Three Cheap Stocks You Can Buy Now

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

In this market, it is becoming hard to find companies that are undervalued. In particular, with the market reaching all-times highs, valuations are becoming somewhat distorted and value is becoming more and more hidden.

However, there is one valuation method that gives a good indication of how the stock is valued compared to the whole market and risk-free bonds, allowing for a more comprehensive evaluation.

A company's earnings yield is calculated by dividing earnings per share for the last 12 months by its current share price. The resulting figure shows the percentage of each dollar invested in the stock that was earned by the company.

A yield that is above the market average, currently 5.1%, or above the yield on the 10-year Treasury (currently 2.47%), can indicate that the company is undervalued. This is not a certainty though, so I have used earnings yield coupled with other valuation metrics to establish a list of three companies that still look undervalued in this strong market.

The results

Technology company SAIC (NYSE: SAI) is currently trading with an earnings yield of 10% and looks to be undervalued compared to the rest of the market and the 10-year Treasury. Additionally, the company trades at one of the lowest valuations in the technology sector. SAIC trades at a trailing-12 month P/E of 10 compared to the sector average of 20 (excluding extraordinarily high and low valuations). In addition, SAIC trades at a price-to-sales ratio of 0.4, which is in the lower 13% of the technology sector's valuation.

SAIC was a victim of sequester cuts as the company's revenue is heavily weighted to the defense industry. It is not possible to know how these cuts have affected the company until second-quarter results are out, but analysts are bearish. Wall Street analysts covering SAIC have revised down EPS estimates for this year, from a high of $1.35 to around $1.14. That said, the company is expected to return to growth next year with EPS of $1.24 penciled in by analysts.

In addition, SAIC offers a dividend yield of 3.4%, above that on offer from both the 10-year Treasury and the market average of 1.9%.

A banking giant

Next up is Wells Fargo (NYSE: WFC), which, as the country's largest mortgage provider is benefiting from the resurgence in housing activity. Wells is trading with an earnings yield of 8.3%, making the company look undervalued but not as undervalued as Goldman Sachs, which is trading with an earnings yield of 10%.

Wells is one of Warren Buffett's favorite positions and it's easy to see why. Wells pulled itself through the financial crisis and is now stronger and bigger than even. Indeed, thanks to Wells' dominance in the mortgage market, the bank is a long-term play as the majority of its mortgages last for more than 10 years. So as a long-term play, Wells should be making money for many years to come.

Still, as one of the biggest banks in the world Wells still looks cheap. The firm trades at a trailing-12 month P/E of 12 compared to the sector average of 14 and produces a return on equity of 13.6% compared to the sector average of 11.7%. Moreover, Buffett is a fan so the company definitely has the long-term investing seal of approval.

A play on the oil market

Lastly, National Oilwell Varco (NYSE: NOV)) is a great company, and according to earnings yield, it's trading at a great price. National Oilwell controls about 60% of the global market for oil-services equipment and still, the company trades at a discount to sector peers. Indeed, compared to smaller peers Cameron International and Baker Hughes, the company is undervalued on a trailing-12 month P/E basis of around 40%! Moreover, National Oilwell trades with an earnings yield of 7.5%, signifying that it is undervalued when compared to the wider market as well.  

With 60% of the oil-services equipment market under its belt, National Oilwell is well placed for future growth. In particular, with oil becoming increasingly hard to find, explorers are having to use much more specialized equipment, which benefits National Oilwell as the company can use its size and experience to undercut its peers.

National Oilwell has a PEG ratio of 0.9, indicating that the stock has growth at a reasonable price while debt remains low at only 20% of equity.

Foolish summary

Overall, earnings yield is a good method of comparing the market valuation to that of the risk-free Treasury. Earnings yield is also a good method of evaluating stocks on an individual method and the three stocks above are testament to that.

Indeed, both National Oilwell and Wells are both market leaders in their fields, but they still appear to be undervalued even though they are both more efficient and generating a better return on capital.

The key to successful long-term investing is to buy and hold good companies at great prices, and right now, both National Oilwell and Well Fargo look very attractive.

Many investors are terrified about investing in big banking stocks after the crash, but the sector has one notable stand-out. In a sea of mismanaged and dangerous peers, it rises above as "The Only Big Bank Built to Last." You can uncover the top pick that Warren Buffett loves in The Motley Fool's new report. It's free, so click here to access it now.


Fool contributor Rupert Hargreaves owns shares of National Oilwell Varco. The Motley Fool recommends National Oilwell Varco and Wells Fargo. The Motley Fool owns shares of National Oilwell Varco and Wells Fargo. 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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