S&P 500 companies are poised to deliver a 22% gain in earnings this year, leaving the benchmark index trading at 15 times forward earnings. That multiple is low compared with past years.
Where do some of the best values lie? Barron’s offers 10 favorite stocks for the coming 12 months—the ninth year we have done so.
Our list tilts toward more economically sensitive issues and value. Value managers see some of the best opportunities in years, and most of our stock picks trade for 10 times forward earnings or less.
The Barron’s picks include mostly familiar companies: Alphabet , Apple , Bank of America , BlackRock , Caterpillar , Chevron , Daimler , and Delta Air Lines .
Rounding out the list are Energy Transfer , a leading energy pipeline operator, and Toll Brothers . Alphabet and Delta are holdover selections from last year.
Admittedly, our record has been mixed. The 2018 picks returned negative 2.2%, four percentage points behind the S&P 500, but the 2017 selections topped the index by seven percentage points.
AlphabetThe parent of Google remains one of the best megacap growth stories, thanks to a dominant and lucrative search-advertising platform that is unlikely to be impaired by regulatory action from Washington.
The company (ticker: GOOG), which also owns YouTube, Android, and a cloud-computing business, has defied the law of large numbers. It continues to record quarterly revenue growth of 20% or more, despite a large annual sales base of more than $100 billion.
The stock, now about $1,062, looks reasonably priced at 23 times projected 2019 earnings of $47 a share. The price/earnings ratio overstates Alphabet’s valuation because the company sits on $102 billion of net cash, or about $145 a share. And Alphabet is losing about $3 a share annually in its Other Bets businesses, which includes Waymo, the leader in autonomous vehicle technology. The losses in Other Bets do not capture the value in the segment. Waymo, which plans to start commercial service later this year, could be worth $50 billion or more, analysts estimate.
RBC Capital Markets analyst Mark Mahaney calls Alphabet an “internet staple” supplanting traditional staples like Coca-Cola (KO) and Procter & Gamble (PG) that have been laggards in the past decade. He and other bullish analysts value the company at about $1,400.
AppleHow much worse does it get for Apple stock? Probably not a lot.
The shares (AAPL) are down more than 20%, to $171, in the wake of a disappointing earnings report for the September quarter. Wall Street has reacted to weak guidance for the current quarter, production cutbacks at iPhone suppliers, and the company’s move to stop disclosing unit sales of iPhone, iPad, and Mac devices—an indication that critical iPhone sales may be headed lower.
The stock is finding support because its valuation looks attractive and there appears to be limited risk to current-year earnings even if one assumes a 5% to 10% decline in iPhone sales. Apple now trades for 13 times projected earnings of $13.30 a share in its fiscal year ending in September. The P/E ratio is about 11 when Apple’s $25 a share in net cash is stripped out.
“It is difficult to see earnings declining below fiscal-year 2018 levels of $11.91, due to strong year-over-year contributions from services, wearables, and buybacks,” Bernstein analyst Toni Sacconaghi wrote recently. And Piper Jaffray analyst Michael Olson wrote last week that “international iPhone weakness and disappointment over future unit disclosure are largely baked into the stock.” He maintained an Overweight rating but cut his price target to $222 from $250.
Apple’s high-margin services revenues—including App Store, Apple Music, and Apple Care—rose 24% in the latest year, to $37 billion, and are on track to hit $50 billion by 2020. In Barron’s cover story last week, we suggested that the company could package some of its services, or iPhones and services, into an attractive monthly subscription service.
One big buyer of the stock in the coming year will be Apple itself. It has the world’s largest repurchase program and is expected to buy back about $70 billion of shares in the current fiscal year, or 8% of those outstanding. Investors also get a 1.8% yield.
Bank of AmericaLarge-bank valuations look enticing after a sharp fourth-quarter selloff driven by concerns over the health of the economy and the financial markets.
The worries look overdone because the Big Six—Bank of America (BAC), Citigroup (C), Goldman Sachs (GS), JPMorgan Chase (JPM), Morgan Stanley (MS), and Wells Fargo (WFC)—should be able to increase earnings even if economic growth slows and markets remain rocky.
Bank of America is a standout thanks to a top U.S. consumer banking franchise, a lucrative wealth management business anchored by Merrill Lynch, and an underappreciated management team led by CEO Brian Moynihan.
Its shares, at $25, are off 16% so far this quarter and trade for only 10 times projected 2018 earnings of $2.58 a share and less than nine times next year’s expected profits of $2.87 a share.
And the bank has one of the most aggressive capital return plans among its peers. It could return almost 10% of its current market value to investors in stock buybacks and dividends in the year ending in June 2019, mostly through repurchases. The shares yield 2.5%.
“Bank of America is getting the job done,” says Mike Mayo, the banking analyst at Wells Fargo. A bullish Mayo sees strong earnings gains in the coming years despite the possibility of a weakening economy as the bank continues to hold expense growth below revenue gains.
“To us, it’s not a close call about higher earnings,” he says. “The question is only the magnitude.” Mayo sees $4 a share in potential earnings in 2022, up more than 50% from the current-year projection. He carries an Outperform rating and a $37 price target.
Warren Buffett is a Bank of America believer, as Berkshire Hathaway added $5 billion of the stock in the third quarter, at above the current market price, to a holding now worth $22 billion. That put Berkshire near an effective 10% ownership cap.
BlackRockAsset managers are having a terrible 2018, with many down 40% or more. Wall Street is worried that the active equity management business is dying.
Many of the stocks look cheap with single-digit P/E ratios, but it probably pays to stick with quality in industry leader BlackRock (BLK) . Its shares, off 25% this year, to $387, look appealing, trading for 14 times projected 2018 earnings of about $28 a share, and yielding 3.2%.
BlackRock is well positioned because it owns iShares, the top exchange-traded fund platform with more than $1.8 trillion in assets. BlackRock operates a growing and lucrative alternative-asset business, is a leader in active bond management, and has developed a profitable risk-management platform called Aladdin used by investment managers.
Investors reacted negatively to a sharp slowdown in BlackRock’s net inflows in the third quarter and nervous equity markets globally. Next year’s earnings could be little changed from this year if markets don’t rally.
When stocks advance, BlackRock should benefit. KBW analyst Robert Lee is bullish on BlackRock’s long-term prospects thanks to “unmatched product breadth, technological capabilities, distribution footprint, scale, and demonstrated ability to generate operating leverage.”
BlackRock’s management team, led by CEO Larry Fink, just may be the industry’s best. Lee carries an Outperform rating and price target of $485.
CaterpillarShares of Caterpillar (CAT), the leading U.S. machinery maker, have slumped 20%, to $126, this year despite reporting what’s likely to be a 70% rise in earnings.
The decline reflects the company’s status as a prime play on the global industrial economy. As Wall Street worries about the outlook for growth, Caterpillar stock has been hit. The shares, as Barron’s noted last week, look inexpensive. They now trade for 10 times projected 2019 earnings of $12.87 and yield 2.7%. The forward P/E has dropped from about 16 at the start of 2018.
Caterpillar’s three main divisions—construction, resource industries, and energy—are all reporting higher profits, and mining in particular is benefiting from pent-up demand after many years of slow sales. CEO Jim Umpleby has emphasized “profitable growth,” and the company is aiming to do that with 1% to 4% price increases at the start of 2019.
J.P. Morgan analyst Ann Duignan sees a “prolonged up-cycle” for Caterpillar and has an Overweight rating and $188 price target. A trade deal between the U.S. and China would almost certainly boost the stock.
ChevronIt’s a standout among major integrated energy companies because of its dividend security, balance sheet, and production outlook.
Chevron (CVX) has finished a major capital spending program, highlighted by the completion of two large liquefied natural-gas facilities in Australia, and it is producing a lot of free cash flow. The company has one of the best positions in the prolific and desirable Permian Basin of Texas and New Mexico.
Shares of Chevron, which are off 7% this year, to $116, trade for 13 times projected earnings of $9 a share and yield 3.9%. Its biggest rival, Exxon Mobil (XOM), was highlighted by Barron’s favorably in a cover story earlier this year. Since then, Exxon has bested Chevron in the stock market, and Chevron’s relative appeal has increased.
With a 30% drop in crude-oil prices in the past two months, investors are again worried about dividend security, and Chevron stacks up well. The company aims to cover its dividend even if Brent crude, the international benchmark, falls to $50 a barrel from its current $60. Analysts expect Chevron to make small annual increases in its dividend while continuing a modest share repurchase program that it started in the third quarter.
“Chevron has an attractive global asset base with the potential for solid production growth and best-in-class cash margins versus global integrated peers,” J.P. Morgan analyst Phil Gresh wrote last week. He has an Overweight rating and a price target of $144.
The integrated oils have lagged behind the S&P 500 for six of the past seven years, and Chevron shares have barely appreciated since 2011. That could change in 2019, especially if oil prices rally.
DaimlerIn a rocky year for major auto stocks, Daimler (DAI.Germany) has been the worst performer with a decline of 33%.
The maker of Mercedes vehicles has a rock-bottom valuation based on sales and profits. Its European shares, now at 47 euros, trade for just six times projected 2018 earnings of €7.67 and at a similarly low multiple on estimated 2019 earnings of €8.30. Daimler’s U.S.-listed shares (DDAIF) change hands at $54.
Daimler is the No. 1 luxury-car maker and a leading producer of heavy-duty trucks, including Freightliner in North America. The company’s variable annual dividend, payable in early 2019, could fall from the €3.65 paid this year, reflecting lower profits. But analysts expect the payout to be at least €3. That would mean a 6%-plus yield—before withholding taxes for U.S. investors.
Highlighting the glaring disparity among auto makers, Daimler is valued at $57 billion, compared with Tesla (TSLA) at $63 billion, even though its annual sales are about 10 times Tesla. Daimler should earn $10 billion this year, against nothing for Tesla. And Daimler’s core automotive business has $15 billion of net cash and equivalents against $9 billion of net debt at Tesla.
Daimler shares have been hit by weak third-quarter profits that reflected disappointing sales at Mercedes and the cost of compliance with diesel regulations in Europe. The company, wrote Morgan Stanley analyst Harald Hendriske last month, is “very cheap” with “brand value” and a generous dividend.
Still, investors are shunning Daimler, fearful that it is too late in the economic cycle to buy auto stocks. One knock against the stock is that there are no likely catalysts. An ultracheap stock, however, can create its own catalyst.
Delta Air LinesA recent selloff in Delta Air Lines (DAL) leaves the best-managed U.S. airline trading for just eight times forward earnings.
Delta’s recent 2019 guidance calling for $6 to $7 a share in earnings disappointed investors because the midpoint was below the consensus of $6.70 a share. Delta shares fell almost 5% following the news, to $53.59, leaving them 13% below their late-November high of $61.
Delta has the best balance sheet among the mainline U.S. carriers and the highest margins, a result of initiatives to get travelers to pay more for extra legroom in coach, bag fees, and a highly efficient maintenance operation. Delta now gets more than half of its revenue from outside the economy part of the cabin.
The company plans $4.5 billion in capital expenditures in 2019, mostly for new planes as it seeks to replace 35% of its fleet by 2023. It is also spending $3 billion to lead an upgrade of New York’s decrepit LaGuardia Airport. And it aims to return $2.5 billion in cash to shareholders in 2019, including a 2.6% dividend yield, the highest among its peers.
In initiating coverage of Delta with an Outperform rating and $71 price target, Credit Suisse analyst Jose Calado recently said Delta has an “excellent balance of strong execution, efficient and disciplined capacity growth, and a pipeline of initiatives to sustain its revenue and margin premium to network peers,” among other attributes.
Buffett is a fan of the industry, as Berkshire Hathaway holds almost 10% of Delta—and a similar amount of other major airlines. There remains speculation that Berkshire would be happy to buy an entire airline. If it does, Delta and Southwest Air are the most likely candidates.
Energy TransferMaster limited partnerships in the U.S. have been getting their act together by setting sustainable distributions (equivalent to dividends) rather than maximizing them, and by ending investor-unfriendly structures that hurt MLP holders and made institutions reluctant to buy.
The moves have had limited success because the sector is off 11% this year. Investors view MLPs as energy proxies, and oil prices are down to $51 a barrel from $76. Industry profits, however, have little exposure to commodity prices.
Reflecting the current disfavor, Energy Transfer (ET), one of the country’s largest energy pipeline operators, trades around $14. The units looks appealing with an 8.4% distribution yield that is well covered by the company’s cash flow. Energy Transfer cleaned up a complex structure in October by combining its general-partner and limited-partner units into a single security—a move that has long been sought on Wall Street.
Chairman and top shareholder Kelcy Warren thinks the units are cheap. He bought three million units in the open market last month at an average of more than $15—above the current price.
Energy Transfer trades at a discount to peers at about nine times projected 2019 earnings before interest, taxes, depreciation, and amortization, or Ebitda. At a peer multiple, its stock could trade around $25, according to Morgan Stanley analyst Tom Abrams.
The company is prudently emphasizing debt reduction over higher distribution or unit buybacks, with its $3 billion annual excess cash flow above what’s needed for distributions. By the middle of next year, the company could be in a position to lift the payout, according to Morgan Stanley.
Toll BrothersWall Street is valuing Toll Brothers (TOL) and its home-building peers as if the housing market is heading off a cliff.
Toll shares, at about $32, are off 32% so far this year and trade around book value, underscoring the pessimism around Toll.
If its earnings were collapsing, such a valuation would be understandable, but the luxury home builder remains highly profitable. Earnings are expected to be little changed in its current fiscal year ending in October from the $4.85 it earned last year.
The stock has been helped of late by a drop in mortgage rates. And the company is expected to continue repurchasing stock after buying back 8% of its shares in its latest fiscal year. The dividend yield is 1.4%.
“The business is not in crisis mode,” wrote Wells Fargo Securities analyst Stephen East, relaying management’s reassuring tone on Toll’s recent earnings conference call. East is among a small group of analysts still bullish on Toll. He carries an Outperform rating and $45 price target. •
Write to Andrew Bary at email@example.com