September is here, and while the seasons are shifting, the market doesn't appear to be cooling down. With the S&P 500 and Nasdaq indexes recently closing at record levels, and high-growth tech stocks continuing to drive the market, investors might also want to scope out some stocks that trade at more conservative valuations relative to their outlooks and fundamentals.
We asked three Motley Fool contributors to profile a stock that they believe is trading at a substantial discount and has what it takes to be a long-term winner. Read on to see why they identified A.O. Smith (NYSE:AOS), GlaxoSmithKline (NYSE:GSK), and Changyou.com (NASDAQ:CYOU) as top value stocks to buy this September.
A divergence worth paying attention to
Maxx Chatsko (A.O. Smith): After being one of the surest bets on the stock market dating back to 2010, shares of water technology specialist A.O. Smith have dropped over 5% in 2018. That may not seem like a big deal, but the stock had delivered a five-year total return (share performance plus dividends) of 311% entering the year, compared to "only" 108% for the total return of the S&P 500.
It's also a bit of a head scratcher, considering the company has continued to deliver on its ambitious growth expectations. That leads me to think A.O. Smith stock is one of the market's best bargains right now.
For instance, in the first half of 2018, the leader in water heater and water purifier products posted year-over-year growth in revenue and operating income of 9.6% and 9.3%, respectively. Lower income taxes this year allowed it to grow net income 18% in the comparison period.
The business' growth isn't surprising -- that's been pretty predictable since the business went all in on its water technology strategy in 2010. However, the stock price had historically kept pace, locking in the stock's P/E ratio at a premium valuation of around 30 in recent years. But now that the business growth and stock price growth have diverged, the stock sports a relatively cheap forward P/E of 20. That's the lowest value since late 2012, which makes A.O. Smith stock a bargain right now for opportunistic investors.
An incredibly cheap big pharma stock
George Budwell (GlaxoSmithKline): With a price-to-sales ratio of 2.5, GlaxoSmithKline's stock is undeniably cheap. Most big pharma stocks trade at far richer valuations.
Why is Glaxo's stock lagging behind the broader field of big pharmas from a valuation standpoint? Three key reasons:
First, the company's flagship asthma medication, Advair, should finally face generic competition in the not-so-distant future. That will undoubtedly place a heavier burden on newer respiratory medicines, such as Ellipta and Nucala, to drive top-line growth going forward.
The second reason is the company's decision to max out its balance sheet in order to dive even deeper into the low-profit consumer healthcare space. Earlier this year, for instance, the company spent $13 billion to acquire Novartis' consumer healthcare business -- which ratcheted up the drugmaker's debt-to-equity ratio to a staggering 928.
And third, Glaxo's enormous dividend yield of 4.97% is ripe for a marked reduction. After all, with a sizable debt load and a trailing payout ratio of 242%, Glaxo simply can't maintain this extremely rich dividend payout for that much longer.
The good news is that Glaxo has an impressive stable of new growth products coming on line right now. For example, its recently approved shingles vaccine, Shingrix, has gotten off to a blistering start. And its HIV franchise -- featuring the heavy hitters Tivicay and Triumeq -- has been performing above expectations in recent quarters. Glaxo's top line should thus continue to head steadily northward, albeit modestly, for the next few years.
In all, this big pharma stock might not jump off the page as a red-hot buy for growth investors. But value investors with an eye toward the future might want to pick up some shares at these bargain basement levels.
A cheap play in video games
Keith Noonan (Changyou.com): Video game stocks have been hot over the last decade, but that's largely because top publishers have managed to consistently increase their earnings amid growth for digital game distribution and in-game purchases. Changyou.com is a Chinese publisher that hasn't been as fortunate.
The company mostly specializes in the massively multiplayer online role-playing game (MMORPG) genre and has the potential to benefit from ongoing growth in China's games industry. But performance is sagging as its biggest franchise is losing steam. Total revenue in its most recently reported quarter dipped 25% year over year, and net income was down 38.5% compared to the prior-year quarter. Shares have lost roughly two-thirds of their value over the last year and now trade at roughly 13 times this year's expected earnings and 1.5 times expected sales. That looks very cheap even in light of the business' downturn.
Changyou had $571 million in cash and short-term investments on the books against no debt at the end of last quarter. That's a strong balance sheet, and the company has a price-to-book value of just 0.9 despite the business being solidly profitable even as sales have fallen. China's video game market is still growing at a healthy clip, and by even managing to stabilize its business, Changyou has the potential to see big valuation gains.
In addition to adding content and making adjustments in order to improve the longevity of its legacy titles, the company has two new MMORPG offerings and several titles in other genres in the near-term-release pipeline. Changyou already looks cheap on a fundamental basis, and scoring a hit with just one of its upcoming titles could send shares soaring.