These Three Companies Are Undervalued
Rupert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Earnings yield is a valuation method used by some analysts to compare individual companies to the rest of the market and government bonds, in particular, the risk-free 10-year Treasury. Currently the earnings yield for the S&P 500 stands at 5.1%, while the current 10-year Treasury yield is about 2.5% - indicating that the market as a whole is undervalued compared to bonds.
What about individual companies? Well, surprisingly despite the fact that the market is consistently hitting new all-time highs, there are still opportunities in the market based on the earnings-yield valuation. As the market average is 5.1%, any companies that are trading at an earnings yield of greater than 5.1% can be considered undervalued.
As earnings yield is based on historic earnings, I have excluded any companies that rely on commodities, as their earnings will be significantly affected by falling commodities prices during this year and next year's earnings yield may not offer much value.
Deere (NYSE: DE), currently trading with an earnings yield of 9.7%, looks to be undervalued compared to the rest of the market and the 10-year Treasury. Deere has been sold off recently as investors are concerned that the company could be hit with falling comp sales after a strong 2012 and a slowdown in the housing market. However, as a producer of farm machinery, Deere is a long-term play as its equipment will always be in demand as the global demand for food grows - this pullback provides an opportunity to buy in at a low price.
Furthermore, compared to its 10 largest peers in the construction-machinery sector, Deere is one of the most profitable, achieving a return-on-equity of 43% compared to the sector average of 20%; this is mostly down to Deere's highly lucrative financing division. The company also has an above-average gross profit margin of 31% compared to the sector average of 26.4%. All in all, Deere is a strong company currently trading at a low valuation.
The old dog
Next up is Western Union (NYSE: WU), which is being shunned by investors in favor of new, fast-growing peers Visa and MasterCard. However, this has resulted in a large discount between Western Union's valuation and that of the rest of the sector. Indeed, on a trailing-12 month P/E basis, Western Union trades at a ratio of 10.4 compared to the sector average of 22.7. Moreover, the company appears cheap on a forward basis, trading at a forward P/E of 10.9 compared to the sector average of 12.
Western Union has an earnings yield of 9.5%, indicating that the company is undervalued compared to the market and Treasuries. Surprisingly, even though Western Union is considered to be an old dog, the company is still achieving a return on assets of 10.6%, above the sector average of 6.8%, impressive considering the company's highly cash-generative peers.
The Wall Street giant
Lastly, Goldman Sachs (NYSE: GS), with an earnings yield of 10%, once again looks to be undervalued compared to the market. In my opinion, Goldman is one of the best opportunities in this piece, as the firm recently announced impressive Q2 earnings and has committed to repurchase around 70 million shares, or 15% of its free float. Tangible book value stood at $141.62 per share and the firm's Tier 1 capital ratio was most recently 15.6%.
Furthermore, analysts have become extremely bullish on Goldman during the past few months, raising EPS estimates for 2013 by 17% since the beginning of the year, indicating that the company will earn $15.21 for the full year, demonstrating year-over-year growth of 8%. Goldman is expected to earn around $16 per share for 2014 and this growth is currently available at a low forward P/E of 10.5.
Overall, although this market is current looking overvalued in some places, there are still opportunities if you look hard enough. The three companies above all provide great opportunities as they are all leaders in their industries, with strong future outlooks, but are still trading at lowly valuations compared to their peers and the wider market.
The best pick would have to be Goldman. The firm basically prints money and looks really cheap right now. In addition the stock buyback should boost both earnings and the share price.
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Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs and Western Union. 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!