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The Dow Jones Industrial Average (^DJI +1.24%) has had its fair share of ups and downs throughout history, but over the past year and a half it's essentially gone nowhere. Based on Tuesday's closing value of 17,675, the Dow is basically flat with its closing value in mid-November 2014.
Sideways markets are often the perfect time for value investors to come streaming out of the woodwork looking for a good deal. Value stocks, as the name would imply, usually offer some form of downside protection for investors if the market heads lower. By a similar token, when the market does eventually find its footing, value stocks should be primed to increase in valuation since they trade at a perceived-to-be discount to either their peers or the broader market in general.
Of course, finding cheap stocks isn't always easy. There's a veritable smorgasbord of financial metrics that investors can choose from when trying to establish which companies offer the best downside protection during a recession and upside potential during the next rally. One of my personal favorites is comparing companies based on annual cash flow per share, or CFPS. Companies with strong cash flow generation are often more liable to pay a dividend -- and reinvested dividends can really jump-start portfolio growth -- and their business models have typically stood the test of time.
The cheapest stocks in the Dow
With this in mind, using data from Thomson Reuters, I screened all 30 Dow components for their estimated 2016 annual cash flow per share. I then divided the current price per share of each Dow component into the estimated annual CFPS estimate from Thomson Reuters to get a price-to-CFPS (P/CFPS) measure that would help us determine which Dow stocks really are the cheapest. Based on the closing data as of June 14, the following Dow stocks are the iconic index's cheapest.
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Travelers Companies: P/CFPS = 4.4
Based on annual cash flow per share forecasting for 2016, property and casualty insurer Travelers Companies (TRV +0.08%) is by far the cheapest, although I'm going to throw a little asterisk next to this figure. You see, neither Travelers nor Wall Street can predict the future when it comes to catastrophes. Thus, while the current cash flow estimates look appealing for Travelers, my guess is the current forecast could prove overzealous if a single act of God were to occur, such as a hurricane or tornado.
Nonetheless, Travelers still looks relatively inexpensive considering the highly profitable nature of the insurance business. Insurers like Travelers can use catastrophes as justification to raise premiums, meaning losses, should they occur, rarely stretch beyond one or two quarters. Additionally, insurers can use their pricing clout in times where claims are lower than normal, too, with the justification being that a catastrophe is coming at some point in the future. It's a business model that's primed for success in almost any market environment.
I'd also suggest that Travelers is poised to benefit from the normalization of lending rates in the coming years. The Federal Reserve has kept lending rates near historic lows for more than seven years, which has hurt companies like Travelers that invest in safe, interest-bearing assets. An increase in the federal funds target could provide a nice boost in investment income for the insurance industry.
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Verizon Communications: P/CFPS = 6.8
With nearly $7.80 per share in expected cash flow in 2016, telecom giant Verizon Communications (VZ +0.08%) is the second cheapest Dow stock. What makes Verizon such an intriguing play is the high barrier to entry in the telecom sector, as well as its customer loyalty.
Within the U.S., you can count the major wireless players on one hand -- and even then there are only two with deep enough pockets to deploy the newest infrastructure to meet consumers' growing data demands: Verizon and AT&T. Among the two, Verizon is leading AT&T in terms of major cities that have 4G LTE coverage. Given these higher barriers to entry and Verizon's leading next-generation wireless network (85% of its total phone base is using smartphones as of the end of Q1 2016, and 92% of data is transmitted via LTE), it tends to command strong pricing power for its high-margin data plans.
Verizon's network has also been a major linchpin that's helped drive customer loyalty. As of the first quarter, retail postpaid churn was just 0.96%, an improvement of seven basis points from the prior-year quarter. In easy-to-understand terms, it's losing less than one in 100 customers to its competition.
Verizon also has long-term growth channels in streaming, content bundling, and potential acquisitions. Verizon acquired AOL in 2015 and has been mentioned as a possible purchaser of Yahoo!'s Internet operations.
Tack on a 4.3% dividend yield and you have what looks to be a very solid, and reasonably cheap, Dow stock in Verizon.
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American Express: P/CFPS = 7
Last, we have credit processing and lending behemoth American Express (AXP +1.89%), which is trading at just seven times its expected annual cash flow per share in 2016.
Unlike Travelers and Verizon, American Express is going through a bit of a transitional period. Last year, Costco (COST 2.05%) announced that it would be ending its partnership with American Express after well over a decade and will accept only Visa (V 0.94%) credit cards. This was a big blow to American Express, given that around 8% of its total billed business in 2014 came from Costco. Thus, AmEx has been on damage control over the past year figuring out how it'll reignite growth.
The good news is the company's core business is still incredibly profitable, and it does have pathways to growth. For example, American Express has long been associated with affluent clientele. Going after the well-to-do makes the company less likely to experience loan delinquencies or slowdowns in spending if global growth weakens or contracts, since the wealthy are less likely to be affected by a global growth slowdown. AmEx's branding and storied history should allow it to retain these affluent clients.
American Express also has time on its side. As a lender and payment processing facilitator, it can "double-dip" by earning money from its merchant network, as well as on interest from loans or fees on its credit cards. This does leave the company a bit more exposed than credit payment processors such as Visa during global downturns, but periods of economic expansion typically last much longer than periods of contraction.
With AmEx losing around a third of its value since the announcement that it and Costco were parting ways, now could be the time to consider gobbling up shares of the company on the cheap.
