When hunting for value stocks, you often have to beat the bushes in the various investment sectors that are out of favor at the moment. When entire sectors are being sold off, there are always a few stocks that are getting punished that really shouldn't be. They may have some characteristic of their business model that makes them less affected than their peers, and this is usually fertile ground to search for bargains.
Here are three companies in the out-of-favor retail and financial sectors that are solid names whose stocks are trading toward the bottom of their historical valuation ranges.
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1. The Home Depot: Prepare to switch into early-stage cyclicals
The Home Depot (HD 1.28%) has been one of the essential retailers that have remained open during the COVID-19 crisis. With time on their hands, consumers forced to stay at home are attacking home-improvement projects and fixing up their properties for potential sale.
The housing market has held up reasonably well during the COVID-19 crisis due to a persistent gap between housing supply and demand. The disease has also caused some urban renters to reconsider where they live and to think about moving to the suburbs. With a lack of supply at the lower price points, first-time buyers may be disappointed at the properties on offer. This means more interest in fixer-uppers, which is good news for Home Depot.
Despite the COVID-19 epidemic, U.S. same-store sales grew 7.5% in the quarter ending May 3. Overall, sales rose 7.1%. Earnings fell due to COVID-19-related charges. The stock trades at 25 times expected 2020 earnings and has a dividend yield of 2.5%. The dividend yield is at the high end of its historical range. If the coronavirus crisis is behind us, and the economic recovery is beginning, the go-to early-stage cyclical play is housing. The Home Depot should ride that wave to future growth.
2. CVS Health: A healthcare transformation story
CVS Health (CVS +0.44%) is another essential retailer that has managed to remain open during the COVID crisis. The company has been digesting its purchase of health insurer Aetna, which has weighed down the stock somewhat. The company is making a transformation from a pharmacy/front-end store to an integrated healthcare company.
First-quarter same-store sales increased 8%, and earnings were up 40%, which was partially driven by acquisition-related charges in the prior year. The company trades at a 3% dividend yield and trades at 9.3 times expected 2020 earnings. This dividend yield is at the high end of the company's historical range, and the P/E ratio is at the low end. You can see the historical trends in the chart below.
CVS Dividend Yield data by YCharts
3. Bank of New York-Mellon: Fee income trumps credit risk
Bank of New York-Mellon (BK 0.04%) is another otherwise solid stock in a sector that is out of favor. The banks have been hit hard in relation to COVID-19 fears, especially those with heavy mortgage and consumer-credit exposure. Since mortgage-forbearance requests have stressed the capacity of mortgage servicers, the public relations is going to be a challenge, especially in an election year. The sheer number of mortgage-forbearance requests has ensured that call response times will come in below the Consumer Financial Protection Bureau's standard times. Luckily for Bank of New York, it has almost none of these issues. Bank of New York is one of the largest trust banks in the world, which means it administers funds for clients.
In addition, the Bank is one of the biggest plumbers in the U.S. financial system, owning Pershing, which clears financial trades. Increased volatility in the stock, bond, and currency markets drove a 16% increase in clearing revenue in the first quarter of 2020. This is all fee income, which is much more stable and less dependent on the credit cycle. Bank of New York trades at 10 times expected 2020 earnings and sports a 3.3% dividend yield. While the whole banking sector will remain under pressure until we are sure the asset writedowns are finished, Bank of New York has some of the least amount of credit exposure.
If we don't see a resurgence in cases of COVID-19, the recovery should pick up steam going into summer and fall. The early-stage cyclical stocks that stand to benefit at this point are typically financial and homebuilding, as they get a boost from the drop in interest rates that inevitably comes with a recession. CVS Health is more of a transformation story as it digests its purchase of Aetna and expands its healthcare delivery business.
All three stocks have strong business models, good dividend yields, and should be considered as good choices for conservative income investors.
