While 2021 may have been a fun year for investors because everything practically went straight up, 2022 hasn't been so nice. This pullback occurred for multiple reasons, but chief among them was stretched valuations. Stocks just got too expensive for the performance of the business.
However, many stocks have rebounded over the past month only to return to questionable valuation levels. Fortunately for investors, there are still a handful of stocks that are still reasonably priced. Here are three I think fit that bill.
1. Alphabet
Alphabet (GOOG 0.74%), the parent company of Google, YouTube, and the Android operating system, makes most of its revenue through its advertising business. Advertising is an area in which many companies reduce spending during tough economic times, and both Alphabet's stock and business performance felt the effects of that in 2022.
The stock trades for a mere 20 times earnings, which is a bargain for Alphabet. It has rarely traded at this level as a public company and is trading here with adversely affected earnings.
In the second quarter, Alphabet's revenue only rose 13% year over year, which did not offset the company's increased expenses. This drop caused its earnings per share (EPS) to fall from $1.36 last year to $1.21. However, when the economy recovers and businesses are more willing to advertise, Alphabet's earnings will rapidly rise. This effect will cause its valuation to become remarkably low, and the stock price will likely rise to offset this anomaly.
Over the past three economic slowdowns or recessions (2008-2009, 2012, and 2020), Alphabet's revenue has dipped, then spiked, then returned to its usual growth pace. As the business enters the first phase of this pattern (the dip), investors must understand that Alphabet has lived through these scenarios multiple times and came out better on the other side.
GOOG Revenue (Quarterly YoY Growth) data by YCharts
Alphabet is one of the most dominant businesses in the world yet trades at almost the same earnings multiple as the average S&P 500 company (the current S&P 500 price-to-earnings (P/E) ratio is 19.8). Betting on Alphabet to recover alongside the broader economy seems like a smart move to me, and investors should use this chance to increase their position in Alphabet.
2. Adobe
Adobe (ADBE 0.89%) is more than just a PDF file type you can choose. Its graphic design products, document processing, and marketing solutions span many industries. Furthermore, Adobe's products are used daily by its core customer base, making it a difficult product to cut even if a business is struggling.
This necessity was reflected in Adobe's second quarter (ended June 3) results. Revenue rose 14% from the year-ago quarter, and EPS increased by $0.16 to $2.50. Additionally, Adobe repurchased $1.2 billion in stock this quarter, more than offsetting its $352 million stock-based compensation. This action reduced the number of outstanding shares, causing EPS to rise, which caused its valuation to tumble further, thus giving investors a better value on the stock.
Adobe trades at 26 times free cash flow -- the lowest it has traded at since it switched its business model to a subscription service in 2014. This valuation decline is partly due to Adobe's slowing sales growth, but 15% growth is still much greater than the market grows annually. Still, analysts expect full-year revenue growth to come in at 11.9% but accelerate to 13.9% next year, showing Adobe has meaningful growth ahead of it.
At an all-time low valuation for its current business model (comparing Adobe's valuation to its pre-subscription-model days isn't an apples-to-apples comparison), Adobe's stock is a steal, down 45% from its all-time high.
3. MercadoLibre
While Alphabet and Adobe may be reasonably priced, MercadoLibre (MELI -1.79%) is criminally undervalued. MercadoLibre has brought nearly every aspect of e-commerce to Latin America: an online marketplace, digital payments, consumer credit, and a vast shipping network. Moreover, Latin America's population is double that of the U.S., so the market opportunity is massive.
Furthermore, while other e-commerce companies have struggled with difficult comparisons, MercadoLibre has blown them away. In Q2, total revenue grew 57% year over year to $2.6 billion. This growth was primarily driven by its fintech division's 107% growth rate to $1.2 billion, but commerce also put up a respectable quarter with 23% growth to $1.4 billion.
With growth rates like that and a broad market still to capture, you'd think MercadoLibre would be trading at a premium valuation. But you'd be wrong. Instead, it's trading at a level last reached during the financial crisis of 2009.
MELI PS Ratio data by YCharts.
At this level, if the stock returns to the low end of its valuation range over the past decade (10 times sales), the stock price is set to double. Of course, that's without any business growth, which isn't a safe bet to make on a booming business like MercadoLibre.
As its e-commerce sales growth pace slows, look for the company to post greater EPS as that business segment matures (analysts expect $7.01 in EPS this year, versus just $11.43 next year). Although with its fintech wing growing rapidly, MercadoLibre remains a great growth stock with its large market opportunity.
I believe all three of these stocks can be safely purchased here without too much risk of overpaying. However, the market may continue to fall, presenting investors with even greater bargains. It could also rebound and leave investors wondering what happened to all these cheap stocks.
The best move is to establish a position today and add over time to capture better entry points potentially. Then, investors can establish a solid position in these fantastic companies through dollar-cost averaging.
