As market meltdowns go, this one, at a glance, has produced meager discounts. Shares had soared just before they began sliding two weeks ago. The net result is a Standard & Poor's 500 index (.SPX) that's down 2% year to date.
The real action, however, has been in corporate earnings. Wall Street's 2018 consensus has climbed 6% since the end of December. In their quarterly reports, companies have been beating both earnings and revenue estimates at rates that are well above average.
We ran a search for stocks that have fallen while estimates for their earnings have risen, and the names that popped up are worth consideration by bargain hunters. Below are seven, including Delta Air Lines (DAL), Apple (AAPL), and Starbucks (SBUX).
Of course, before buying shares now investors should consider whether recent market turbulence is the start of something more sinister. There are a few comforting signs. Downturns of 5% to 15% are common, occurring about once a year on average, according to Jason Pride, director of investment strategy at Glenmede. Historically, the market has often pulled through such corrections to post positive returns for the year, particularly during economic expansions.
If there is a recession on the horizon, it is presenting few clues. Jonathan Golub, chief U.S. equity strategist at Credit Suisse, tracks seven indicators that can foretell a recession, including credit performance, the shape of the yield curve, and the health of the labor and housing markets. All seven recently pointed to further expansion.
David Kostin, the chief U.S. equity strategist at Goldman Sachs, calls the stock market expensive even after its recent decline. But he predicts 14% corporate earnings growth this year, including 5% from tax cuts, and is sticking with his S&P 500 target of 2850 by year's end, implying 9% upside from recent levels.
Among our survivors are a pair of utilities, NextEra Energy (NEE) and American Electric Power (AEP). Those are unlikely candidates for bargain-hunting this late into an economic expansion, when interest rates have begun to rise. Higher yields on bonds can make dividend-paying shares like utilities less attractive by comparison. But Morgan Stanley's equity strategists upgraded the utility sector this past week, calling it the one group where the risk of rising rates has already been priced in, and one that is well-positioned if rates rise less quickly than expected.
NextEra has long traded at a premium to the sector because of its attractive growth profile. It combines a regulated power distributor, Florida Power & Light, with NEER, the largest producer of solar and wind power. By next year, renewables are expected to contribute 43% of earnings per share. NextEra's strong balance sheet makes it likely to benefit from an infrastructure push, where regulators are permitting attractive returns for companies willing to invest in power grids, and from industry consolidation.
In recent years, NextEra failed to close attempted bids for utilities in Hawaii and Texas after pushback from regulators in those states. UBS analyst Daniel Ford, who launched coverage of utilities on Feb. 1 with a Buy rating on NextEra, views it as likely to keep trying, and to succeed. His price target of $177 implies 20% upside from recent levels. The dividend yield is 2.7%.
Ford also likes American Electric Power, which has operations in 11 states, most of them in the east. It is betting big on wind with a $4.5 billion Oklahoma project called Wind Catcher, which, if it secures key state approvals in the first half of this year, could lead to a rise in the stock's valuation. For now, Ford doesn't include Wind Catcher in his price target of $76 for the shares, suggesting 17% upside. Dividend yield: 3.8%.
5 picks for a value stock rebound
Travel-reward mavens say the SkyMiles program operated by Delta is stingier than programs offered by other airlines, based on the value miles hold when securing free flights. That's a good sign for shareholders, however. Delta regularly ranks near the top of its peer group on measures of reliability and customer satisfaction, so it doesn't have to give away the store on rewards. The airline group sold off in late January after United Continental Holdings (UAL) said it would increase capacity by 4% to 6% through 2020.
Historically, capacity growth in good years has led to price wars. But consolidation has left the industry with four big players today, down from seven in 2000, making price wars less likely, and operating costs are much lower now than back then. Delta is expected to grow its earnings per share by 14% a year, compounded, over the next three years.
Starbucks beat quarterly earnings estimates on Jan. 26 but missed on revenue, and same-store sales grew just 2%, short of the 3% Wall Street was looking for. Shares slid in response. For good news, look east. Starbucks recently bought out its joint venture in East China and by next year, the country will account for 10% of sales for Starbucks. Same-store sales growth in China is higher than in the U.S. and management aims to add thousands of new stores there. According to Cowen analyst Andrew Charles, that provides increased confidence that Starbucks will be able to grow earnings per share by more than 12% annually for years to come.
Barron's recommended Apple shares in a cover story last year ("Apple to Hit $1 Trillion in Market Value in 2018," Dec. 23). Earnings estimates for the fiscal year through September have pushed 8% higher since then, but shares are lower on concerns that iPhone X demand is slowing. High customer retention rates suggest that any shortfall in iPhone X orders could lead to healthy sales for the next model, expected in the fall. Meanwhile, services revenue was up 18% last quarter. Management said on Feb. 1 it will bring company cash in line with debt over time. That could result in $125 billion of fresh spending on stock buybacks, dividends, or both.
Verizon (VZ) will get a big benefit from a corporate tax cut this year. Earnings are projected to grow 20%, of which 16 percentage points could come from tax cuts. Don't expect a dividend hike right away. Shares already yield 4.7%, and Verizon will probably spend its added cash flow to help bring down leverage remaining from its massive 2014 deal with Vodafone Group (VOD) to buy out its Verizon Wireless stake. Beyond this year, Wall Street predicts only single-digit earnings growth, but shares are priced for low expectations at 11 times forward earnings estimates, a 35% discount to the S&P 500.
D.R. Horton (DHI) has had the biggest haircut on our list, with its forward price/earnings ratio falling to 11.3 from 15.9. Investors are worried a rise in mortgage rates could cut into housing demand. Meanwhile, the biggest constraint to housing sales in recent months has been a lack of supply, not demand. That bodes well for Horton, the nation's largest home builder, with a focus on entry-level and move-up buyers. It takes a conservative approach marked by small land deals and quick turnover into finished houses, which helps limit risk. The P/E looks especially low considering that Wall Street expects earnings per share to rise at a double-digit pace in coming years.
Mortgage rates might indeed rise from here. But higher rates are typically a response to inflation. A little inflation is a sign of a healthy economy — something home builders will be happy to see.
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