What is a value stock? Many investors -- including Warren Buffett -- would say that both growth and value stocks are tied at the hip and that investors are just looking to buy shares in a company at a discount to the cash it will generate for shareholders.
However, Wall Street loves to categorize stocks as being in either the growth or the value camp. Value stocks are generally classified as stocks with a price-to-earnings (P/E) ratio below the market average, while growth stocks are ones with fast-growing financials, regardless of what their earnings multiples are.
Even though these are arbitrary distinctions, it can be useful to own both growth and value stocks to balance out the volatility in your portfolio. This can be helpful psychologically when one category is experiencing a huge drawdown, dampening the impact on your portfolio in a bear market. Here are three value stocks that are smart buys this month.
1. Nelnet: A diversified student loan business
Student loans get a bad rap in many circles, but it is a stable business whose payments from borrowers are backed by the federal government. Nelnet (NNI 0.38%) owns a large book of student debt and services hundreds of billions of dollars worth of loans every year. The company is not allowed to originate new loans (the U.S. government does that itself now) but its existing portfolio is still set to generate cash for the company for many years.
Over the next decade-plus, management estimates this loan portfolio will generate $1.72 billion in cash flow for Nelnet, the majority coming in the next five years. If student loans are forgiven and repayments accelerate, this estimate gets lowered to only $1.14 billion. However, the cash will come to Nelnet quicker. With the company's market cap of only $3 billion, a lot of what investors are paying for is just from this existing loan book.
With the cash generated by the student loan portfolio, Nelnet has been investing in other businesses. These include education software and payments processing (which does close to $100 million in quarterly revenue), a venture capital portfolio, renewable energy, real estate projects, and the launch of a bank.
NNI PE Ratio data by YCharts
It is difficult to value all these separate businesses. But as an investor in the company, all I'm looking at is the stock's cheap valuation (its P/E ratio is only 6) and its superb track record of growth. Book value per share -- calculated as assets minus liabilities, an important metric for an investment company -- has compounded at 17.2% a year since Nelnet went public in 2004.
If this continues over the next decade, I think it is likely Nelnet shareholders will do well over that time span as well, especially considering the discounted starting valuation.
2. Sprouts Farmers Market: A niche grocery chain
Sprouts Farmers Market (SFM +1.57%) is a grocery chain focused on serving healthy eaters at a reasonable price. The thesis for Sprouts is simple. It caters to people who eat lots of fruits and vegetables and ones who follow specialty diets like vegan or keto.
With only 378 stores across the United States, Sprouts has a long runway to grow its store units this decade, with a goal of growing by 10% or more a year after 2022. The business has stable unit economics, with a gross margin of around 36% and an operating margin of approximately 5.5% for the last five years. It has generated positive net income every year over that time span.
The company is guiding for earnings per share (EPS) of $2.22 at the midpoint of its guidance, giving the stock a forward P/E of 12.3. This is well below the market average of 19. Plus, with a lot of green space to grow its store count, the company has a clear path to growing its EPS considerably over this decade, making the stock an easy buy right now.
NASDAQ: SFM
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3. Altria: The ultimate sin stock
If you don't like sin stocks, then Altria Group (MO 0.12%) may not be for you. However, if you are comfortable investing in tobacco companies, the stock looks cheap at a current price of $43 a share.
Altria is the owner of Marlboro cigarettes in the United States. Cigarette volumes have been in decline for years, but the company has been able to mitigate that trend by consistently raising prices on cigarette packs, leading to stable revenue and increasing profit margins. However, this strategy cannot last forever.
Management knows this and as a result, it has invested in many different lower-risk "sin" and nicotine products, including the cannabis space and vaping. Some haven't worked out, like its huge investment in Juul Labs, but it has a promising product with its On! nicotine pouches. Unit volumes for On! grew 75% year over year through the first half of 2022. While still much smaller than cigarette volumes, the segment will get much larger in a few years if it keeps up this torrid growth rate.
In 2022, management is guiding for an adjusted EPS of $4.86 at the midpoint. This equates to a P/E of just 8.8. It also gives the company plenty of room to fulfill its annual dividend of $3.76 per share (an 8.8% yield) while also returning cash to shareholders through share repurchases. If you believe in Altria's strategy of raising cigarette prices while transitioning to lower-harm products, the stock looks like an easy buy right now.
