With the current bull market careening toward the 10-year mark, genuine bargains remain difficult to find. Shares of the highest-quality companies are, for the most part, trading at generous valuations, and any stock that looks cheap is most likely cheap for a reason.
But there are some exceptions. International Business Machines (IBM -1.05%), Skechers (SKX 11.20%), and Hanesbrands (HBI 0.22%) are all good companies, and they all sport pessimistic valuations. I own all three, and I think you should consider them for your portfolio as well.
Image source: Getty Images.
International Business Machines
If you had bought shares of IBM at the start of 2011, your investment in the century-old tech company would have gone nowhere. The stock trades for roughly the same price today as it did back then, with some surges and plunges in between. The S&P 500 has gained about 120% in that time.
I suspect the next seven years will look a lot different, because IBM is finally turning the corner. The company returned to revenue growth at the end of 2017 after nearly six years of declines, with a growing cloud-computing business and the launch of a new mainframe system goosing the top line. The cloud business has grown into a $17.7 billion behemoth, and advances in artificial intelligence and quantum computing provide plenty of long-term growth opportunities.
IBM stock is cheap no matter how you slice it. The company expects to produce at least $13.80 in adjusted earnings per share this year, putting the price-to-earnings ratio at about 10.5. IBM also expects full-year free cash flow of about $12 billion, putting the price-to-free cash flow ratio just shy of 11. Thanks to this pessimistic valuation and an ever-rising dividend, the stock now sports a dividend yield of roughly 4.4%, right around its two-decade high.
The bar is pretty low for IBM to be a solid investment from here. The biggest risk is the possibility that newer businesses like cloud computing end up being less profitable than the declining businesses that are being replaced. But given the beaten-down valuation, I think that's a risk worth taking.
Skechers
In the past year, shares of Skechers have booked two massive one-day moves, one up, and one down. In October, a solid third-quarter report featuring a big earnings beat sent the stock up nearly 40%. It finished the month up 27%.
Some of that gain was undone in April. Skechers' first-quarter report was fine, but its guidance fell short of expectations. The stock plummeted 26% as investors balked at the company's slower growth outlook.
Long story short, Skechers stock is volatile. Many growth stocks make similar massive moves, even when the news doesn't seem to warrant them. What makes Skechers different, though, is that the stock isn't priced like a growth stock at all. Trading for around $30 per share, Skechers looks more like a value stock.
Consider this: Back out the $615 million of net cash on Skechers' balance sheet, and the stock trades for just 12.5 times the average analyst estimate for 2018 earnings. This is a company that's still growing revenue by a double-digit percentage. Growth may slow down, but that valuation is baking in some wildly pessimistic assumptions.
Hanesbrands
Apparel manufacturer Hanesbrands is doing just fine. The company's activewear and international businesses are growing, offsetting weakness in the core innerwear business. Organic sales, which exclude the impacts of currency and acquisitions, rose 1.1% year over year in the first quarter, the third consecutive quarter of growth. That growth is despite the ongoing retail shakeup that's sending an increasing percentage of apparel sales online.
Adjusted earnings per share is expected between $1.72 and $1.80 this year, down from $1.93 in 2017. That sounds bad, but a higher expected tax rate is the main problem. Applying Hanesbrands expected 2018 tax rate to its 2017 results, the midpoint of the company's guidance represents a 5% increase. That's a lot better, but still sluggish.
Still, given Hanesbrands' valuation, slow growth isn't a problem. The stock trades for just 12.8 times the midpoint of the company's guidance range, and it sports a dividend yield of roughly 2.7%. Like Skechers, this looks like a case of the market being overly pessimistic.
Unlike Skechers, Hanesbrands carries quite a bit of debt on its balance sheet. Debt totaled more than $4 billion at the end of the first quarter, driven in part by acquisitions meant to expand the international business. Debt is my biggest problem with Hanesbrands, and it's the reason the stock is one of my smaller positions.
If you can get past Hanesbrands' not-so-great balance sheet, the stock looks like a good deal to me.
