The value strategy involves finding a stock before the market does, building a position in it and then holding on to it to profit from its appreciation in value. Alternatively, you find a high-potential stock that has been beaten down by the market and take advantage of the dip to build a position.
It’s a simple enough strategy but not everyone is equally successful at it. That’s because there are two parts to it, the first being the estimation of potential and the second being the price. Most people choose value based on the price and do a less than ideal job of identifying potential.
So what often happens is, you get into a cheap stock only to find that the price doesn’t budge. By the time you get out of the thing, you’ve likely just wasted your time, or as is often the case, you’ve made a small loss. This is what is called a value trap.
So it’s important to avoid a value trap when picking value stocks. While there’s no specific formula that will work in all cases, there are a couple of things you can do to improve your chances of success. The most important thing to do is to check the financials.
If the company’s revenue and earnings are on a general upward trajectory (even if it’s a very gradual curve upward and even if there are temporary issues), it indicates that the company has a viable business model and is able to compete effectively. So chances are it is innovative enough and has able management. You could confirm this from news articles and the most recent quarterly report.
The stability of revenue, earnings and cash flows is generally easier to find in large cap stocks, so the best value is often found in these more mature names.
The second part is to do with the valuation. You should check that it is undervalued in terms of P/E, PEG, P/S, or any other basis that is relevant to the industry in which it operates.
Let’s take a look at some examples-
Formerly Fiat Chrysler Automobiles, Stellanis designs, engineers, manufactures, distributes and sells passenger vehicles, pickup trucks, SUVs, and light commercial vehicles worldwide.
The Automotive – Foreign industry, to which Stellantis belongs is in the bottom 8% of Zacks-ranked industries. The unattractive industry rank is understandable given the ongoing supply chain challenges, the semiconductor shortage, and the advent of EVs that has increased challenges for many traditional players.
Stellantis shares currently carry a Zacks Rank #1 (Strong Buy) and Value Score A. The shares have appreciated 37.4% over the past year, but at 5.03X forward earnings, they are trading below their median level over the past year.
The company’s results were severely impacted by the pandemic and related lockdown last year, but bounced back immediately thereafter. As a result, 2021 revenue and earnings are expected to grow 83.7% and 173.5%, respectively with more growth the following year. What’s more, the 2021 EPS estimate is up 4.2% in the last 60 days while 2022 estimate is up 5.9%.
Olin Corporation is a vertically-integrated global producer and distributor of chemical products. It also makes ammunition in the U.S. Its products are used in a broad range of industries including water treatment, pulp and paper, soaps and detergents, civil engineering, military and industrial markets.
Olin belongs to the Chemical – Diversified industry, which is at the top 41% of industries. With manufacturing activity continuing to increase since the lockdown last year, Olin has seen strong and steady growth in its revenue. Earnings growth has also been extremely strong.
As a result, analysts have continued to raise their earnings expectations. So it turns out that the EPS estimate for 2021 increased $1.26 (17.1%) in the last 30 days alone. The estimate for 2022 increased $2.08 (29.9%) during the same period. No wonder the shares carry a Zacks #1 rank.
Olin shares have a Value Score A. The shares currently trade at 7.17X earnings, which is below the median level over the past year. And that’s despite the 202.0% gain in the share price over the past year.
Avis Budget Group CAR
Avis Budget Group is a leading provider of rental vehicles across 180 countries in North America, Europe and Australasia. It has an average rental fleet of nearly 650,000 vehicles with more than 11,000 car and truck rental locations all over the world.
The Business – Services industry to which Avis belongs is in the top 35% of Zacks-ranked industry. A position in the top 50% indicates better prospects (as indicated by our historical data), especially when it is coupled with a Zacks #1 rank, as is the case for Avis.
Like Stellantis and Olin, Avis too suffered hugely on account of the pandemic, but it didn’t bounce back quite as fast. That’s because of the operating from home environment that continued through the year. Now that the markets are opening up and large sections of the economy are getting back to regular operations, Avis and its business service peers are seeing a strong rebound. This is reflected in the company’s revenue and earnings performance this year.
Not only that. Avis also has a Value Score of A. Despite the 618.6% surge in its share price over the past year, the shares trade at 1.69X sales, which is between its median value and high point over the past year. The estimate revision trend is also extremely encouraging. For 2021, analysts have raised their EPS estimate by $4.20 (29.7%)
Toll Brothers TOL
Toll Brothers builds single-family detached and attached home communities; master planned luxury residential resort-style golf communities; and urban low, mid, and high-rise communities, principally on the land it develops and improves.
The Building Products – Home Builders industry, to which Toll Brothers belongs, is in the top 32% of Zacks-ranked industries. The residential construction market is likely to remain one of the hottest until around the middle of next year when the inventory situation will normalize to a great extent. Until then, home builders will be able to enjoy strong pricing, which will however be somewhat offset by the rising cost of raw material.
The October quarter is the strongest one for Toll Brothers while January is the weakest. Because of strong demand, Toll Brothers is seeing some very strong revenue growth barring seasonal variations. Likewise for earnings.
The Zacks Rank #2 (Buy) company is one of those few that are expected to grow at a double-digit rate both this year and the next. The EPS estimate for the year ending Oct 22 is up 1.6% in the last 30 days.
Toll Brothers shares have appreciated 40.1% over the past year. Since it is currently trading at 7.22X earnings, which is well below the median level over the past year, the shares look undervalued.
Rome, Italy-based Eni is among the leading integrated energy players in the world with operations across 43 countries.
Eni belongs to the Oil and Gas – Integrated – International industry, which is in the top 11% of Zacks-ranked industries. Coupled with the Zacks #1 rank on Eni shares, this makes an attractive investment. But we can and should dig further.
So a look at Eni’s operating results over the past five years, we see some languishing in 2018 and 2019, followed by the plunge in the June quarter of 2020, when the whole world was off the roads. Oil & gas stocks are coming back very strongly this year with huge demand spurring strong pricing. Moreover, the strength is expected to continue next year as well.
The estimate revisions tell the whole story. While estimate revisions have been smaller for most stocks this quarter, Eni’s 2021 earnings estimates have jumped 46 cents (17.5%) in the last 30 days. For 2022, Eni is currently expected to make $3.74, an estimate that has jumped 33 cents (9.7%) in the last 30 days.
Eni shares have appreciated 50.5% over the past year. They currently trade at $7.83X, close to their annual low of 7.81X over the past year. So these shares are likely to keep going higher.
One-Month Price Performance
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Avis Budget Group, Inc. (CAR): Free Stock Analysis Report
Eni SpA (E): Free Stock Analysis Report
Toll Brothers Inc. (TOL): Free Stock Analysis Report
Olin Corporation (OLN): Free Stock Analysis Report
Stellantis N.V. (STLA): Free Stock Analysis Report
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