Cheap stocks flirting with new highs

As the market rally has made equities expensive, it's hard to find relatively strong ones at attractive valuations.

By Stock Traders Daily Aug 24, 2012 12:25PM

By Dennis Hobein, Stock Traders Daily


The stock market is not cheap. In fact, in my opinion, it has become pretty expensive, making the task of finding strong stocks with attractive valuations all the more difficult. Furthermore, earnings growth rates are on the decline, making stock-picking an even trickier proposition.


Broadly speaking, and from a pure fundamental perspective, it is a daunting task to try and rectify the reasoning behind the ~10% move higher for the SPDR S&P 500 ETF (SPY) since the beginning of June. Whether it's ongoing expectations of more easing from the Fed, or simply a case of investors having nowhere else reasonably attractive to park money, few people seem to feel that the catalysts behind the rally are legitimate.


But, ultimately, it is not our job as investors and traders to determine whether we believe the market is "right or wrong." Not only could this create undue emotional stress as a trader or investor, but it could also lead to missed opportunities or losses. What we can and should do, though, is look at the facts. 


The fact that I would like to point out today is that the S&P 500 is trading with a price-to-earnings (P/E) ratio of 16.2, above its historical mean (15.5) and median (14.5). If we use the Shiller price-to-earnings ratio -- which is based on average inflation-adjusted earnings from the previous ten years -- the market looks even pricier at 22.6. This is well above the mean of 16.4 and median of 15.8. This might be tolerable if corporate earnings growth rates were on the rise, but they are not. For Q2, earnings-per-share (EPS) growth was a modest 8.4% and revenue growth was nearly non-existent, at +1%.


So, what's my point? My point is, the market's rally has made stocks expensive and finding relatively strong ones that still have low valuations is a challenge. With that said, here are a few that I found:


Healthy gains for Amgen

One stock that looks poised for a break-out is Amgen, Inc. (AMGN), the mature biotech company that focuses on therapeutics to treat infections and inflammatory diseases. In 2012, the stock has moved higher in a "stair-step" fashion and is currently moving in sideways in a tight $82 to $84 trading range. A break above $84 would put the stock at fresh 52-week highs and within shouting distance of all-time highs.


The most recent catalyst for the stock was a blow-out second quarter earnings report in which EPS jumped by 34% year over year to $1.83, easily topping the $1.54 consensus, on revenue growth of 13% to $4.48 billion. The 13% topline growth was its best performance in at least two years.


Adding to the bullish case is its still cheap valuation. At the moment, AMGN has a very reasonable one-year forward P/E ratio of 12.1. The company also pays a dividend that is currently yielding 1.8%.


Tuning into DTV

When I performed this screen, one stock that caught me off-guard a bit was DIRECTV (DTV). The company is coming off uninspiring Q2 results on Aug. 2, missing EPS estimates by four cents, so its strength came as a surprise. Nonetheless, shares made 52-week highs on Aug. 13 and are currently trading just below those levels.


There are a couple likely explanations for its recent strength. For instance, DTV is making good progress in what it feels is its greatest growth opportunity -- Latin America. In Q2, Latin America revenues grew by 20%, but excluding FX impact, revenue was up an impressive 30%. Brazil has been a standout for DTV as its HD subscriber base grew by more than 85% with more than two-thirds of this coming from upgrades from existing clients.

Another positive for the stock is its agreement with Viacom on July 20, which removed on overhang. Specifically, it announced that all 26 Viacom networks -- including Comedy Central, MTV, Nickelodeon, etc -- will return to DTV's lineup immediately.


Finally, DTV still looks quite cheap with the stock trading with a one-year forward P/E ratio of just under 10 and trailing price-to-sales ratio of 1.1.


Solid technicals, and fundamentals to match

Skyworks Solutions Inc (SWKS) is a stock that has a very attractive mix of solid fundamentals and technicals. After surging higher from January to April, shares have put in a constructive consolidative pattern over the past few months. Today, however, the stock is threatening to bust through the upper-end of this trading range, propelling it to new 52-week highs.


What also stands out about SWKS is that it has the fundamentals to match. For some background, the company develops semiconductors, power amplifiers, and other components for smartphones (yes, including iPhones) and mobile devices. Not a bad end market. It also has established a track record of topping consensus expectations, beating the Street's top and bottom line estimates for the past five quarters.


Its growth rates aren't spectacular with recent revenue growth in the high single and mid-teen levels recently. For FY13, analysts are projecting EPS and revenue growth of 15% and 14%, respectively -- again, nothing overly exciting. But, with a one-year forward P/E ratio of 14, its PEG falls below 1, and with cash and equivalents of $1.71 a share and no debt, its valuation looks enticing.


Popping the Cork on STZ

The last stock I'd like to highlight is Constellation Brands (STZ), the producer and marketer of alcoholic beverages. The stock rocketed higher in late June, and has continued to rally, after it announced its agreement to purchase the 50% of the Crown Imports (Modelo, Corona, Negra) venture that it currently does not own. The transaction has been heralded by analysts and investors alike, as the price tag for the acquisition was viewed as attractive.


Despite its 66% surge higher since mid-June, the stock still has a low one-year forward P/E of 11.9.


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