Finding a stock that looks cheap isn't hard, and sometimes a rock-bottom valuation alone is enough to produce market-beating returns. But I think better results can be achieved by buying shares of high-quality companies with growth potential for less than they're worth.
Three of our Foolish investors have some ideas when it comes to value stocks for the discriminating investor. Here's why Visa (V -0.48%), International Business Machines (IBM -0.89%), and Gilead Sciences (GILD -1.15%) should be on your radar.
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A familiar name with room to grow
Steve Symington (Visa): I touted Visa as an enticing value stock for thrifty investors following its strong second-quarter 2017 report in April. But I feel the need to reiterate my long-term bullishness ahead of its fiscal Q3 release later this month, especially in light of Visa's encouraging 2017 investor day a few weeks ago.
Of course, it's tempting to think that Visa may not have much room to grow, given its $221 billion market capitalization as of this writing. However, investors can take solace knowing that around 85% of the world's retail transactions are still in cash and check, leaving Visa with a massive runway for growth as it continues to facilitate the transition to plastic.
In addition, Visa notes that spending within its already transitioned base is quickly shifting from physical to digital. That's great, considering that around $0.15 of every dollar spent is charged on a Visa card with physical transactions, while the number rises to $0.43 for every dollar spent in digital transactions.
Finally, Visa already has around 3 billion cards accepted at 44 million merchant locations around the globe. But over the longer term, as its platform and product base becomes more ubiquitous, Visa predicts it will be able to increase both figures by nearly tenfold, resulting in 30 billion ways to pay at 400 million merchants.
With shares trading at around 24 times this year's expected earnings -- a perfectly acceptable premium for this already strong, high-potential business -- I think investors with the patience to watch the world change in Visa's favor will be more than happy with the long-term results.
Big tech at a discount
Tim Green (International Business Machines): Being a value investor isn't a simple game of buying stocks with low valuations. There are plenty of stocks that look cheap, but far fewer that genuinely trade for less than they're truly worth. IBM, while facing challenges that justify some of the pessimism surrounding the company, is a stock that value investors should consider.
IBM has been undergoing a transformation for the past few years, shedding underperforming business and moving resources into growth initiatives such as cloud computing, artificial intelligence, and security. Revenue has been declining for five years, and the company faces the challenging task of trying to please Wall Street while making the investments necessary to thrive for decades to come.
IBM's cloud business produced $14.6 billion of revenue over the past year, and all the company's growth businesses collectively grew by 12% and accounted for 42% of total revenue. Declines in legacy businesses are still dragging down IBM's results, but the company does expect to grow per-share adjusted earnings to at least $13.80 this year. That puts the P/E ratio at just about 11.
Beyond cloud computing, IBM is investing in other innovative technologies. Its Watson cognitive-computing system is being used in a wide variety of industries, and it recently signed a deal with major European banks to build a trade finance platform based on blockchain, the technology that underlies cryptocurrencies such as bitcoin. How long it takes for these investments to return IBM to growth is unclear, but what is clear is that investors can buy the stock today for an attractive price.
Better days ahead for this big biotech
Keith Speights (Gilead Sciences): You might look at Gilead Sciences' results over the past year or so and think the sky is falling. Gilead's revenue is dropping dramatically. So are earnings. And the biotech's share price has plunged nearly 40% over the past two years as a result. However, all this bad news has made Gilead one of the better value stocks on the market, in my view.
Gilead stock currently trades at only 7 times trailing earnings. That's cheaper than a lot of stocks that don't have nearly as many positives as Gilead does.
What are those positives? For one thing, Gilead's cash stockpile as of the end of the first quarter totaled $34 billion, including cash, cash equivalents, and marketable securities. The biotech is also the most profitable big drugmaker on the planet, with a net margin of more than 43%. And Gilead generated nearly $14.8 billion in free cash flow over the past 12 months.
These positives give Gilead Sciences flexibility for improving its fortunes that most companies don't have. The company's executives have stated that one or more acquisitions are in store at some point in the future. A few smart deals could significantly change the trajectory for Gilead.
Gilead also has a strong pipeline that could pay off in a major way. A new hepatitis C combo awaits regulatory approval. The company also has several strong late-stage candidates, including its bictegravir/F/TAF combo for treating HIV and autoimmune-disease drug filgotinib. Better days should be ahead for this big biotech.
