I'm not going to lie: Finding bargains in the stock market right now isn't easy. Valuations are high, which means that companies are going to have to deliver impressive rates of return for years to make some investments worth it. In even the most expensive market, though, you can find stocks trading at cheap valuations for one reason or another. Luckily for investors, two quality businesses have fallen into cheap-stock territory lately -- homebuilder LGI Homes (NASDAQ:LGIH) and oil and gas behemoth ExxonMobil (NYSE:XOM).
Let's take a look at what's causing their stocks to trade at bargain-basement valuations these days and why investors may want to pick up shares now.
Just what the housing market needs right now
After a long boom, there are signs that the housing market is starting to cool off as concerns about high prices and affordability are keeping potential buyers away. While those high prices have been great for the bottom line of many homebuilders, there are some signs that companies aren't going to be able to pass on these higher prices for much longer. What's worse is that this is happening as homebuilders are gobbling up every spare parcel of land for their next community developments and plowing lots of cash into the most speculative aspect of the homebuilding industry.
If home prices and affordability are the greatest concerns for buyers, then LGI Homes may actually benefit. Unlike other homebuilders that tend to maintain a portfolio mix of entry-level, move-up, and luxury homes, LGI focuses almost exclusively on the first-time buyer. It delivers a more limited set of home designs within its communities without the customization that other homebuyers provide to focus on lower-cost development and keeping its price point down.
This past quarter, LGI Homes' average selling price per home was $231,200. While that price has gone up and is out of the reach of some first-time buyers, the average selling price for most of LGI's competitors is $100,000 more than that. Being able to provide homes at a much lower price point and marketing campaigns geared toward monthly payments commensurate with local home rental rates gives LGI a large pool of buyers that most of its peers ignore today.
LGI Homes' shares have been dragged down with the rest of the homebuilder industry and trade at a forward price-to-earnings ratio of 7.0. While its own rising average sales price could dampen sales, it is still best positioned to cater to the largest buyer demographic these days and is the most likely to march on through this housing swoon.
The growth is in the plan, but not in the earnings reports
ExxonMobil has been getting a lot of attention lately, but not for the right reasons. Even though oil prices are rising, the company's earnings results have been rather tepid because of declining oil and gas production. Concerns that Exxon isn't plowing enough money into developing new sources has scared off investors to the point where its shares aren't that far off the lows we saw when oil prices were less than $30 a barrel. As a result, its stock doesn't warrant the premium it once did compared to its integrated oil and gas peers.
While it can be agonizing to buy and hold Exxon's stock right now, there is a clear plan in place to grow production and earnings. Management is banking on four core development projects -- Permian Basin shale oil, offshore Guyana, offshore Brazil, and LNG in Mozambique -- and expects to deliver an additional 1 million barrels per day of production between now and 2025. Not only is that a lot more production, but some of these projects have incredible rates of return. Current development plans in Guyana put its breakeven price at less than $10 per barrel. All of these investments, as well as an expanding portfolio of chemical and refining assets, should double Exxon's 2017 operating cash flow even if oil prices stay around $60 a barrel.
I can completely sympathize with investors' frustration over Exxon's apparent lack of growth over the next year or two, but its plan has the potential to generate incredible returns for investors patient enough to hang on and build a position today. Exxon has historically stuck to a long-term plan and doesn't make knee-jerk reactions when the market doesn't like what it's serving at the moment. It's an approach that has worked for decades, and it's hard to see why it won't work this time.
Out of favor for now
Between the broader market headwinds facing LGI Homes or Exxon's seeming inability to capitalize on current trends right now, there are not a lot of people on Wall Street who hold these stocks in high regard -- or at least that's what the valuations of these stocks suggest. For longer-term investors, however, there is an opportunity here for both stocks. In LGI Homes, you have a company that has the right product for today's expensive housing market, and in Exxon, you have a company with a long-term plan that may take some time to materialize but is an attractive one nonetheless. These could make for solid investments that trade at bargain valuations today.