3 Stocks That Other Investors Are Overlooking, but You Shouldn't

In his recent article "4 Gotta-Have Stocks That Are Finally Cheap Enough to Buy," my fellow Fool Anand Chokkavelu wrote the following:

I frequently hear frustrated investors complain, "But look at the price charts of Wal-Mart (NYSE: WMT  ) and Microsoft (Nasdaq: MSFT  ) . They haven't done anything for a decade!"

Amen. I'm an owner and a big fan of both of these stocks and have written quite a bit about how silly I think it is that they trade at their current valuations. And while there are definitely a good many Foolish readers on the same page as me, there are also quite a few readers who will chime in to complain that these are terrible investments -- and will point to the lackluster stock price chart from the past decade.

But as Anand rightly points out, while the stocks have been suffering, both companies have been quite successful. Both have significantly grown profits, raked in gobs of cash, and paid out a lot of that cash to investors in the form of dividends.

Unfortunately, investing isn't always as simple as buying great companies. You can buy the greatest company out there, but if you pay too high of a price, you may struggle to make money as the valuation comes back to earth.

Of course, this also means that just because a company's stock has been performing poorly doesn't necessarily mean that the company is a lost cause as an investment. In fact, it could be quite the opposite as years of poor stock performance pile up, investors increasingly give up on the stock, and what was once a wildly overvalued stock suddenly becomes a very attractively undervalued stock.

I think both Microsoft and Wal-Mart fit that bill. I also happen to think these three companies do as well.

Medtronic (NYSE: MDT  )

Source: S&P Capital IQ and Yahoo! Finance. Operating income = trailing-12-month operating income as of Jan. 1 of each year.

A leader in the medical device field -- particularly when it comes to pacemakers and other cardiac devices -- Medtronic has been anything but static over the past decade, even though its stock hasn't done much of anything. As the graph above shows, while the stock has been falling, profits have been steadily rising. Combine those two and what you end up with is a fast-falling valuation. Back in 2001 and 2002, Medtronic's stock traded at a trailing price-to-earnings multiple in the 60s and 70s. Today it's just 12.

Of course, if you look at the numbers coming from Medtronic, it's astoundingly hard to miss the strength of the company. Return on capital over the past 12 months has been 11.2%, the operating profit margin was 29%, and with a 62% debt-to-equity ratio, the balance sheet is very reasonably capitalized.

Abbott Labs (NYSE: ABT  )



Source: S&P Capital IQ and Yahoo! Finance. Operating income = trailing-12-month operating income as of Jan. 1 of each year.

Some things are particularly tough to track down. Four-leaf clovers. Perfectly fitting jeans. A low-calorie cheesecake that doesn't taste like cardboard. Dividend aristocrats.

Now Abbott Labs obviously doesn't fit most of those, but the company is, in fact, a dividend aristocrat. That means that the company has increased its dividend every year for at least 25 years. That's a long time. That's longer than many major, well-known companies have even been in existence. Of course, it's probably because of the requirement of that unusually long commitment that less than 10% of the S&P 500 companies qualify for dividend aristocrat status.

But dividend aristocrat or not, many investors would have nothing to do with Abbott today thanks to the fact that its stock has gone nowhere over the past decade. As with Medtronic, though, Abbott's profits have continued to climb in spite of the faltering stock price and that's dragged down the valuation from lofty heights early in the 2000s to less than 14 currently (if we exclude one-time charges).

The stock currently yields 3.6% and investors stand to see some extra "value realization" (there's some Wall Street talk for ya) as the company splits into two companies.

Walgreen (NYSE: WAG  )

Source: S&P Capital IQ and Yahoo! Finance. Operating income = trailing-12-month operating income as of Jan.1 of each year.

And once again we have a stock that's done a whole lot of nothing for a very long time. But what of the company? From the graph we can see that it's obviously been racking up profits. It has an extremely strong balance sheet, uses its capital efficiently, and, like the other two companies above, its valuation has fallen considerably over the years. Sure, it has a tough archrival in CVS Caremark (NYSE: CVS  ) , but it's largely a two-horse race in that market -- which ain't a bad place to be.

Oh, and remember what I was saying about Abbott being a dividend aristocrat? Well, ditto all of that for Walgreen, because it makes the cut (CVS doesn't).

The stock, the company, and your winning portfolio
Investors sometimes make mistakes. Sometimes those are very large mistakes. However, investors aren't stupid. When a stock is falling, there's often a good reason for it. In fact, in the case of all three stocks above -- or all five if you include Microsoft and Wal-Mart -- there was a good reason for the stocks to fall. The key word, of course, being "was."

Years ago, the valuations for these stocks were too high and they've been adjusting back ever since. The companies have been fine, the stocks have just been (rightly) ill.

But after years of falling valuations, we're now left with three (or five) attractive stocks with attractive companies behind them. So, dear reader, if lackluster stock performance has kept you at arm's length, this Fool humbly recommends that you tune in for another look.

You can lock on for that closer look by adding any, or all, of the stocks above to your watchlist. If you don't have a watchlist, you can create one here.

The Motley Fool owns shares of Wal-Mart Stores, Abbott Laboratories, Medtronic, and Microsoft. Motley Fool newsletter services have recommended buying shares of Microsoft, Wal-Mart Stores, and Abbott Laboratories. Motley Fool newsletter services have recommended creating a bull call spread position in Microsoft. Motley Fool newsletter services have recommended creating a diagonal call position in Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of Abbott Labs, Wal-Mart, Microsoft, and Medtronic, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


Read/Post Comments (11) | Recommend This Article (26)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 31, 2011, at 3:35 PM, jimmy4040 wrote:

    The numbers say that this is the strongest correlation between indidivdual stocks and indexes that has ever been seen. The day when a value investor could find a stock and hold indefinitely have disappeared with the financial crisis.

  • Report this Comment On October 31, 2011, at 5:38 PM, TMFKopp wrote:

    @jimmy4040

    It's true that that's the case right now, but do you really think that that will hold over longer timeframes?

    That would suggest that pretty much all individual securities would eventually be badly mispriced as everything converges towards some average. I don't believe in perfectly efficient markets, but I certainly think that markets are more efficient than that...

    Matt

  • Report this Comment On October 31, 2011, at 6:59 PM, nin4086 wrote:

    Did you account for increase in number of shares (dilution) in your calculations? I think you should use market capitialization and not per share price in your thesis.

  • Report this Comment On October 31, 2011, at 9:00 PM, jerryz11 wrote:

    There are two big reasons for the low valuations for medical device companies and pharmas:

    1) innovation risk: can they keep coming up with profitable innovations like before when return on investment has been barely positive for the last 10 years and more (at least for big pharmas) and regulatory hurdle for new product approvals will be increased in the future? Even if some companies can avoid the dry spell, it's no easy task to identify which are the lucky ones.

    2) reimbursement/pricing risk: will they be paid as handsomely as before for their products? Governments will be tightening their belt. Healthcare expenditure is an obvious target for the inevitable budgetary axe when it's been growing at twice the rate of the understated official inflation rate. Added to this are the recent findings that in many cases doctors have been "paid" (bribed may be more accurate) to recommend the devices even when not medically needed.

    Betting on the future recovery of PE multiples for these companies is betting that things will remain more or less the same as before. That doesn't seem a sure bet to me.

  • Report this Comment On October 31, 2011, at 9:42 PM, wolfhounds wrote:

    At one time or another I owned ABT, MDT, WMT, WAG, and CVS. Since I reinvesrted dividends in my IRA I made a decent return vs. the S&P. Two years I decided there were better companies, especially medical device companies to invest in. I bought ISRG and have added at every major pullback. Barring some overall financial catastrophe, I will continue to add if we ever see a major pullback again. I would rather invest in innovation than hope worn out stocks get revived.

  • Report this Comment On November 01, 2011, at 1:04 AM, ayaghsizian wrote:

    It funny how companies with proven earnings growth and years of increased dividends trade at such low valuations. But a company is only worth what we're willing to pay for it. We don't want to pay more than 10x for MSFT but many will pay 100x for AMZN. My guess is MSFT will continue to grow earnings and dividends and will be a boring long term investment over the next ten years, but AMZN will be like investing in MSFT ten years ago where earnings will grow but share price will not.

  • Report this Comment On November 01, 2011, at 1:33 AM, youngblood58 wrote:

    Fool keeps touting Abbott and I just don't get it. We'll see if it's truly undervalued.

    Don't see it myself.

  • Report this Comment On November 01, 2011, at 8:04 AM, NovaB wrote:

    WM and T pay better.

  • Report this Comment On November 01, 2011, at 8:39 AM, pondee619 wrote:

    Are you hyping ABT based on the chart presented, or based on its actual current price? Your chart places ABT below $50 the quote on the right show a prioce over $50.

    "You can buy the greatest company out there, but if you pay too high of a price, you may struggle to make money as the valuation comes back to earth." At which price are you hyping ABT? The current one ($50+) on the historic one (<$50)? Perhaps we could expect current information with your stories?

  • Report this Comment On November 01, 2011, at 2:03 PM, GregLoire wrote:

    I've been saying this for a long time. Valuations can only get so low before the profits are going to force the stock price up -- it's not reasonable to expect a profitable company with stable long-term growth to ever hit a P/E of 5, let alone for a significant amount of time.

    It's the earnings that always win out in the end. The people making the mistakes here are the ones buying stocks with high valuations, not the ones buying "flat" stocks with low valuations and solid fundamentals.

  • Report this Comment On November 01, 2011, at 5:33 PM, ipsiety wrote:

    Hi Matt,

    I have a different question. How do you make these over-layered graphs (one on top of another) ? I want to make these for my watchlist stocks.

    Thanks,

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