Value stocks can be hard to find in a market that's trading near all-time highs. But shrewd investors willing to look past Wall Street's whims and short-term obsessions can still find some underappreciated equities with a lot of long-term potential.
Asked for stocks in that category, three of our contributors recommended Dunkin Brands Group (DNKN), Goodyear Tire & Rubber (GT -2.17%), and General Motors (GM -0.05%) as great values for investors. Here's a look at why:
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Take advantage of this East Coast obsession
Brian Stoffel (Dunkin' Brands): I spend most of my time on a coffee farm in rural Costa Rica. That makes me a coffee snob, so it's difficult for me to understand the obsession on the East Coast with Dunkin' Donuts' coffee.
Having said that, customers' affinity to the chain and its coffee is undeniable. While Dunkin' isn't immune to the "Amazon effect" -- with a decline in retail traffic and a demand for cheaper, more convenient options in grocery stores -- it has a rabid fan base. That helps explain how it was able to expand its gross margins by 194 basis points to 83.7%, from 2014 to 2016.
I think too many investors fail to appreciate the power of Dunkin's business model and moat. Take one look at the company's cash flow statement and you'll see what I mean: While its normal business operations brought in $661 million in cash flow over the past three years, management laid out only $69 million on capital expenditures. That's the beauty of a capital-light franchise model that requires very little inventory.
It's also what makes the company's 2.2% dividend yield appealing. While the yield itself isn't eye-popping, the payout only required 49% of free cash flow over the past year. And while shares trade for a market-average of 25 times trailing earnings, the potential for Dunkin to use its excess free cash flow to buy back shares means investors could benefit even in a sideways market.
This value stock will keep you rolling forward
Dan Caplinger (Goodyear Tire & Rubber): Shrewd value investors look for stocks in industries that are out of favor, but have the potential to regain the growth rates they've experienced in the past. Goodyear Tire & Rubber is a good example. As the key player in the tire industry, it has gone through some tough times lately. A supply glut for heavy-duty trucks in the key Americas segment has led to substantial production cuts by vehicle makers, which in turn have dampened sales for the tire maker. Yet Goodyear has found ways to post profits, and that has led to attractive valuations on an earnings basis even though sales trends look less than stellar.
The key question for Goodyear is what happens in the future. On one hand, new car sales might well already have peaked, a thesis that has some investors expecting weaker performance from Goodyear in the years to come. Yet some analysts believe that Goodyear could benefit from greater adoption of car-sharing services, perhaps in combination with autonomous driving technology, because in that situation, it would be less necessary to market tires to individual vehicle owners, allowing for lower advertising and overhead costs, and a more efficient distribution model. Considering it is trading at a rock-bottom multiple of about 7 times trailing earnings and pays a modest dividend, Goodyear checks many of the boxes for value investors.
The forgotten auto giant
Travis Hoium (General Motors): Shrewd investors will understand that the success in the auto business isn't just about having the flashiest cars or the most-hyped technology. It's about executing on financial discipline and being expert in manufacturing, two areas where General Motors has improved since it went through bankruptcy during the financial crisis. Once you have those foundations laid down, then it's OK to make prioritize working next-generation technology into your vehicles or new business models into your operation. But without that solid unpinning, it'll be tough to make money.
General Motors has proven its ability to make money the last few years, which is more than could be said for rising competitor Telsa, which is currently more valuable by market cap. But when you look at the scale of these companies, you see that GM is the bigger, more profitable one. And it may be further ahead in terms next-wave technology than you think.
GM Net Income (TTM) data by YCharts
It was GM, not Tesla, that first launched an electric vehicle for the mass market. It's GM, not Tesla, that has vehicles driving autonomously around the streets of San Francisco at night. And it's GM, not Tesla, that owns a stake in (arguably) the best ride-sharing company in the U.S., Lyft. If investors are looking for a truly shrewd auto investment today, General Motors is a great pick and comes at the low valuation of just 5.4 times trailing earnings.
