There's only one thing better for your portfolio than buying stock in a great business, and that's buying that great business at a decent discount. It doesn't happen that often, but every once in a while the market misprices the value of a business that is a worthy investment.
We asked three of our contributors if they saw a cheap stock out there that investors should consider. Here's a quick rundown on the three they identified: Target (NYSE:TGT), General Motors (NYSE:GM), and Terra Nitrogen Company (NYSE:TNH)
Stumbling, but too cheap to ignore
Rich Duprey (Target): Mass merchandiser Target hasn't looked like a winning investment in quite some time, and after reporting disappointing holiday season sales along with a dour outlook for 2017, let's just say the market showed it no quarter. Its stock has lost about 18% of its value since it revealed its results, and is down about 32% over the past year.
It's not an unreasonable reaction, but there comes a point when a company that's not in any danger of going out of business just becomes too cheap to ignore. Target is that company.
As bleak as its operations look, the retailer still generates substantial free cash flow. As of the end of 2016, Target produced some $3.9 billion worth, which, when you compare it to its $39 billion enterprise value, means the company is trading at just 10 times the value of those cash flows, a ridiculously cheap, bargain-basement price for an otherwise wounded, but not fatally so, retailer.
It won't be easy for Target to turn things around, not when almost all of retail is in the throes of upheaval from changing consumer shopping preferences, but its recent new store design could have a positive impact on sales, as it will allow shoppers looking to do fill-in buying or just making a quick trip to get in and out, while those who want to walk the aisles at their own pace will still be able to do so.
It's also continuing to make up for lost time on the e-commerce front. Having been infamously late to the game, it reported last quarter that online sales surged 34% from the year-ago period, and digital sales now comprise 6.8% of sales. Still, the softness it experienced in its stores even caught management by surprise.
As noted, though, Target isn't a retailer on its way to the graveyard in the way Sears is, and there is still plenty of promise in the company and its stock. Particularly at the deeply discounted price it's trading at, Target is a ridiculously cheap stock that likely won't remain this inexpensive for long.
Pennies on the dollar
Daniel Miller (General Motors): If you're looking for a ridiculously cheap stock for your watchlist, you don't have to look much further than the largest Detroit automaker: General Motors. According to Greenlight Capital as of March 28, using the midpoint consensus estimates for 2017, General Motors was trading at literally the cheapest price-to-earnings ratio in the S&P 500, at 5.6 times -- below that of its closest competitor, Ford, at 7.2 times, and far below the S&P 500 average multiple of 21.8 times. In addition, management is focusing on both near-term and long-term strategies to boost shareholder returns, and is paying a 4.4% dividend yield to boot.
In the near term, General Motors is focusing on improving its stock price by improving its return on invested capital. It's exiting or reducing its operations in less lucrative markets and segments, including its recent exit of Europe by selling its Opel/Vauxhall brands. It also pulled Chevrolet out of Europe and pulled out of Russia entirely. In fact, GM's adjusted ROIC, amended for the sale of its European operations, reached 30% during 2016, which is strong for a major automaker.
General Motors has made its intentions for the long term pretty clear. It created its Maven brand to cover its expanding smart mobility projects such as car-sharing, among others. It quickly developed the Chevrolet Bolt, which boasts nearly 240 miles of range per full charge, and invested $500 million in ride-hailing start-up Lyft -- and don't be surprised if GM eventually supplies Lyft with a fleet of Bolts. GM acquired Cruise Automation in hopes to bolster its development of driverless-vehicle technology, which could be a market worth hundreds of billions, or trillions, in the distant future.
All the while, General Motors dishes out a 4.4% dividend yield with a low payout ratio of only about 24%, using the midpoint of management's 2017 earnings guidance. It even added an incremental $2 billion to its share repurchase program after cutting its losses in Europe. Ultimately, GM is the cheapest stock in the S&P 500, and it's focusing on returning value in the near term, long term, and through dividends and buybacks. What more can investors ask for?
Unparalleled returns at a reasonable price
Tyler Crowe (Terra Nitrogen Company): I can see why investors might want to shy away from Terra Nitrogen. Since it's a variable-rate master limited partnership, its payout each quarter changes based on how much cash comes in the door. That has been a losing proposition lately as nitrogen fertilizer prices declined to 12-year lows at the end of 2016, and it looks like it's going to take a while for the market to absorb excess production capacity.
That said, there are plenty of reasons to like Terra Nitrogen's stock today. The first is that the company generates incredible rates of returns for investors. Terra uses cheap, domestic natural gas as a feedstock to manufacture urea and ammonium nitrate products. Also, unlike most master limited partnerships, the company has zero debt on the books, which means that more cash flows to the bottom line, In the fourth quarter, Terra Nitrogen produced a net income margin of 34% even during a period of feeble fertilizer prices. This performance helped maintain a streak of producing a return on equity in excess of 50% for more than a decade.
What makes Terra Nitrogen's stock an attractive investment today is that it sells at a very reasonable price. The stock is down 37% over the past three years and trades at an enterprise value-to-EBITDA of 6.8 times. For a business that has shown it can produce robust returns during tough times, even during the low point of an industry cycle, it seems that Terra's stock is incredibly cheap.
Daniel Miller owns shares of General Motors. Rich Duprey has no position in any stocks mentioned. Tyler Crowe owns shares of Terra Nitrogen. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.