Value investors aim to buy stocks trading at a discount to their intrinsic net worth. That's an easy enough concept to grasp, but putting it to work in the real world takes a great deal of skill.
With that in mind, we asked a team of Fools to identify a company that they believe is trading a discounted price right now. Here's why they picked Jazz Pharmaceuticals (NASDAQ:JAZZ), IBM (NYSE:IBM), and General Motors (NYSE:GM).
A rare opportunity
Brian Feroldi (Jazz Pharmaceuticals): Most investors don't think of the biotech sector as a great place to go bargain hunting, which makes sense given that the vast majority of biotech stocks are unprofitable. However, Jazz Pharmaceuticals isn't a typical biotech stock. It's already highly profitable and primed for strong growth in the years ahead. When adding in its cheap valuation, this is a great stock for value investors to get to know.
While Jazz boasts a handful of drugs on the market, its cash cow is a drug called Xyrem. This narcolepsy treatment is expected to ring up more than $1 billion in total sales this year. Wall Street is concerned about incoming generic competition for Xyrem, but management recently announced a deal that should protect Xyrem's profit stream for at least a few more years.
Like every other biotech, Jazz's future potential is all about its pipeline. The biggest near-term opportunity is for Vyxeos, a hopeful treatment for acute myeloid leukemia. This drug is pending FDA approval and has already received priority-review status. Market watchers expect this drug to ring up roughly $400 million in peak sales if all goes well.
Jazz boasts a large pipeline of drugs that promise to extend its leadership position in treating rare sleep disorders. JZP-110 is a next-generation sleep compound in late-stage trials for treating excessive sleepiness associated with obstructive sleep apnea. The company expects to have the drug in regulators' hands by the end of the year. JZP-258 and JZP-507, two other potential sleep-disorder winners in development, could help offset any future weakness from generic Xyrem competition.
Jazz offers investors a cash-cow business now and the potential for upside if its pipeline compounds work out. That's an attractive combination for a company trading at around 11 times next year's earnings estimates.
Worth the ride
Keith Noonan (General Motors): Investing in cyclical stocks can be tricky. Companies near the top of their sales cycles often display strong revenue and attractive P/E ratios only for conditions to change, causing earnings to decline and share prices to plummet. These concerns are worth weighing for those considering an investment in General Motors. There are signs that industry sales could be stalling after declining sales in March and April, but the automaker looks like a savvy value investment even with these threats in mind.
Trading at less than 6 times forward earnings estimates, GM looks cheap even with the possibility of decreased earnings on the horizon. Its most recent quarter saw the company grow sales 10.6% year over year and increase net income 33.5%, while its chief rival, Ford, posted declining sales. General Motors might also have avenues to growing earnings, or at least limiting downside, even in the event of a changing macro environment. For example, the company recently sold off its European division in a $2.3 billion deal, a move that should have a beneficial impact on profitability, as the segment had become a consistent money loser. GM's 11% stake in ride-sharing company Lyft and its investment in autonomous driving could also help it weather a possible downturn.
With a share price that seems to underestimate the extent to which General Motors is equipped to weather cyclical swings. combined with a dividend that's yielding 4.4%, the auto stock looks to be a smart choice for value investors.
Missing the change
Reuben Gregg Brewer (International Business Machines): IBM's shares have fallen over 15% since their March highs. A big part of that drop was the technology company's first-quarter earnings release, in which it reported its 20th consecutive quarterly revenue decline. And of course, it didn't help that Warren Buffett announced that he'd been selling the stock.
There's no question that IBM's shrinking legacy businesses remain a challenge. However, the bigger story is that IBM is shifting in new directions -- its so-called strategic imperatives. Revenue at these businesses, which include hot areas such as cognitive computing and cloud computing, grew 13% year over year in the first quarter and as a group make up 42% of revenues. That last figure continues to grow as IBM invests for the future.
IBM is a huge company, with operations around the world. But it's not a start-up that can shift direction on a dime. Change takes time at IBM. In the meantime, despite falling revenue, IBM is still expecting adjusted earnings, which takes out one-time items, to come in at $13.80 a share this year. Using that number gives the company an enticing price-to-earnings ratio of around 11. And don't forget the nearly 4% yield backed by a dividend that's been increased for 22 consecutive years.
This isn't exactly a dying company that's sticking its head in the sand. It's a highly profitable enterprise investing for the long term in growing businesses while milking its cash-cow businesses to pay for the transition. When revenue from the strategic imperatives hit 50% of the pie, the equation here is likely to change materially, and investors will start to believe that IBM has a much brighter future.
Brian Feroldi has the following options: short January 2019 $185 puts on IBM, short January 2019 $180 puts on IBM, long January 2018 $175 calls on IBM, and short January 2018 $175 puts on IBM. Keith Noonan has no position in any stocks mentioned. Reuben Brewer owns shares of IBM. The Motley Fool owns shares of and recommends Ford. The Motley Fool has a disclosure policy.