For as volatile as the last year has been, investors have to be feeling good right about now. Following a 34% swan dive in the benchmark S&P 500 (^GSPC 1.26%) during the first quarter of 2020, the broad-based index finished the year higher by 16%. That's nearly double its average annual gain over the past 40 years. Most impressively, these gains came amid the steepest economic downturn in decades and a pandemic.
However, a skyrocketing stock market has also exposed just how pricey equities have become. The Shiller price-to-earnings ratio for the S&P 500 -- i.e., the average inflation-adjusted earnings from the previous 10 years -- is now up to 35, which is its highest reading since the dot-com bubble. This figure is more than double the mean and median price-to-earnings ratio for the widely followed index over the past 150 years.
But here's what's truly amazing: You can still find value if you look hard enough. Thanks to 24 years of forward price-to-earnings data on a multitude of industries from market analytics company Yardeni Research, three stand out as still being historically cheap in an otherwise pricey market.
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Drug retail
When it comes to truly cheap industries, drug retailers (e.g., pharmacies) are near the top of the list. This is an industry that regularly commanded a forward P/E ratio ranging from 20 to 35 between 1997 and 2007. Nowadays, it sports a forward P/E of just 9.8, and it's bouncing off of an all-time low set during the March coronavirus swoon.
To give you an example of the values you can scoop up in drug retail, Walgreens Boots Alliance (WBA 1.60%) and CVS Health (CVS 1.36%) are currently valued at 9.4 and 9.8 times their respective forward-year earnings. That's far less than half the forward P/E of the S&P 500 (22.6), according to Yardeni's data.
I know what you might be thinking, and you're correct: The retail drug industry is a low-margin, highly competitive space. Foot traffic was down in 2020 due to the pandemic, and more companies (ahem, Amazon) are entering the online pharmacy space. But these pharmacy giants have tricks up their sleeves to stay relevant and highly profitable.
For instance, CVS Health acquired Aetna in 2018. By growing vertically, CVS provided a dangling carrot to keep more than 20 million of Aetna's members within its network of pharmacy services. This deal is also providing substantial cost synergies and should boost CVS Health's organic growth rate.
Meanwhile, Walgreens Boots Alliance is already well into its turnaround plan, which includes $2 billion in cost cuts and major investment in digitization to improve direct-to-consumer sales. Walgreens has also partnered with VillageMD to open up to 700 full-service clinics at some of its locations throughout the U.S. This should incentivize repeat business and streamline patients to its higher-margin pharmacy.
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Integrated telecommunication services
Another industry that's hardly flying above ground level while the stock market soars is integrated telecom services. The current forward P/E ratio of 10.1 for integrated telecom companies is just above the lows hit in March 2020 and late 2008. By comparison, this is an industry that has regularly averaged a forward P/E of closer to 14 or 15 over the past 24 years.
Integrated telecom companies like AT&T (T 0.18%) and Verizon (VZ -0.10%) have consistently sported lower P/E ratios because their growth heyday is long gone, and they're lugging around quite a bit of debt. AT&T and Verizon respectively have more than $187 billion and $138 billion in total debt. Servicing this debt, coupled with a saturated U.S. telecom market, has everyone except income investors largely bypassing the industry. However, this could be a mistake.
Telecom service providers are set to benefit from the rollout of 5G wireless infrastructure. It's been a decade since consumers and enterprises have benefited from faster download speeds, so you can be certain that AT&T and Verizon are going to see tangible improvements in organic growth over many years as the tech upgrade cycle pushes data consumption higher.
These integrated telecom giants can also excite investors by continuing to invest in their streaming capabilities to offset cord-cutting. AT&T's HBO Max was a slow starter following its late May launch, but it saw a nearly 50% boost to its subscriber count in a matter of six weeks during the fourth quarter. Meanwhile, Verizon recently unveiled its second-generation Stream TV device that allows users to stream content from many of the most popular platforms.
With a forward price-to-earnings ratio of 9.4 for AT&T and 11.1 for Verizon, there's value to be had here for patient investors.
Image source: Getty Images.
Biotech
Believe it or not, the high-growth biotechnology industry is another source of deeply discounted value for investors. Biotech stocks offer a forward P/E of only 11.4, which is just a stone's throw from an all-time low for this fast-paced industry, and roughly half the forward P/E of the S&P 500.
You might be scratching your head and wondering how an industry with so many money-losing companies could offer such a low price-to-earnings ratio. The answer has to do with Yardeni looking at industries within the S&P 500. One of the many criteria used for S&P 500 inclusion is recurring profitability. This is a fancy way of saying that riskier, money-losing biotech stocks aren't being used in this P/E calculation.
Perhaps the biggest bargain in the entire biotech space, Alexion Pharmaceuticals (ALXN), is currently being gobbled up by AstraZeneca. The biggest knock against Alexion has always been its overwhelming reliance on blockbuster drug Soliris. However, Alexion recently allayed these fears by developing and introducing next-generation therapy Ultomiris. Ultomiris is administered less frequently than Soliris, and is designed to replace it over time. In other words, Alexion's innovation has protected its cash flow for years to come. I believe AstraZeneca is getting an absolute steal at just 12.5 times forward earnings.
Value seekers can also find deals among high-growth biotech stocks like Vertex Pharmaceuticals (VRTX 0.23%). Vertex has found incredible success in treating gene-specific mutations of cystic fibrosis, a disease characterized by thick mucus production that can obstruct the lungs and pancreas. The company's latest drug, Trikafta, was so effective that it was approved by the U.S. Food and Drug Administration five months ahead of its scheduled review date. With combination therapy Trikafta in its sails, Vertex is looking to double its revenue between 2019 and 2023.
Long story short, there are still screaming bargains to be had for value investors.
