Finding value stocks when the market is posting new highs and interest rates are close to zero is not an easy task. Stocks have very little competition from bonds -- who wants to tie up their money for 10 years in a Treasury paying 0.7%? -- which often means stocks will appear expensive across the board. That said, there are always pockets of value in the stock market; the trick is to figure out which ones are value and which ones are value traps.
The following names represent companies that are free and clear of any financial distress and are performing well.
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PennyMac Financial
PennyMac Financial Services (PFSI +1.77%) is one of the biggest mortgage originators and servicers in the country. The COVID-19 crisis encouraged a massive amount of monetary support from the Federal Reserve, which pushed short-term interest rates to zero and began buying mortgage-backed securities again.
The actions of the Federal Reserve have created the best of all worlds for mortgage originators. Rates at all-time lows mean that millions of consumers can lower their monthly mortgage payments substantially by refinancing. PennyMac is expected to earn $15.31 per share in 2020, and the stock is trading in the low 50s. This means that PennyMac is trading at a price-to-earnings (P/E) ratio of 3.5.
The mortgage origination business is notoriously cyclical. The next year or two should prove to be peak earnings, as once a borrower refinances at current rates, the likelihood of another refinance is pretty low. While this effect is a negative for the origination business, PennyMac Financial also has a mortgage servicing arm, and that will benefit from this effect. As rates rise (probably years from now), the company's portfolio of mortgage servicing assets will increase in value.
PulteGroup
PulteGroup (PHM +1.18%) is a diversified homebuilder that just reported a massive jump in orders at the tail end of the second quarter. For the whole sector, Q2 was truly a tale of two quarters, where the economy abruptly stopped in April, and then social distancing concerns and working from home drove new demand for people to flee the cities.
While 2020's numbers will be affected by the slowdown earlier in the year when Pulte suspended land investments for a period, the acute shortage of affordable housing (The National Low Income Housing Coalition estimated 7.2 million units are needed) works out to be five years of housing starts at the annual pace of 1.5 million, as reported in the latest numbers out of the Census Bureau.
Pulte saw a 77% increase in orders from first-time homebuyers, and that segment remains critical for the company. Pulte is trading at 10 times expected 2020 earnings per share. Earnings growth is 17% this year, and next year's growth is expected to be 12%. This means that Pulte is trading at a price-to-earnings-growth (PEG) ratio of .6, which is indeed quite cheap.
Altria Group
Altria Group (MO 0.86%) is the classic defensive stock, selling cigarettes worldwide. Since it is extremely out of favor with the Ethical and Social Governance (ESG) crowd, it trades at a low multiple. Altria is trading at about 10 times expected 2020 earnings per share and has a 7.9% dividend yield. While the cigarette market is probably going to shrink as fewer and fewer people take up the habit, there are still estimated to be 1 billion smokers in the world, and Marlboro is the king of cigarette brands.
For investors who are able to look past Altria's fundamental business, the stock is a cash-generating machine. Last year, the company had free cash flow of $7.6 billion, or $4.20 per share, which works out to be 10.5 times free cash flow (FCF) per share. Flipping the FCF ratio gives you a 9.5% free cash flow yield, which is rare these days.
