If you could only invest in one stock across different themes, which should it be? We’ll be covering all the strategies here from value stock investing to growth, tech, index funds and by the end of the series, you’ll have a portfolio of the very best stocks to buy! Make sure you join the community, tap that subscribe button so you don’t miss any of these because it’s going to be a complete portfolio of the best stocks.
In this video, I’ll show you what I’m looking for in value stocks, four simple factors to watch for so you know you’re investing in the very best out there. I’ll show you how to use this in a portfolio, how to combine the very best stock from different strategies into a high-return portfolio. I’ll then highlight four value stocks to watch, four that just nearly missed being the top pick and then reveal that best value stock for your money, one I think has as much as 64% upside potential!
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First though, I also want to personally invite you to get the Weekly Bow Tie, our free weekly newsletter with all the stock market news, strategies and trends you need to know. Each week, before the market opens, I’ll show you what I’m watching and the stocks that could highlight the week. It’s all totally free, just something I like to do for you out there in the community so look for the sign-up link below.
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Nation, it’s been a tough year for investors but that doesn’t mean you can’t make money. The idea that investors lose money in a stock crash is a myth. You see here the return on the S&P 500, that broad market index, along with the 11 sectors of the economy and you see the S&P has fallen nearly 12% over the last year. So yes, if you just invested in the index fund, across the entire market you lost 12% of your money.
But you see the individual stocks on the right and 150 of those stocks, almost one-in-three, are up for the year and 42 of those stocks are posting gains of 20% and more! In fact, the top 20 stocks in the index contributed more to its gains than the remaining 480 stocks combined!
Nation, I buy index funds and am just fine getting the market returns on part of my portfolio but you NEED to know how to pick the best stocks to buy! Every investor needs a basic understanding of the factors that will find you those stocks that are going to outperform.
Now I want to get into our list of those value stocks to watch, cheap stocks that nearly got that top spot but stick around because I’ll show you what to look for in these next.
First up, The Mosaic Company, ticker MOS, down 43% from its high just four months ago and a great play on the future of agriculture.
Mosaic is a leader in crop nutrients phosphate and potash and ramping up its low-cost potash fields to really drive profitability. Fertilizers are a commodity product, the price doesn’t leave room for differentiation, so management has to be laser-focused on costs and efficiency. The world is expected to reach eight billion people this year though and that means increasing food demand that will drive demand for fertilizers.
Mosaic trades for just 6.4-times on a price-to-earnings basis versus an average of 8-times for stocks in the basic materials sector and the company traded as high as 8.3-times just last year.
The ROE and operating margin, and I’ll explain what these are and why they’re so important when looking for value stocks in a minute, but both of these are around 25% for Mosaic.
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Now that’s higher than the return on equity and op margin for rival Nutrien which has an ROE of 19% and a margin of 21% but it is quite a bit lower than the metrics for another rival, CF Industries. The tradeoff is that shares of CF are priced so much higher on that PE basis, at 11-times earnings, that Mosaic is still the better value stock. But there is a tradeoff when looking at these numbers so stick around to hear the explanation on this later.
The company’s debt is 39% of equity, again I’ll go over this in a minute, but it’s not high compared to Nutrien’s 50% debt-to-equity ratio and 54% for CF Industries. I actually think Mosaic could use a little more debt to leverage its returns higher without getting into trouble.
Analysts have an average target price of $74 per share, up 65% from here and even the low target is 26% higher, so a lot of confidence from the analyst community and the shares pay a 1.3% dividend while you wait.
We’ve still got three more stocks to watch and that number-one best value stock to buy but I want to get your input on this as well. Watch through and let me know if you think one of these runner-up stocks should be the top pick or if you have a different value stock you like. Scroll down and let me know in the comments, what value stocks are you watching?
Next on our list of value stocks, Tyson Foods, ticker TSN, the largest U.S. processor of chicken and beef along with pork and protein-based snacks.
I highlighted Tyson a few months ago in a video on companies with the best tools to fight inflation and I really like this one on that trend in growing food demand. Tyson has been able to grow its operating margin to 12% over the past five years from just 2% before 2017 and is really well run.
Shares trade for just 7.5-times on a price-to-earnings basis, less than half the average multiple of 22-times earnings for companies in Consumer Staples and a four-year low for Tyson. The average price multiple has been 11.7-times over the past five years, so this stock is trading at a 36% discount.
The operating margin of 12% and ROE at 23% are both well above industry peers like Hormel and Conagra Brands and the debt-to-equity ratio of 43% is very low for a food processor. These companies have relatively stable cash flows as a staple product so they can handle higher debt loads and not run into cash flow problems. For example, Conagra has a debt-to-equity ratio over 100%.
There’s just four analyst targets here but the average is for $93 a share, about 12% upside and 19% upside to the highest target, along with that 2%-plus dividend yield.
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We’ll get right back to our list but all you out there in the Nation know, I’m not just about dropping a list of stocks in your lap and saying, go buy these. I want you to be a better investor, to be able to make your own investments so I want to show you the factors I looked for when picking these best value stocks to buy.
First though, why even care about value stocks? This graph shows the Vanguard Growth Fund, ticker VUG, in red has absolutely demolished the Vanguard Value Fund, ticker VTV, in green over the last five years. In fact, growth stocks beat the overall market, the S&P 500 in purple, by more than 12% and more than doubled the return on value stocks over the period.
But value stocks do have a history of beating growth. This chart goes back to 1983 with the areas in blue where value beat growth and those in orange where growth stocks dominated. And you can see, that market dominance by either can last a very long time. After the tech bubble burst in 2000, it was value stocks all the way for eight years while growth stocks have led for the past decade.
And it looks like that leadership has shifted again. Growth stocks started to break down in March of last year and since the beginning of this year, it’s been value all the way. That value stocks ETF is up 32% over the last two years, 12% better than the market and beating growth stocks by more than 24%!
But more importantly, and why I’m starting the series of best stocks with this one is that, if we continue to see market weakness, if stocks overall keep falling then value stocks are going to fall less than others. These stocks are already cheap on a valuation basis, they already have the fundamentals that make them a good buy. That acts as a floor of support so when the bottom drops out of the market, these value stocks have a parachute that slows the descent!
I know you want to get back to that list but I do want to show you what makes for a good value stock.
First is the classic value metric, the price-to-earnings ratio, the price of the shares divided by the company’s earnings over the last year. And you know, I like the price-to-sales ratio better here because it’s less easily manipulated by management but I want to keep this screener simple and I’ll link to a video in the description detailing why you can’t always trust the numbers you see companies reporting.
More important than looking for a cheap stock with a low PE ratio of like 10 or less, you want to find stocks with a PE ratio below competitors in their industry. This is something we’ve talked about before, that you need to be comparing stocks against similar companies. For example, shares of Alcoa trade for a price of 11.4-times its earnings over the last year, looking relatively cheaper against shares of Meta Platforms at 12.4-times on a PE basis.
The problem though, and this is why I listed the stock sectors and the average PE ratio of stocks in each sector, is that what might be cheap in one sector is expensive in another. If you only ever invested in stocks with a PE ratio of 10 or less then you’d end up with a portfolio almost entirely in Basic Materials, Energy and Financial stocks because the PE ratios just tend to be lower in those three sectors. But comparing PE ratios against other companies in the same sector or against the sector average will help you find value stocks across the market.
Look again and you see that Meta is actually the value stock among the two. Shares of Alcoa trade for 40% more than the average PE in its sector while shares of Meta are priced at a steep discount.
Now a low PE ratio alone doesn’t make a stock a good investment. In fact, many low PE ratio stocks are cheap for a reason and that’s why we look at these other factors.
You can find all these ratios free on Yahoo Finance under the statistics tab for any stock. I like to double-check the numbers and I’ll show you how to do that in a video linked in the description but here I just want to give you a quick overview.
If you scroll all the way down, you’ll find the total debt-to-equity ratio…probably the single most important measure for a value stock. Remember, most value stocks are cheap for a reason and 99% of the time it’s because the company has an immense amount of debt that is limiting financial flexibility and could even force a bankruptcy so this is the first place you want to check.
The debt-to-equity here is a percentage so this is 11.9% and that’s the long-term debt the company owes divided by the amount of stockholders’ equity. Here again you want to be comparing this against similar stocks because high debt in one sector might be normal and totally workable in another but generally the lower the better.
These other two measures, the operating margin and the return on equity, are great metrics for company profitability and management effectiveness. All you in the Nation know, the operating margin is probably my favorite metric…the core operational profitability of the company. It’s how much in operating income management can squeeze out of every dollar in sales. The return on equity is the company’s net earnings divided by shareholders’ equity, so that bottom-line measure for what kind of a return are shareholders getting on their investment.
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When you’re looking for value stocks, start with the PE ratio to find those below the industry or sector average, then you look at these other metrics. Which of those cheap stocks have a lower debt-to-equity ratio and which are run better with higher operating margins and ROEs? That’s how you find the cheap stocks that have real value under them.
Next on our value stock list, American International Group, ticker AIG, one of the largest insurance and financial services firms and sporting a 2.5% dividend.
AIG got destroyed in the financial crisis but has built itself back up and insurers typically hold up very well in a recession. Besides the valuation measures we’ll look at, I like this one on the higher rate environment as well. You see, insurers need to invest all those premiums they collect but have to invest it in ultra-safe bonds and other investments because they can’t take the risk. When they need the cash to pay claims, they can’t wait for stocks to rebound. Rates on bonds and other yield investments have been absolute dog shit for the last five years but are now starting higher which will mean higher profitability for the insurers.
AIG has a PE ratio of just 4.5-times, less than half the average for companies in the financials sector. The operating margin of 23% and ROE of 17.5% is above the industry average and peers like Hartford Financial which books 15% for both metrics. Debt to equity is tricky for financial firms because of how they report liabilities, really just their deposits for backs or premiums for insurance companies, but here 51% isn’t too high considering the cash flow stability.
Analysts have an average target of $71 a share, almost 38% upside from here and again, here another deep value stock where even the lowest target is above the current share price.
This next value stock, Freeport McMoRan, ticker FCX, nearly made the top stock pick and is down 49% from this year’s high on the falling price of copper.
Despite lower metals prices, Freeport is doing everything right from increased production to higher operating margins and even decreasing debt. Copper and some of the industrial metals the company mines are going to sell off in a recession but we could be seeing a serious shortage of copper and higher prices in the near future. Electric vehicles alone use more than three-times the amount of copper compared to traditional cars. Copper is also a major component of renewable energy delivery along with construction.
After the selloff, shares are trading in line with the sector average around 8-times on a PE basis but well under peers like Newmont with its 47-times PE and even Southern Copper, which I also like, but trading for 11.6-times earnings. At eight-times, FCX is trading at half its valuation of last year.
The operating margin of 39% and ROE of 29% is below that of Southern Copper with an ROE of 43% and 55% margin but way above Newmont and still a very well run company.
Debt to equity of 40% is just under the industry average and easily manageable. For example, Southern Copper has a debt to equity of 90% and still easily covers its interest expense.
Analysts have an average target price of almost $45 per share which would be 66% upside from here and a 142% upside to the highest target.
I’m revealing that top value stock next, the one value stock I think every investor should own, but I also wanted to show you how to use this series of videos…how to create a portfolio of the best stocks to buy.
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And here I’ll use the core-satellite strategy, easily my favorite way to invest and something we’ve talked about before on the channel. The strategy is called core-satellite because you have a core of investments that make up between 50 to 60 percent of your portfolio. These are in exchange traded funds, ETFs. For example, you might have 15% of your money in the Vanguard Real Estate Fund, ticker VNQ, which holds shares of companies in the real estate sector. Maybe you hold another 10% of your money in the Vanguard Long-Term Bond ETF, ticker BLV, which invests in hundreds of bonds and pays a 3.3% dividend. Finally, maybe you hold another 50% of your portfolio in a few funds like the ProShares S&P 500 Dividend Aristocrats ETF, ticker NOBL, a fund of the best dividend stocks in the market.
So by investing most of your money, that core fifty or sixty percent in three to five funds, you get instant diversification across stocks, bonds and real estate. You money is spread out across hundreds of stocks, you’ve got bonds in the bond fund and cash flow from the real estate fund.
Then with that satellite portion of your portfolio, the remaining 40% or so of your money, you invest in individual companies that you really think could produce those higher returns, the best value stocks, the best growth stocks, all the stocks I’ll be showing you in this series..
The beauty of this core-satellite strategy though is that because you only have that 40% of your money to invest in these individual stocks, and say you invest three- to five-percent of it in each stock, that means you’re only picking maybe eight to ten individual stocks. So instead of having to find 20 or 30 stocks, doing the hours of analysis on each one and keeping up-to-date on each one, you only need a handful of winners, the very best stocks in each theme like value, tech and dividends.
And the best value stock, one I own in my portfolio as well as our Bow Tie Nation portfolio, shares of Citigroup, ticker C, on its 5.5-times PE ratio and a dividend yield over four percent!
Now all you in the Nation know I’ve been following the banks this year. The net interest margin, that’s the difference between the rate banks pay on savings accounts and the rate they collect when they lend out the money, the key profitability for banks just fell off a cliff over the last few years but is now heading higher.
In fact, Mike Mayo, managing director at Wells Fargo is estimating that the profitability from that net interest margin over the next two years could be the highest it’s been since the 80s!
The Fed just published its stress tests on the banks late June and found the industry capital requirements so strong that analysts expect the largest U.S. banks to return more than $80 billion to shareholders in dividends and share repurchases this year.
Valuation on Citigroup is just 5.5-times on that price-to-earnings basis and the stock goes for just half its book value. The average PE for financials is 11.3-times and most banks trade for around book value. For example, Bank of America trades for 1.07 times book and JP Morgan is valued at 1.3-times book value. Citigroup is trading at a 37% discount to its five-year average price-to-book value.
Profitability is a little lower with a 9% ROE and 31% operating margin, slightly below the industry average. Bank of America has an 11.5% ROE and an operating margin of 35% but the valuation is just too cheap for Citigroup and that net interest margin is going to be the rising tide that lifts all boats.
Analyst targets only put the shares about 26% higher over the next year to $59 each but I think it’s stronger than that, especially over the next three years. It’s one of my favorite long-term stocks along with the dividend and I like it all the way back up to the peak of $74 a share for a 64% upside return!
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