Usually, people don't bust out the scary stuff until October, but in the stock market, it was late September that spooked investors, sending stocks on a screaming decline. But while other investors are running from the tricks this month, you should be on the lookout for treats in the form of undervalued stocks.
We asked three Motley Fool contributors what stocks they think look underappreciated by the stock market right now. They came back with BP (BP -1.77%), Emerson Electric (EMR -1.80%), and Royal Gold (RGLD -3.32%). Here's why these are their top picks this month.
Image source: Getty Images.
Market overkill could spell opportunity
John Bromels (BP): Let's get one thing clear right from the get-go. I'm bearish on the oil industry as a whole, and investing in any oil stock -- even an integrated oil major like BP -- carries a certain degree of risk these days. That said, I think the market may have gone a little bit overboard in selling off the energy giant, which could spell opportunity for careful investors.
BP's stock hit an all-time high in 2006. Since then, the Great Recession, the 2010 Deepwater Horizon disaster, the oil price downturn of 2014-2017, and the COVID-19 pandemic have each clobbered the company's stock. Its shares have lost about 78% of their value since that 2006 high -- more than any other oil major during the same time period.
Currently, BP's stock is trading below $17 per share, the cheapest price of the oil majors. The yield on its dividend -- which it cut in half earlier this year -- is now 13%, the highest of the oil majors. And its price-to-sales ratio, at just 0.2 times sales, is the best of the oil majors, too (not to mention near a historic low for the company).
Oil prices are down, and global oversupply coupled with reduced demand is weighing down the entire industry, and is likely to continue to do so for the foreseeable future. BP, however, has probably come the furthest in its plans to diversify away from oil. CEO Bernard Looney has announced an ambitious plan involving a 40% reduction in oil investment by 2030, and investments of $5 billion per year in renewables.
There are a lot of potential pitfalls for BP in pursuing such a strategy, but the possible upside is enormous, and BP is priced very competitively compared to other renewable energy companies. While I'm not a fan of the oil industry, BP's price may simply be too low for energy investors to ignore.
Undervalued due to fears over oil exposure
Lee Samaha (Emerson Electric): Sometimes investors avoid a stock simply because it has a high-profile exposure to an end market that's seemingly in decline. In the case of Emerson Electric, it appears the exposure of its automation solutions segment to the price of oil has spooked investors.
There are three points to make on this issue. First, Emerson's exposure to oil is significant, but it's not the main source of revenue. Upstream oil and gas and pipelines and terminals contribute 31% of the automation solutions segment revenue and contributed to 58% of segment earnings in 2019.
Clearly, the price of oil does influence capital spending in the energy industry, but it's not the main source of revenue for the company. The commercial and residential solutions segment (climate technologies, tools, and home products) produces 42% of earnings and the automation solutions segment has exposure to a number of the heavy industries including refining, chemicals, power, and factory automation.
Second, it's incredibly difficult to know where energy prices are headed, and by deliberately avoiding an energy stock you are making an assumption about where they might be in the future. Unless you have a strong view on such matters, or are managing the risk in your portfolio, then a stock like Emerson deserves a look anyway.
Third, as you can see in the chart below, despite major fluctuations in the price of oil and the sale of its network power business at the end of 2016, Emerson has a very good track record of generating the free cash flow necessary to cover its dividend. With a dividend yield of slightly more than 3% and a current price-to-free-cash-flow multiple of just 15.8 times the stock looks undervalued.
EMR Free Cash Flow Per Share data by YCharts
This value is as good as gold
Scott Levine (Royal Gold): Mining the market for stocks to buy at a discount? With the S&P 500 soaring 31% over the past six months, it may seem daunting to try to find stocks that are trading at compelling valuations. But the old maxim "seek and ye shall find" still rings true -- in particular when it comes to gold stock Royal Gold. With political uncertainty likely to extend through the weeks leading up to the election -- and possibly beyond -- gaining exposure to gold seems like a worthy strategy to diversify one's portfolio. And now seems like an especially good time as the average price of gold has dipped about 2.4% lower from August to September.
A royalty and streaming company, Royal Gold is probably not what investors who are unfamiliar with the mining industry imagine when they hear of gold-oriented stocks. Whereas there are plenty of gold mining companies that are responsible for digging the yellow stuff out of the ground, Royal Gold operates behind the scenes. By supplying mining companies with the up-front capital needed to develop assets, Royal Gold gains the right to purchase the mined metal at a preset price or to receive a percentage of mineral production.
Due to Royal Gold's extensive portfolio, which includes royalty and streaming agreements with many of the mining industry's leading companies, investors who pick up shares of Royal Gold mitigate the risks related to an investment in a single mining company. In addition, the geographic diversity in the company's portfolio -- its seven principal properties are located on three continents -- reduces the risks associated with adverse conditions in any single country or region.
Currently, shares of Royal Gold are trading at 23.2 times operating cash flow. Although this is slightly higher than their five-year average multiple of 22.1, the stock seems like a bargain considering its multiple for 2019 was 28.6. And that's not the only indication that suggests the stock is undervalued right now. Shares of the other leading royalty and streaming company, Franco-Nevada Corporation are currently changing hands at 37.7 times operating cash flow -- a premium to their 2019 and five-year average ratios of 36.4 and 31.8, respectively.
