Two Undervalued Opportunities From Earnings Season

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The market has been fairly strong lately, and many companies are starting to look expensive. But it´s not only a matter of indexes and averages, each stock has its own drivers, and not every individual name is trading near historical highs.

In fact, earnings season can be a great time to search for undervalued stock opportunities.  Investors tend to overreact to disappointing earnings reports; short term thinking and emotional selling can create some interesting opportunities in high quality stocks at convenient prices, and these two names deserve some attention.

The Fallen Apple

Shares of Apple (NASDAQ: AAPL) took a brutal beating after earnings, the stock fell by nearly 12% on a single day, as it’s accumulating a loss of more than 35% from its historical highs near 705 back in September of last year. After such a reaction from investors, we could have thought that the company was about to go broke, or that Apple had appointed Kim Kardashian as the new chief product engineer, but nothing that dramatic has happened to the company.

In fact, Apple reported better than estimated earnings per share at $13.81 versus $13.44 expected by analysts on average. Sales were a little below expectations though; the company reported $54.51 billion in revenue versus 54.73 billion expected by Wall Street Analysts. This is still an overall increase of 18% annually for the quarter, and if we consider that last year included an extra week, adjusted revenue growth would have been 27%.

Investors and analysts have been getting really concerned about growing competitive threats from Samsung and other manufacturers, but the recent selloff is much overdone for such a strong company with a tremendous brand value and enormous financial resources.

The fact that Apple is trading at similar valuation ratios to those of Microsoft (NASDAQ: MSFT) is a great comparison to understand just how cheap the stock is at current levels. Both Microsoft and Apple trade at forward P/E ratios barely below 9, and price to free cash flows in the area of 10 for Apple and 11 for Microsoft.

But the similarities end there, while Apple has been an undisputed leader of the mobile revolution, Microsoft has missed many of the most relevant trends in the tech industry over the last years. In fact, the iPad is cannibalizing PC sales and creating a serious problem for Microsoft and its Windows business. Growth trends for Apple and Microsoft could hardly be more dissimilar, yet both companies trade at almost the same valuation ratios.

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Investors will sooner or later recalibrate their expectations about Apple: it may not be the ultra-high growth company it once was, but it’s still a fantastic business, and current valuation doesn’t do it any justice.

 A High Quality Retailer in the Bargain Bin

Coach (NYSE: COH) has been an outstanding success story over the last years, the company has found a profitable niche in “affordable luxury,” which means high end products that are still accessible for most people. The company has superior profitability ratios, well above most competitors in the retail business, and many exciting growth possibilities via expansion in Asia and new product lines.

However, the stock is not in style this season: shares of Coach got hammered by nearly 16% after reporting disappointing earnings for the last quarter, and they are now looking quite cheap trading below $50 per share when they were at almost $80 in March of 2012.

The company showed some worrisome trends in the North American region: overall sales increased by 1% in the last quarter, while comparable store sales showed an unexpected decline of 2%.  Not everything was bad news in the last earnings report, sales in China increased by an outstanding 40% annually, and the new men´s category did even better with a 50% year over year growth rate.

But North America is still the biggest segment, and overall results were disappointing: total sales grew by 4%, and earnings per share increased by only 5% annually. This is well below analyst´s expectations for the quarter, and weakness in the company´s biggest segment deserves some attention.

Coach has been feeling the pressure from competitors like Michael Kors (NYSE: KORS), which has been growing like crazy thanks to its trendy designs and differentiated brand presence. The company has increased sales at an almost 44% annually over the last five years, and in the process it has taken market share away from Coach.

Michel Kors is in fashion, and there is no reason to believe it wills stop growing anytime soon. But that doesn´t mean there won´t be enough room for different players in the industry, there is no such thing as too many handbags and purses for most women. Besides, Michael Kors is trendier – and probably more targeted towards younger consumers – while Coach is more on the classic side.

The company still has sky high profitability with gross margins above 72% and operating margins of more than 30%. Michael Kors, in comparison, carries gross and operating margins of 57% and 24% respectively. Coach is doing great with its growth initiatives like Asian expansion and men´s products, and the company has the brand power to achieve more growth in North America in the middle term.

At a current P/E of 13.5 the stock is trading at valuation levels not seen since the great recession, so this may be a great to grab shares of this high quality retailer from the bargain bin.

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Bottom Line

 The market is making new highs, and it’s not easy to find undervalued opportunities in this kind of context. But Apple and Coach have been excessively punished for disappointing Wall Street analysts in the last quarter; so long term investors with a contrarian mindset have good reasons to consider a long position in these high quality names trading at convenient entry prices.

acardenal owns shares of Apple and Coach. The Motley Fool recommends Apple and Coach. The Motley Fool owns shares of Apple, Coach, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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