Searching for 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.

Right now, the market is full of uncertainty. Even before the Fed statement on June 19 the market was full of uncertainty. To some, the market looks to be overbought and due for a correction; for others, the market still looks undervalued.

Personally, I don't sit in either camp, but I do think that while the market is so unpredictable and bouncing around its multi-year highs, there are still some opportunities left to buy undervalued stocks. It is just a case of doing some extra work and looking carefully.

The best way to find undervalued companies is usually the simplest: Comparison of key ratios to the rest of their sector.

Where to start?

As I have written about here, one of the most overvalued sectors right now is consumer goods. However, it appears that there are still some stocks that have not yet caught up.

The consumer goods sector as a whole is currently trading at a TTM price-to-earnings ratio of 20.9, a price to book value of 124, and a price-to-free cash flow ratio of 13.8. The sector also offers an average dividend yield of 2.9%.

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

Yes, in fact there are. The first is well known cereal producer Kellogg (NYSE: K). Kellogg's may not be undervalued right now, as it trades at a P/E of around 25, but the company is expected to produce earnings growth of 6.6% this year, putting it on a forward P/E ratio of 15 -- below the sector average. In addition, the company offers its investors a 2.8% dividend yield, around the same as the sector average.

The second company on offer in the sector is ConAgra Foods (NYSE: CAG). Once again the company is in line to be the cheapest stock in the sector when it reports earnings for this year, as the company currently trades at a forward P/E ratio of 13.5. The company offers its investors a 3% dividend yield, and is expected to grow its earnings per share by 16% next year.

Both Kellogg and ConAgra have the lowest forward P/E ratios in their S&P 500 sector:

 

Forward P/E

Sector Average

17.5

ConAgra

13.9

Kellogg

15.6

Major drug manufacturers

Another sector that appears to have some stocks on offer is the S&P 500 major drug manufacturers sector.

The sector trades at an average TTM P/E multiple of 34.4, and at a forward P/E multiple of 16. Additionally, the sector trades at a P/B ratio of 3.4 and a price-to-free-cash ratio of 32.1. On average the sector offers a dividend yield of 3.1%.

So what's on offer?

Well firstly, Merck (NYSE: MRK) appears to be significantly undervalued when compared to its peers in the rest of the sector. The company currently trades at a TTM P/E ratio of 24.3 and a forward P/E ratio of 12.7. The company trades at a P/B ratio of 2.7 compared to the sector average of 3.4, and a price-to-free-cash ratio of 32.1. In addition, the company offers investors a 3.6% dividend yield, 0.5% above the sector average.

Merck's stock has been sold off after a bad first quarter and competition from generic versions of its treatments. However, the company still has a strong drug pipeline and more importantly, along with its first quarter results, the company announced a $15 billion share repurchase program  - 10% of Merck's current market cap, which should put a spring in the company's step.

Secondly, Pfizer (NYSE: PFE) appears to be trading at the same low valuations as Merck. The company trades at a TTM P/E ratio of 20.6 and a forward P/E ratio of 12.5. The company trades at a P/B ratio of 2.5, below the sector average of 3.4 and a price-to-free-cash ratio of 24.2. Additionally, Pfizer offers investors a 3.3% dividend yield, above the sector average of 3.1%.

Pfizer has been sold off during the past few months after a poor first quarter. The company has been held back by falling sales of its cholesterol fighter Lipitor, which has been competing with cheaper generic versions of the drug. Overall, Pfizer's revenue fell 9% in the first quarter - 1% of that was due to the strong US dollar. However, the company is working hard to turn itself around and is selling down non-core divisions and has a strong pipeline of treatments for cancer, arthritis and blood clots. The company has also authorized a new $10 billion stock buyback program. 

Compared to the rest of the S&P 500's major drug manufacturers sector, both Merck and Pfizer appear undervalued on a forward earnings multiple basis.

 

Forward P/E

Sector Average

16.3

Merck & Co

12.8

Pfizer Inc.

12.5

Conclusion

Although the market may seem overvalued and uncertain to some right now, by using the most simple of valuation methods its is possible to identify some stocks that are still undervalued in relation the the rest of their sectors. 

Kellogg, ConAgra, Pfizer and Merck are all trading at discounts to their sector valuations and offer good opportunities for profit as the valuation gap closes.

 

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Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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