the quality of our equity research group here. It looks like she joined Morningstar in 2025 as an equity analyst. And I know she had at least several years of experience covering equities before that. She’s actually also the chair of our capital-allocation methodology team. Personally, I’ve worked with Julie for over 13 years now, and I’ve always really respected her analysis.

Dziubinski: And when did she start, Dave? Was it 2005?

Sekera: 2005, yes. I’m sorry.

Dziubinski: Let’s start out with two stocks you like that are MCOs. The first is CVS Health, which you did mention earlier. It’s a giant among MCOs. The stock’s down about 26% over the past 12 months. What do you like here?

Sekera: The stock’s currently a 5-star stock, trades at over a 30% discount to our fair value, and yields about 3.5% right now. And we do rate CVS with a narrow economic moat. Now, I think a lot of investors may still think of CVS as being just a drugstore chain, but they’ve gone through a lot of M&A in the past couple of years. In 2017, they acquired Caremark, which is a PBM. In 2018, they merged with Aetna. And most recently, they bought a healthcare provider. Now among the MCOs, they’re actually one of the most diversified. In fact, I think they have the highest percentage of revenue from non-healthcare-insurance business.

Now, on the retail side, they have been under a lot of pressure here, as pretty much all retailers have been. And over time, we do think that their stores will evolve and move away from being just drugstores to including healthcare services as well. And that, of course, over time, we think will help drive foot traffic and higher margins in the retail business. On the PBM side, there’s a lot of concern in the market about new entrants into this space, such as Mark Cuban’s new venture. Plus, CVS itself is losing some of its clients. Some of its clients are bringing their own PBM business in-house. But we’ve accounted for this in our model. We have lowered our margins. We’ve also taken this as a hit to the top line. But we don’t really foresee this as being a long-term paradigm shift in the PBM business, in and of itself.

On the healthcare side, CVS is leveraged mostly to Medicare Advantage. And CVS did score poorly with the government star ratings last year. And it’s lost some growth from those low ratings. But the Medicare Advantage, overall, is under some fundamental pressure in and of itself. In the short term, the government is only providing a 3% rate increase in 2024, and that’s below our forecast for healthcare inflation next year. So, we do think that a lot of these Medicare Advantage providers next year are going to need to adjust their pricing and/or their benefits to offset that margin pressure.

So, looking forward here. When I pull up the model, we are looking for top-line growth to slow to only 1.5% in 2024, rebounding to 3.5% in 2025, and then getting back to more of that normalized long-term rate of 5.0% in 2026. We expect operating margins will remain flat at 4.6% for the next couple of years. Historically, that’s averaged more like 5% over the last three years. And again, all of that sounds very negative. And to some degree, it is. But when we look at the stock, we think that’s already priced in. It’s trading at only an 8 times forward-earning multiple.

Dziubinski: The second MCO on your list of undervalued stocks for contrarians is a smaller name among the MCOs, Centene. The stock is down about 13% during the trailing year, but you like it. Why?

Sekera: The stock is rated 4 stars, trades at a 21% discount, and again, we rate the company with a narrow economic moat. Now, I find this really interesting. Centene is actually almost the exact opposite of CVS. And the reason is that they’re entirely focused on government-reimbursed healthcare, so Medicaid, Medicare, and the individual exchanges. And I think the concern here is how much Medicaid redetermination is going to impact their business in 2024 and maybe even into 2025 as well. So, we do account for some losses. But again, it’s not going to be a total loss. Many of those that do get moved off of Medicaid will move on to individual exchanges, where Centene does have a strong business, and, in fact, is actually more profitable as well. So taking a look at our forecast, we are looking for a slight deterioration in both the top line and the operating margin here in 2024, but then rebounding thereafter.

Dziubinski: Let’s move on to another industry in healthcare, this being medical devices and instruments. You have two picks here. The first is Baxter International BAX, which is down almost 30% during the past year. What’s the story with this stock?

Sekera: The stock is currently rated 5 stars, trades at a 44% discount to our fair value, and the dividend yield right now is about 2.6%. So, the company does have a wide range of medical instruments and supplies. Some of the areas it’s in are acute and chronic kidney failure, injectable therapies, IV pumps, and just other hospital-focused offerings. Now, we did cut our fair value in early 2023, but, in our view, it looks like the market has just sold off too much. The company’s had some supply chain issues. That hit the company pretty hard, and they’re still working through some of those issues. But those supply chains, they will normalize and will get back on track. Our estimated P/E right now is only 13.3 times, which, by itself, appears cheap. But we do think that’s also on depressed earnings. So if you look at a forward P/E ratio, based on our 2025 earnings, that drops all the way down to 11 times.

Dziubinski: Your next undervalued stock for contrarians is a smaller-cap player in the medical device and instrument industry: ICU Medical ICUI. That stock’s down around 23% during the past 12 months. Tell us about it.

Sekera: The stock is rated 4 stars right now, and trades at a 34% discount. And this company is really just a pure play on infusion therapies. In fact, it’s one of the largest players in its industry. And it provides consumable systems and services as well. And that stock also has been under a lot of pressure. It’s suffered from supply chain issues as well. In fact, I think a lot of the top-line weakness is it just didn’t have the inventory in stock to be able to sell when it needed it. Now last quarter, management guided the top line down again. But underneath that, we’re starting to see an improvement in the supply chain, and that actually led to an improvement in its gross margins. So, we are looking for revenue to pick back up next year, and look for that gross margin to increase back toward normalized historical levels. Between those two, we think that’s going to drive some double-digit earnings growth.

Dziubinski: And your last pick this week is a wide-moat name from the medical diagnostics and research industry. The stock is down around 10% during the past year. It’s Agilent Technologies A.

Sekera: The stock is now rated 4 stars, trades at about a 26% discount to our fair value, and I think the yield is a little under 1% right now. I think this is another example of a stock that ran up too far too fast in 2021. But now, it’s done the opposite. It’s fallen too far too fast as the company failed to meet which were probably unrealistic expectations back then. The company itself is a leading provider of tools that are used to look at the structural properties of chemicals, molecules, and cells. We need to take a look at the revenue here. Half of it comes from healthcare; half of it is from nonhealthcare, so a nice diversified line there. And then also I like half of its sales are recurring, so, again, those consumable products used in its tools and its products, which also helps build its wide economic moat. That’s based on a combination of a couple of different things, but I think most of its moat source comes from its intellectual property.

The company also spends a good amount of money on R&D, just so that way we do have ongoing innovation in order to maintain that IP. Then there are also some regulatory factors to keep their clients from moving off of their products onto different products on the regulatory side. But I think the market here is just overly focused on that short term. Specifically, last quarter, it looks like sales here dropped 2%. That’s mainly from an 8% decrease in biopharmaceutical products. And specifically, it looks like Julie noted that, in China, sales were down 30%. But she noted it’s not specific to just Agilent. That was really industrywide. Management did cut their guidance. Their earnings guidance now is $5.40 to $5.43 a share. That was a $0.20 per share reduction. And we’re looking through this short-term weakness. We did maintain our long-term projections, and we held our fair value unchanged. And when I look at those projections that underline our fair value, we’re only looking for top-line growth of about 5% on average over the next five years, and we’re looking for earnings to grow at about a 7% rate.

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. Dave and I will be back live next Monday at 9 a.m. Eastern, 8 a.m. Central. In the meantime, please like this video and subscribe to Morningstar’s channel. Have a great week.