The S&P 500 (.SPX) has been hitting record high after record high in December. And it’s gotten more expensive in the process. With earnings-per-share growth slow in 2019, much of the index’s rise this year has come from rising valuations. The S&P 500 now trades for close to 19 times consensus earnings estimates over the next four quarters—well toward the high end of its historical range.
Like any index, the S&P 500 is made up of a collection of stocks. When the market-cap weighted index is hitting new highs, it’s because a majority of its combined market cap is too. It follows that plenty of its components are pricier now than they were at the beginning of the year.
That makes stock picking a harder job. Buying stocks when they’re already expensive means there could be less upside remaining, and gives them further to fall.
Barron’s decided to look for stocks in the index that are participating in the push to new records, but still look cheap relative to the market. They’ve got some momentum yet could still have room for their valuations to rise.
Here are the top 10 stocks with the lowest forward price-to-earnings multiple in the S&P 500 that have hit at least one-year highs this month:
There are a lot of financials on that list. Blame the yield curve. Banks and insurers do a fair amount of their business by borrowing short to lend long. That makes their earnings sensitive to the spread between the yield on their long-term assets—like loans or mortgages—and their short-term liabilities.
After spending several months inverted in 2019—meaning short-term rates exceed long-term rates—the yield curve remains only slightly upward sloping. And investors don’t expect much steepening of the curve next year.
The case for bank stocks like Goldman Sachs (GS), Morgan Stanley (MS), or Citigroup (C) in 2020 is more about their other businesses like in capital markets and wealth management. Cost-cutting could also help earnings. And the sector is certainly cheap relative to the market.
Plus, financials have some momentum now. The Financial Select Sector SPDR ETF (XLF) has jumped 15% since early October, versus just over 10% for the S&P 500.
Taking out the banks and insurers yields a more diverse list of stocks:
United Rentals (URI) is at the top of the list. The equipment-renter’s stock has climbed 63% since the start of 2019, and over 40% since early October alone. It now trades for just 8.3 times its expected earnings over the next year, versus an average of 9.6 times over the past five years.
Heavy equipment usage is particularly economically sensitive. That means United Rentals and its peers can see big swings in their revenues and earnings. Investors won’t assign a high valuation multiple to a company with such major cyclicality in its business. Sometimes cheap stocks are that way for a reason.
United Rentals stock’s recent boom comes thanks to growing hopes of a rebound in construction and manufacturing activity next year. Home builder D.R. Horton’s (DHI) stock has rallied back from a losing 2018 on a similar wave, and also remains below its long-term valuation.
Verizon Communications (VZ) is an immensely profitable company and it does enjoy highly predictable sales. Analysts expect the company to rake in $20.6 billion in net income in 2020. But they don’t see Verizon growing much, with earnings-per-share forecast to increase only about 3% annually in each of the next few years. Investors won’t pay up for growth that might barely beat inflation, even with a 4% dividend yield.
A few health-care names make the cheap new highs list too, including DaVita (DVA), Allergan (AGN), and Bristol-Myers Squibb (BMY). Botox-maker Allergan is set to be acquired by AbbVie (ABBV), and there’s been some skepticism about the merits of that deal.
Bristol-Myers Squibb stock has also been held back by its own merger controversy, although it has recently rocketed back from a rocky start to 2019. Its shares tumbled in early January after it announced that it would be acquiring the biotech firm Celgene. Investors took some time to come around to the deal, which closed last month.
But Bristol-Myers Squibb’s business has kept on ticking, and analysts see several promising drug projects at the newly combined company. They see earnings per share jumping 46% in 2020, then a further 19% in 2021. At 10.7 times forward earnings, the stock trades for less than half of its 21.7 times average valuation over the past five years.
Some cheap stocks deserve to be cheap, while others present opportunities for investors to get in attractive levels. The stocks on these lists may have already left the station, but that doesn’t mean it’s too late for investors to get on board.
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