Finding a value stock isn't always as easy as just screening for stocks with low price-to-earnings ratios -- although that's a good place to start. Sharp investors know that sometimes, there's more to a value stock than just a low P/E ratio. They know that to find the real bargains in an overheated market, sometimes you have to dig deeper.
Aiming to get some insights into some less obvious value stock ideas, we asked some of The Motley Fool's sharpest investing minds to tell us their favorite value picks -- and tell us why they're bargains, even when that may not be obvious to everyone.
A retail baby thrown out with the bathwater
Leo Sun (American Eagle Outfitters): Many retail apparel stocks were crushed over the past few years, because of declining mall traffic, the rise of fast-fashion retailers such as H&M and Zara, fickle consumer tastes, and tough competition from e-commerce players. But one stock that got unfairly crushed was American Eagle Outfitters.
American Eagle is down more than 20% for the year, but its numbers aren't as awful as that decline suggests. Comps rose 2% last quarter, and the company expects flat growth to a low-single-digit comps decline for the current quarter. Wall Street anticipates 2% sales growth this year, but its earnings are expected to fall 12% because of steeper discounts.
However, American Eagle's earnings are expected to rebound slightly next year on the strength of its denim offerings, the expansion of its higher-growth Aerie lingerie and activewear brand, a potential turnaround in its menswear business, and buybacks and store closings.
That recovery will take time, but American Eagle remains a solid value play with a hefty dividend. The stock trades at just 10 times earnings, which is half the industry average for apparel retailers. It pays a forward dividend yield of 4.5%, which is supported by a low payout ratio of 46%. It also doesn't have any debt, and its free cash flow of $168 million over the past 12 months gives it enough ammo for potential acquisitions.
An overlooked immuno-oncology play
George Budwell (Bellicum Pharmaceuticals): The rapidly growing field of immuno-oncology has become inundated with would-be competitors and so-called "me-too" drugs that have little chance at carving out a profitable niche in this increasingly crowded space. The small-cap biotech Bellicum Pharmceuticals, however, is one of the few rare gems that still has a reasonable shot at becoming a major player in this high-growth field.
The underlying reason is that Bellicum is developing cell therapies that come with far more control once infused into a patient than any of its chief competitors offer -- thanks to its robust molecular switch technology. That's a big deal, because anti-cancer cell therapies such as chimeric antigen receptor T-cell therapy have been plagued by safety issues, as well as a lack of potency in the solid tumor setting. Simply put, Bellicum has a realistic chance of earning a best-in-class designation later down the road, overcoming its competitors' first-mover advantage as a result.
The big drawback with Bellicum is that the company remains a couple of years away from bringing one of its novel cell therapies to market. Specifically, the biotech's lead candidate, BPX-501, is slated to potentially reach the market in the stem cell transplant setting in perhaps 2019. Until then, the company will be forced to rely heavily on secondary offerings to fund its clinical activities, especially since it lacks a big pharma partner with deep pockets.
That said, this biotech does have a well-differentiated anti-cancer platform that could transform it into a leader in this multibillion-dollar field. And that's the kind of deep value that should appeal to particularly bright investors.
Everyone can see this is a value stock. Only sharp investors will notice how truly cheap it is.
Rich Smith: (General Motors): I'll go ahead and state the obvious: At a mere 5.6 times earnings, General Motors is an obvious value stock even to those who may not be the "sharpest" investors. Where acuity comes into play with GM, though, is seeing how much more of a value stock it is than it already appears to be.
You can do that, as investment banker Morgan Stanley recently did, by taking a close look at the sum of the parts that make up GM and imagining "what if" scenarios surrounding how reshuffling these parts could make GM even more valuable. Here's a very simple example. General Motors breaks its business down among four main geographic lines:
- GM North America, accounting for $119 billion in sales last year.
- GM Europe -- $18.7 billion in sales.
- GM South America -- $7.2 billion.
- GM International Operations -- sales "everywhere else," which accounted for $11.7 bilion in sales.
Of those four divisions, only GM North America and GM International are currently profitable, earning GM $12 billion and $1.1 billion in operating profit last year. Data from S&P Global Market Intelligence shows that, combined, those two divisions accounted for 105% of the $12.5 billion in operating profit that GM earned in 2016. But what would happen if GM's other divisions began pulling their weight and earning at least a nominal profit? What would happen if those underperforming divisions simply went away and stopped dragging down everyone else's profits?
Because that's exactly what's happening. Right now, GM is in the process of selling its European business, Opel-Vauxhall, to Peugot. On one hand, this sale will remove more than $257 million in annual losses from GM's income statement, immediately improving the profitability of GM's business as a whole. On the other hand, it will bring $2.3 billion in cash proceeds to GM -- underscoring the fact that even while losing money, certain "parts" of GM, such as GM Europe and even less profitable GM South America, still have value.
Sharp investors would be wise to take note.