Over the past decade, growth stocks have been all the rage while value stocks have lagged. But remember, this isn't normal. The last 10 years have seen an unprecedentedly long period of low rates and technological disruption, which has benefited high-growth stocks.
However, with the rollout of a vaccine and a new stimulus package signed, it's entirely possible that value stocks, which trade at much lower multiples than growth stocks, and which disproportionately benefit from a strong economy, could outperform in the new year.
Here are three bargain-priced value names to put on your buy list in January.
In an age where many cloud software stocks trade at 20, 30, or even 40 times sales or higher, hyper-converged infrastructure software provider Nutanix (NASDAQ:NTNX) looks downright cheap at only 5 times sales. That's especially true as Nutanix's hyperconverged infrastructure products help companies run applications across multiple clouds, hybrid clouds, and on-prem data centers, a market that's projected to grow at a 21% CAGR through 2023.
On the surface, Nutanix's discount may seem warranted; last quarter, Nutanix's revenue fell by 0.6%, with a $182 million operating loss in the third quarter alone. However, those numbers are deceptive. Nutanix is in the midst of switching its business model from a one-term software license to a recurring subscription model. When a company takes such an action, its revenue will come down or stagnate for a period of time, as annual revenue displaces multi-year revenue; in other words, Nutanix isn't booking the entire amount of the license revenue that may occur over several years.
More telling is Nutanix's annual contract value (ACV), and that figure surged 29% last quarter, more in-line with the company's growth prospects in hybrid cloud management. Total customers grew 21%, and large customers that spend over $1 million per year grew by 29%. Gross margin also expanded by 180 basis points, seeming to validate the thesis that subscriptions lead to more efficient margins, and that one day Nutanix will make profits with enough scale.
Nutanix is also a fine company, with a customer-obsessed culture that leads to very low churn and a net promoter score of 90, which is extremely high. The company also won numerous awards in 2020, with both Gartner (NYSE:IT) and Forrester classifying Nutanix as the leading product in the HCI market, along with numerous awards for being an excellent partner and place to work in 2020.
Another reason the stock may be undervalued is that founder and former CEO Dheeraj Pandey stepped down as CEO in August for personal reasons. However, the company received a boost of confidence via a $750 million investment from private equity firm Bain Capital around that time. Just recently, Nutanix hired Rajiv Ramaswami, COO of rival VMware (NYSE:VMW) as its new leader.
Although it's never great to see a terrific founder leave, Bain's involvement, an experienced new CEO, and Nutanix's cheap valuation amid a growing business makes it look like a very cheap stock heading into 2021.
Bank of America
Recessions are never great for financial institutions, but they are often some of the best times to buy beaten-down banks, provided those banks survive. No problem there for Bank of America (NYSE:BAC) which is currently Warren Buffett's favorite bank and his second largest public stock holding.
Why does Buffett love Bank of America so much? Probably because CEO Brian Moynihan has positioned the company as a low-risk lender, mostly to prime borrowers, while cutting costs and investing in technology. The focus on credit quality may have held back growth over the past few years, but as Buffett has often said, you only find out who's swimming naked when the tide goes out.
Bank of America certainly isn't swimming naked; this year, the bank remained profitable every quarter, despite increasing its loan reserves in response to COVID-19. Charge-offs have also remained remarkably low during this unique downturn.
Though it has investment banking and sales and trading arms like other large-cap U.S. banks, Bank of America is primarily focused on plain vanilla consumer and business loans, which also makes Bank of America fairly sensitive to the yield curve.
Although the Federal Reserve has pledged to keep short-term rates near zero for the foreseeable future, it doesn't control the long end of the yield curve. With the recent passage of stimulus and the rollout of new vaccines, it's very possible that inflation could pick up later this year and heading into 2022. That could definitely cause long-term rates to rise, which would benefit Bank of America's net interest margins.
Trading at just 1.06 times book value and 13 times next year's earnings estimates, which will still be somewhat depressed by COVID, and Bank of America looks like a cheap stock that will benefit from a rebound in economic activity next year.
Semiconductor equipment stock Applied Materials (NASDAQ:AMAT) is also wildly underrated by Wall Street heading into 2021, trading at just 17.7 times next year's earnings estimates, despite booming spending on advanced semiconductors. Yes, the sector has been cyclical in the past, with large booms leading to busts; however, the industry is still making its way back from the big bust of 2018-2019 from the U.S.-China trade war. So just because Applied Materials has seen hot sales growth this year doesn't mean this current growth cycle is over.
In fact, Needham & Co. analyst Quinn Bolton just raised his target on Applied Materials to $110, nearly 40% higher than today's price, and put it on his conviction list for 2020. Bolton believes more spending on DRAM memory next year, along with continued gains in foundry and logic spending, will help Applied Materials more than other peers because of its DRAM-skewing product mix.
Yet stepping back and looking at the big picture, the long-term strategic nature of advanced semiconductors, along with Applied's recurring revenue services business, should smooth out the semi-cap cycles of the past. A smoother cyclicality could very well lead to multiple expansion for Applied, which is still cheaper than its semiconductor equipment peers, which themselves are much cheaper than high-flying software stocks. This is despite the fact that semiconductors are key enablers of the all the big tech themes of the next decade, from 5G to artificial intelligence to the Internet of Things.
With such a low valuation, a 1% and growing dividend, ample buybacks, and a promising long-term growth story, Applied is another value stock to scoop up in the new year.