After a close-to-30% surge in U.S. stocks in 2019 (as measured by the S&P 500), some investors think the index looks expensive. Using price-to-earnings multiples, it would appear so: Trailing-12-month price-to-earnings on the S&P 500 is currently 26.1 and the one-year forward metric is 20.1, among the highest it's been in a decade since the 2008-09 financial crisis.
There are reasons for this situation -- including the rally in share prices in 2019, falling earnings since the middle of 2018 but an expected rebound in earnings in 2020, and richly valued but high-growth tech companies like Microsoft, Amazon.com, and Google parent Alphabet making up a bigger chunk than ever before of the 500-company index -- but many investors are nonetheless concerned about lofty valuations.
If you're in that boat, don't worry. Even with stock indices on fire, there is value to be found out there. Broadcom Inc. (AVGO 1.04%), Chevron (CVX 0.18%), and Foot Locker (FL +0.00%) look like three absurdly cheap stocks to me right now. Let's take a closer look and see if these three might pique your interest as well.
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1. Broadcom: A big chipmaker betting on software integration
Manufacturing is a cyclical sector, and chipmaking is no exception. Silicon products are a basic commodity of the digital age, and supply-and-demand fluctuations can send sales at semiconductor companies on wild up-and-down swings. Chip innovation helps offset the usually bumpy ride, but even then surges in demand from a new end market can quickly reverse course from oversupply as other chipmakers catch on to the trend and try to cash in.
Data centers and networking hardware are examples of this. As a result of a slowdown in data center construction, Broadcom experienced a high single-digit drop in sales during 2019. Total revenue finished up 8% anyway. That was thanks to the company's new complementary network infrastructure and enterprise software segment, built via the acquisition of CA Technologies in 2018 and Symantec's (now NortonLifeLock's) enterprise security business. Higher sales and profit margins from software also led to a 12% increase in free cash flow (money left after basic operating and capital expenses) last year.
As a result of solid business performance and software integration, Broadcom now trades for a meager 14.6 times trailing-12-month free cash flow, and 12.6 times one-year forward expected earnings. Granted, Broadcom had only $5.06 billion in cash and $30 billion in long-term debt on its balance sheet at the end of 2019. The cheap valuation is pricing in risk as Broadcom works down all that debt taken on to fund its acquisitions, besides ongoing weakness in its data center and networking chip mainstays.
Nevertheless, the valuation looks downright cheap. Management provided an outlook for about 11% revenue growth in 2020, factoring for further double-digit growth in software and a return to growth for its chipmaking business during the back half of the year. Add in a 4.1% dividend yield and this value stock looks like a deal.
2. Chevron: Big oil is down, but not out
The oil and energy industry had a rough go in 2019. U.S.-China trade war disruptions, tensions in the Middle East, and a slowdown in the global economy sent oil prices on an up-and-down ride that has ended with a 5% year-over-year decline as of this writing -- including a nearly 19% tumble to start 2020 alone.
Oil stocks tend to follow oil prices around, and big energy giant Chevron is no exception. Its shares are also down 4% over the last year as the global economy currently has an ample supply of fossil fuels. A $6.6 billion net loss in the fourth quarter of 2019 due to impairment charges on lower profit margin projects as the company refocuses on better returns hasn't helped either. Investments into more environmentally friendly sources of energy are also a work in progress and threaten companies like Chevron over the very long term.
Image source: Getty Images.
But for now, fossil fuels are still the key ingredient in the global energy mix, and buying dips on oversupply tends to be profitable as demand eventually picks up and works off excess inventory. As for Chevron, even though the final quarter of the 2010s ended on a sour note, it remains quite profitable, with operating margins averaging in the high-single digits and generating $13.2 billion in free cash flow last year. Despite dealing with volatile oil prices and asset losses in the last year, the stock trades for 16.1 and 16.0 times free cash flow and forward earnings, respectively.
Plus, the company was able to raise its dividend payout another 8% in January 2020, making it good for a current annual yield of 4.6%. Chevron is down at the moment, but it's far too soon to call it out and looks like a timely value stock addition.
3. Foot Locker: An unloved shoe retailer
The world has gone sneaker crazy, but one would never know it looking at traditional retailers like Foot Locker. Sales are up a meager 3.6% over the last trailing three-year stretch, and shares have taken a precipitous 42% fall over that same time frame.
The problem, as it often is in the retail space these days, is e-commerce. The internet is democratizing retail, and shoe manufacturers have been taking advantage by building their own direct-to-consumer selling businesses online. Nike even ended its pilot program selling on Amazon to focus on its own digitally backed retail infrastructure. When consumers can go directly to the source for the goods they want, that leaves middlemen like Foot Locker out of the mix. Thus, shares are currently going for a shocking 7.6 times trailing-12-month free cash flow generation.
Manufacturer disruption is a big part of the cheap valuation, but it's only part of the story at Foot Locker. The retailer remains a key distribution partner for sports apparel makers, especially in malls and other markets where in-person shopping is still strong. The company also has a presence in harder-to-reach emerging markets, a key area of growth for the shoe industry. Plus, it also has been investing in online sales and recently unveiled its FLX membership program -- uniting all of its brands (including Champs Sports, Footaction, and Eastbay) into one platform -- and has an investment arm to take positions in youth culture start-ups. Comparable store sales have been showing signs of life this year (up 5.7% in the fourth quarter of 2019), and Foot Locker has been getting good returns on its meager sales expansion. Free cash flow is up 18% over the last three years.
As a result, this seemingly left-for-dead retailer is paying a well-funded 3.8% annual dividend. The final whistle has yet to be blown on Foot Locker, and the love of sneakers and sportswear looks like more than just a passing fad. The steep discount on the stock thus doesn't appear totally deserved.
