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The U.S. stock market has had its fair share of hiccups in 2016, but at the end of the day, the scoreboard still reads green, with the broad-based S&P 500 up better than 5% since the beginning of the year.
Unfortunately, some stocks have been left in the dust. There's usually a reason that a company underperforms the market, but it's up to investors like you and I to determine whether these reasons are business-altering events or temporary obstacles. Where the latter condition is true among the stocks left behind during the most recent rally, bargains may be found.
3 top value stocks to consider buying
The term "value stock" has no universally agreed upon definition, but I define it as a stock with a valuation that is substantially lower than the average of the broader market and its industry peers. Traditionally, either the P/E ratio or PEG ratio is used to determine relative "cheapness," with a single-digit P/E, or a PEG ratio around or below one signaling a "value stock."
If you're on the lookout for deeply discounted value stocks this fall, then I'd suggest looking no further than the following three companies.
Goldman Sachs
Within the financial sector, value investors looking for a deeply discounted, high-quality company should give serious consideration to investment banking firm Goldman Sachs (GS 1.23%). Shares of Goldman Sachs were down 7% year-to-date through Oct. 7.
The two biggest challenges for Goldman -- and the main reasons why its share price has been under pressure -- are the volatility in the stock market and historically low lending rates. Both factors have hurt Goldman's dominant position as a market maker in bonds, which in turn has negatively affected its recent profits and margins. For example, investment banking revenue fell 11% year-over-year to $1.79 billion during the second quarter.
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However, there's reason to believe that over the long run, Goldman Sachs will regain its bond market dominance. As the U.S. economy continues to recover, the Federal Reserve's likely response will be to normalize interest rates. A rising rate environment favors growth in bond investments and potentially calmer markets, which should be a boon to Goldman Sachs.
Further, a rising rate environment could make it more difficult for wealthier investors to get consistent market returns, since higher lending rates tend to slow market growth and inflation. This could wind up boosting demand for Goldman Sachs' financial advisory services. We already witnessed 3% year-over-year growth in this operating segment in Q2 2016.
In the interim, low rates may continue to yield positive results for Goldman in its position as a leader in advising mergers and acquisitions. Access to historically cheap capital is encouraging businesses to expand, and Goldman has benefited from this trend.
Currently valued at 10 times forward earnings and a PEG of 0.7, Goldman Sachs is worth a look.
Delta Air Lines
Next on the list for you non-traditional value stock investors is major U.S. airline Delta Air Lines (DAL 0.31%). Shares of Delta Air Lines are down 23% year-to-date.
What's holding Delta's stock down? Look no further than jet fuel prices. The irony of the situation is that crude oil prices are well off their highs and jet fuel prices have dropped, leading to big fuel cost savings for the entire airline industry, including Delta. Adjusted fuel expenses declined by $408 million in the second quarter from the prior year on 28% lower jet fuel costs. But lower fuel prices also mean a highly competitive fare environment since all airlines have extra operating cash flow to spare. Further, a rebound in oil prices from their February lows could portend rising jet fuel prices in the future.
Image source: Delta Air Lines.
So why buy Delta Air Lines now? To begin with, its balance sheet looks as healthy as it has in many years. Airlines typically go deep into debt in order to expand capacity within their fleet. If this expansion is done without a lot of forward thinking, it can be a problem. Delta currently has less than $5 billion in net debt-to-equity ratio of 66%, which is extremely manageable compared to its major airlines peers with debt-to-equity ratios well in excess of 100%. In fact, Delta has chosen to expand its capacity at a slower pace than its peers in order to maintain the integrity of its balance sheet, which was probably a smart move on the part of management.
Meanwhile, Delta's older fleet of planes doesn't necessarily put it at a disadvantage. With jet fuel costs having fallen, Delta's less fuel-efficient aircraft don't hurt the company's bottom line nearly as much as they did when crude was at $110 per barrel. With no urgency to upgrade its fleet, even with lending rates near historic lows, Delta can focus on reducing its interest expenses by paying down debt.
Delta is also attractive for income seekers and long-term investors, with the company paying a forward annual dividend yield of 2.1% and regularly buying back its own stock, which can have a positive impact on EPS. Sporting a forward P/E of just 7, Delta could be a high-flier that you won't want to pass up.
Mylan
There's absolutely no shortage of vitriol surrounding branded and generic drugmaker Mylan (MYL +0.00%) at the moment. Its brand-name injectable epinephrine product, EpiPen, has come under fire for the repeated huge price increases the company has passed along over the past decade. In 2007, an EpiPen cost a little more than $100, whereas today, the cost has ballooned north of $600. Fear of pricing sanctions and future monetary penalties have sent shares of Mylan down 34% year-to-date through Oct. 7.
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Though this is far from the type of attention Mylan wants as an innovative drug company, it's not exactly thesis-altering either. Remember, the U.S. healthcare system has a laundry list of inherent advantages that drugmakers are able to take advantage of. These include long patent protection periods, the inability of Medicare to negotiate on price, and the unwillingness of insurers to put their feet down on large price hikes. While consumers may not appreciate what Mylan is doing by raising the price of its flagship therapy, it's merely utilizing the protections afforded to it by the U.S. healthcare system.
More importantly, Mylan remains one of the most important drug developers in the generics market. Of its $2.56 billion in second-quarter revenue, $2.14 billion came from generics (a 4% year-over-year improvement). The IMS Institute for Healthcare Informatics is forecasting that generic scripts written will increase from 88% in 2015 to 91% to 92% by the end of the decade. That bodes well for Mylan, and it should only serve to increase its generic pricing power.
Another overlooked fact is that Mylan is based in the United Kingdom. The U.K. has a considerably lower corporate income tax rate than the United States, meaning Mylan is able to hang onto more of its profits, which could be beneficial if it's aiming to increase its portfolio through M&A.
Currently trading at a forward P/E of 6 and PEG of just 0.6, value investors may want to consider snapping up this broken stock, which is far from having a broken business model.
