Finding Undervalued Stocks in the S&P 500

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

In the first piece that I wrote on the subject of finding undervalued stocks in the S&P 500 based on low valuations, I initially believed that opportunities would be few-and-far between. However, it appears that there is actually a large number of companies that are trading at astonishingly low valuations in relation to the rest of their sectors, which spurred me to write another post on the subject.

Where to start?

In the first piece I covered the Consumer Goods sector as one of the most overvalued sectors in the S&P 500. But what about the most undervalued?

According to this article by ValueWalk, one of the most undervalued sectors in the market is Energy. According to 27 year historic valuation averages. Specifically, one of the most sold-off sectors in the market right now is the oil & gas drilling & exploration sector. Currently, the oil & gas drilling & exploration sector currently trades at a average P/E ratio of 16.6 and price to book value of 2.5. The sector offers an average dividend yield of 3.2% and trades at a price-to-free-cash-flow ratio of 38.

So, are there any good stocks on offer in the sector?

Yes, in fact one of the cheapest stocks in the sector is the world's leading oil & gas equipment producer, holding 60% of the market: National Oilwell Varco (NYSE: NOV). National Oilwell currently trades at a TTM P/E ratio of 12.3, far below the sector average. In addition, the company trades at a forward P/E ratio of 10.5 and a price to book ratio of 1.4 -- once again, both below the sector average. Unfortunately, the company trades at a price-to-free-cash-flow ratio of 86, and only offers a dividend yield of 1.5%, both below the sector average. However, as National Oilwell is a market leading company and is trading at such a low earnings multiple in comparison to the rest of the sector, the low yield can be overlooked.

The second company that trades at a relatively low valuation in relation to its sector is oilfield services provider Baker Hughes (NYSE: BHI). Currently, Baker Hughes trades at a TTM P/E of 16.5, which is around the same as the sector average. That said, the company is trading at a forward P/E ratio of 11.1 and a P/B ratio of 1.2, both below the sector average. Baker Hughes offers a 1.3% dividend yield, once again below the sector average; but the company's low valuation offsets the low dividend.

You could be mistaken for assuming that National Oilwell and Baker Hughes are trading at low valuations because they are not going to grow this year. But in fact the opposite is true. National Oilwell's earnings are predicted to grow a staggering 24% this year, while Baker Hughes' earnings are expected to grow by around 33%. 

Out of the S&P 500 oil & gas equipment and services sector, both National Oilwell and Baker Hughes have some of the lowest forward P/E ratios:

<table> <thead></thead> <thead> <tr><th> <p><strong> </strong></p> </th><th> <p><strong>Forward P/E</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Oil & gas equipment and services sector average</p> </td> <td> <p>12.6</p> </td> </tr> <tr> <td> <p>National Oilwell Varco</p> </td> <td> <p>10.5</p> </td> </tr> <tr> <td> <p>Baker Hughes Incorporated</p> </td> <td> <p>11.1</p> </td> </tr> </tbody> </table>

Major chemical producers

Another sector which offers some stock that are undervalued relative to the rest of the sector, is the S&P 500 major chemical producers sector.

Currently, the major chemicals sector trades at an average TTM P/E ratio of 21.1, and a price-to-book value of 11.7. In addition, the sector offers a average dividend yield of 2.6% and the sector trades at an average price-to-free-cash-flow ratio of around 100.

So, where is the value in the sector?

Well, firstly it would appear that the world renowned Dow Chemical (NYSE: DOW) is actually one of the cheapest companies in the sector right now. Dow currently trades at a low TTM P/E of 14.6 and P/B ratio of 2.3, both of which are below the sector average. In addition, the company offers investors a dividend yield of 3.9%. However, Dow Chemical does trade at a price-to-free-cash-flow ratio of 154 --way above the sector average.

Elsewhere, Eastman Chemical (NYSE: EMN) currently looks expensive, trading at a TTM P/E ratio of 20.3 - although still below the sector average. That said, the company is trading at a forward P/E ratio of 10, a P/B ratio of 3.5 and a price-to-free-cash-flow ratio of 61, all below the sector averages. However, the company only offers investors a 1.7% dividend yield, about 1/3 below the sector average.

Both Dow Chemical and Eastman Chemical have the lowest forward P/E ratios in the sector, and despite their low valuations, their earnings are expected to grow rapidly over the next few years:

<table> <thead></thead> <thead> <tr><th> <p><strong> </strong></p> </th><th> <p><strong>Forward P/E</strong></p> </th><th> <p><strong>EPS Growth 2013</strong></p> </th><th> <p><strong>EPS Growth 3-YR Predicted (compounded)</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Major chemicals sector average</p> </td> <td> <p>12.8</p> </td> <td> </td> <td> </td> </tr> <tr> <td> <p>Dow Chemical Company</p> </td> <td> <p>11.7</p> </td> <td> <p>214%</p> </td> <td> <p>46%</p> </td> </tr> <tr> <td> <p>Eastman Chemical</p> </td> <td> <p>10</p> </td> <td> <p>114%</p> </td> <td> <p>24%</p> </td> </tr> </tbody> </table>

Conclusion

Although the market may seem overvalued and uncertain to some investors right now, by using the most simple of valuation methods, it is possible to identify some stocks that are still undervalued in relation the rest of their sector. Dow Chemical, Eastman, National Oilwell and Baker Hughes are all trading at discounts to their sector valuations and offer good opportunities for profit as the valuation gap closes. Moreover, each company is strong and is forecast to grow earnings rapidly over the next year or so.

There are many different ways to play the energy sector, and The Motley Fool's analysts have uncovered an under-the-radar company that's dominating its industry. This company is a leading provider of equipment and components used in drilling and production operations, and poised to profit in a big way from it. To get the name and detailed analysis of this company that will prosper for years to come, check out the special free report: "The Only Energy Stock You'll Ever Need." Don't miss out on this limited-time offer and your opportunity to discover this under-the-radar company before the market does. Click here to access your report -- it's totally free.


Fool contributor Rupert Hargreaves owns shares of National Oilwell Varco. The Motley Fool recommends National Oilwell Varco. The Motley Fool owns shares of National Oilwell Varco. 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!

blog comments powered by Disqus