Is it time to be worried about a stock market correction? Some seem to think so. Just last week, analysts at Deutsche Bank cited the high valuation of the S&P 500 relative to its history as a potential reason for worry. And it's true that low interest rates, technological disruption, and a government stimulus have all come together to put stocks at high valuations relative to current earnings.
The naysayers always have some reason the market is about to crash, but that doesn't mean it will happen, or that the market won't got on to hit new highs over time, as it always has.
Still, if you're nervous about the valuations of many top stocks, there are quite a few bargains to be had. With enough looking, investors can still find quality companies trading at low valuation ratios across a range of sectors. Today, financial stock Discover Financial Services (DFS 0.06%), tech giant Micron Technology (MU -0.88%), and U.S. cannabis company Ayr Wellness (AYRW.F 1.75%) all appear to fit that description.
Discover one of the cheapest dividend stocks around
Credit card giant Discover Financial is up an impressive 33% on the year, but the stock is still one of the cheapest in the financial sector, which is also one of the lowest-valued sectors around. Yes, thanks to government stimulus and much better-than-expected loss rates coming out of the pandemic, Discover has released a lot of the extra credit reserves it took in the first two quarters of 2020, which has turbocharged its earnings this year, bringing its P/E ratio down to just 7.7. Yet the stock still trades at less than 10 times its average 2022 estimate, which doesn't incorporate any extraordinary benefits.
Why so cheap? Well, investors are perennially skeptical of unsecured credit card loans, and that's where Discover makes the vast majority of its profits. Its other lending products are student loans and unsecured personal loans. Discover, of course, also has its proprietary credit card network, but its payments business, while perhaps making the business vertically integrated and more efficient, yields little in operating profit.
Still, the flip side of this "risk" is that Discover can charge high credit card interest rates, which gives it a net interest margin over 10% -- much higher than traditional banks. And Discover has a history of managing risk very well. Its operating income showed remarkable stability for the five years before the COVID-19 pandemic, with a high return on equity consistently in the low to mid-20% range. Earnings and dividends per share grew every year with the help of generous share repurchases.
Now that the pandemic is receding, those share repurchases are commencing again, with management recently authorizing a new $2.4 billion share repurchase program, which would amount to 7% of Discover's market cap, along with a 14% dividend increase, to a 1.7% yield at today's stock price. Discover is also now back in growth mode, after tightening things up last year. CEO Roger Hochschild said on the conference call with analysts that new account growth is up 26% over 2019.
While the delta variant may slow the recovery, 2021 economic growth should still be strong, with consumer balance sheets in good shape. That means financials like Discover should do well, and those benefits should trickle down to its shareholders, too.
Micron is confident enough to reinitiate a dividend
If I were to tell you that a company recently felt confident enough in its outlook to reinitiate a dividend for the first time in 25 years, you might be surprised that the stock would be down 22% from recent highs, and that it trades for just 7 times next year's earnings estimates. Yet that's exactly what has happened with Micron Technology, a global leader in memory and storage chips.
There's no doubt that Micron's business can be highly cyclical, and that we are currently in some stage of an upswing in memory prices. Therefore, investors appear to be thinking ahead, anticipating the next downturn, which is why shares have lagged recently.
However, Micron is a consistently improving business, and it should become less cyclical, for a few reasons. First, the DRAM industry, where Micron gets about two-thirds of its revenue, has consolidated to just three large players. Those three are now exercising disciplined supply growth, a contrast from the past. In addition, the ability to scale DRAM further is becoming harder, meaning that increasing supply is becoming more difficult. At the same time, DRAM demand is strong and diversified across artificial-intelligence servers, cloud growth, 5G mobile phones, more powerful laptops, and more computerized automobiles. Finally, Micron has recently caught up to competitors in leading-edge technology, while gearing its portfolio toward higher-value solutions.
All of this has meant higher highs and higher lows in terms of margins through the cycles. At the beginning of the 2000s, Micron's adjusted EBITDA margins would turn negative in cyclical troughs; however, EBITDA margins bottomed around 40% in the last downcycle and are still trending upward.
Combined with a strong balance sheet with more cash than debt, Micron is one of the cheapest stocks in the otherwise-expensive tech sector, despite a positive outlook for demand for the next decade. I'd expect shares to move higher once again in due course, and investors now get paid a dividend while they wait.
Ayr Wellness is a pot company repurchasing its own stock
Despite strong financial results, cannabis stocks have been decimated since March. The reason? It's a bit hard to say, but it could be several things: "Hot money" may have been chasing federal legislation that would end cannabis prohibition, but with no action yet this far into the year, it appears patience is wearing thin. In addition, many institutional investors still can't own U.S. pot stocks, which can only trade on Canadian exchanges or over the counter until federal decriminalization happens.
Up-and-coming cannabis company Ayr Wellness was already one of the cheapest stocks in the space, and the recent sector sell-off has made it even more of a bargain. The sell-off doesn't have much to do with earnings results, as Ayr just reported heady 222% revenue growth in its recent quarter, while raising its 2022 guidance to $800 million in revenue and $300 million in adjusted EBITDA. That means its stock, with a market cap just under $1.5 billion, trades at a forward enterprise value-to-EBITDA multiple of just 5.
That's a really cheap valuation for a high-growth company. In fact, it's so cheap that Ayr's management just initiated a repurchase program for up to 5% of Ayr's shares outstanding over the next 12 months. With so much opportunity for growth, devoting cash to repurchasing shares says something about what management thinks of the current stock price.
While cannabis legislation hasn't come as fast as many had hoped, it's still in play. The deadline just passed for stakeholders to give comments that will inform the final Senate legalization bill, co-sponsored by Majority Leader Chuck Schumer, Senate Finance Committee Chairman Ron Wyden, and Sen. Cory Booker. Perhaps some forward momentum on federal legislation this fall will break this super-cheap pot stock out of its recent malaise.