While bargains are few and far between in a surging market, they can be found. Find out why UPS, GameStop and U.S. Silica made the list.
The bull market just celebrated its ninth birthday. Wall Street has generated huge returns during that period, with the S&P 500 quadrupling, making it the second longest and second greatest bull market in U.S. history. Even the brief correction last month hasn’t seemed to slow the bull’s seemingly unstoppable rise.
This successful run comes with a downside, however. Finding bargains in this market is like searching for a needle in a haystack.
With that in mind, we asked three Motley Fool investors to choose top companies they believed provide great values today. They offered convincing arguments for United Parcel Service, Inc. (NYSE:UPS), GameStop Corp. (NYSE:GME), and U.S. Silica Holdings, Inc. (NYSE:SLCA).
Buying Brown could earn you some green
Rich Smith (UPS): Over the past 10 years, investors have consistently been willing to pay about 24 times trailing earnings to own UPS stock. There have been a couple aberrant years, in which UPS’s P/E ratio shot much higher than 24, but the broader long-term average shows that 24 times earnings is what most investor feel to be the “right” price for UPS stock.
So why is UPS stock selling for less than 19 times earnings today?
In a word, Amazon.com (NASDAQ:AMZN).
Granted, there are other reasons investors aren’t totally enthused about UPS these days. For example, last month UPS warned investors that it plans to spend billions more on building up its infrastructure over the next few years, than it has usually spent in years past. But UPS suffered an even bigger drop in stock price when rumors began rumbling about Amazon’s plans to get into third-party package delivery, potentially turning from a UPS customer into a UPS competitor.
Is there a risk that Amazon will do that? Sure there is. Amazon’s Jeff Bezos famously says that other companies’ profit margins are his opportunity to profit. I wouldn’t be a bit surprised to learn that Amazon, which earns only about $0.02 on every dollar of revenue it collects, covets UPS’s 11.4% operating profit margin. But even so, does that threat make UPS worth 20% less than its average valuation over the past decade?
No mood to play games
Danny Vena (GameStop): The move to e-commerce has left plenty of casualties in its wake, as U.S. shoppers increasingly turn to their keyboards for purchases and abandon shopping malls. GameStop hasn’t been immune to this threat, as digitally downloading games directly from the publisher becomes the rule rather than the exception.
This, combined with a slowing secondary market for games, has resulted in a stock that has languished over the past year, falling 36%, even as the broader market gained 18%.
Yet considering the holiday sales it generated at the end of last year, the stock’s punishment may be overdone. Global same-store sales increased 11.8% overall, up 13.7% in the U.S. and 7.9% in international markets, while worldwide omnichannel sales increased a whopping 21.5%. Total sales hit $2.77 billion, up 10.6% year over year compared with the holiday sales period in 2016.
The stock isn’t without risk, however. GameStop saw an 8.1% year-over-year decline in its higher-margin pre-owned software sales. Revenue from its technology brands segment also suffered, falling 20% from the prior-year period. GameStop expects to take an impairment charge between $350 million and $400 million for its tech brands business, the result of longer upgrade cycles for new mobile devices and changes AT&T Inc. made to its compensation structure.
GameStop’s dividend exceeds 9%, and a yield that high is typically a warning sign for investors, but the company currently pays out only 44% of income to support the dividend. The company just announced its next quarterly dividend of $0.38, which will be paid later this month, so for now, at least, the dividend appears safe. These fears are baked into GameStop’s valuation, as it currently trades at a paltry 4.7 times next year’s earnings.
Even considering its somewhat higher risk profile, I think GameStop is absurdly cheap.
Permian sand is a possible game changer
Maxx Chatsko (U.S. Silica Holdings): Wall Street is cautiously approaching the frack sand industry’s recovery following its overnight collapse in 2015 and 2016, when American companies sharply reduced investment in oil and gas production. That’s the simple explanation for absurdly cheap valuations across the industry, anyway, but it sure doesn’t seem to be reflecting reality.
U.S. Silica Holdings made a strong case for a higher valuation when it announced full-year 2017 earnings. The company reported full-year revenue of $1.24 billion last year, compared with just $559 million in 2016, or a 122% increase. Operating income improved from a loss of $53.5 million to a gain of $168.5 million in that span. The company’s reward for its incredible improvement: a 42% drop in its share price in 2017.
Right now U.S. Silica trades at just 8.8 times forward earnings — a historically cheap valuation. While Wall Street doesn’t want to get stung again from a production pullback, the industry is much more resilient today than it was a few years ago.
Moreover, frack sand companies including U.S. Silica are in the process of opening mines and production facilities within the Permian basin itself. That could reduce frack sand prices by 40% to 50% — with the reductions coming from freight costs currently incurred when shipping sand from as far north as Wisconsin or Canada — and save up to $500,000 per well. In other words, frack sand miners with Permian operations should be able to increase their value to oil-producing customers, while decreasing risks for their own shareholders. The extra security should be worth a premium valuation — once Mr. Market comes to his senses.
