The prevailing sentiment among investors is that the stock market is currently overpriced, with a price-to-earnings ratio of around 24, significantly higher than the historical average of 15. This perception, while generally accurate, overlooks pockets of value that still exist. The key to uncovering these undervalued opportunities lies in venturing beyond the popular technology sector, home to the “Magnificent Seven,” and exploring sectors that have fallen out of favor. These overlooked sectors, including energy, banking, and homebuilding, offer a selection of companies trading at attractive valuations. As of late December 2024, dozens of large-cap companies boasted price-to-earnings ratios below 15, with a significant portion maintaining healthy balance sheets with low to moderate debt levels.
Within the energy sector, ConocoPhillips (COP), a major oil and gas producer with global operations, presents a compelling investment case. While smaller than giants like Exxon and Chevron, ConocoPhillips demonstrates robust profitability, with a return on equity of 20% in the recent four quarters. Furthermore, the company offers an attractive dividend yield exceeding 3%, leaving room for potential increases. Trading at less than 12 times earnings, ConocoPhillips represents a value proposition in the energy landscape. Similarly, Paccar (PCAR), a dominant player in the heavy-duty truck manufacturing industry with a significant market share, exhibits impressive financial performance. Consistently exceeding a 20% return on equity, Paccar has demonstrated its ability to generate strong profits. Despite its stock price doubling in the past five years, the company still trades at a reasonable valuation of under 12 times earnings.
Schlumberger (SLB), a leading oilfield services provider, offers another investment opportunity within the energy sector. Despite a significant stock price decline in 2024, the company’s prospects are tied to the future price of oil. With oil prices historically fluctuating between $50 and $100 per barrel, and currently around $70, there is potential for price appreciation in the coming years. Geopolitical tensions in the Middle East and potential policy changes regarding renewable energy subsidies could contribute to higher oil prices, benefiting Schlumberger.
Shifting to the homebuilding sector, D.R. Horton (DHI), the largest homebuilder in the United States, offers exposure to a market sensitive to interest rates. Following a period of investor optimism driven by anticipated interest rate cuts, homebuilder stocks, including D.R. Horton, have retreated. This presents a buying opportunity, as the stock currently trades at a compelling valuation of around 10 times earnings. In the banking sector, M&T Bank, a large regional bank with a strong presence in the Eastern United States, stands out for its consistent profitability. Using return on assets as a key metric, M&T Bank has consistently exceeded the 1% benchmark, demonstrating its financial strength. Trading at 14 times earnings, the bank offers a relatively attractive valuation within the financial sector.
Finally, within the materials sector, Nucor Corp (NUE), the largest steel company in the United States, benefits from trade protection measures and a recovering domestic economy. With a history of consistent profitability since the Great Recession, Nucor has weathered economic downturns effectively. The stock’s significant decline of 22% in 2024 presents a potential buying opportunity, as it trades at a mere 11 times earnings. These six companies, spanning diverse sectors, illustrate that despite the overall market’s elevated valuation, pockets of value remain for discerning investors willing to explore beyond the popular technology darlings.
The search for undervalued stocks necessitates a contrarian approach, looking beyond the market’s current favorites. By focusing on out-of-favor sectors like energy, banking, and homebuilding, investors can uncover compelling opportunities. These sectors often contain companies with strong fundamentals trading at attractive valuations due to temporary headwinds or market sentiment.
The identification of these undervalued companies involves analyzing key financial metrics such as return on equity, return on assets, and price-to-earnings ratios. These metrics provide insights into a company’s profitability, efficiency, and market valuation, helping investors assess the intrinsic value of a stock relative to its current price.
While the overall market may appear expensive, a deeper dive reveals hidden gems within specific sectors. The energy sector, impacted by fluctuating oil prices and geopolitical events, offers potential for value appreciation. Similarly, the homebuilding sector, sensitive to interest rate movements, presents opportunities for investors anticipating a change in monetary policy. The banking sector, while facing regulatory scrutiny, also contains well-managed institutions trading at reasonable valuations. Finally, the materials sector, often tied to economic cycles, can offer value during periods of economic recovery or increased infrastructure spending.
The examples of ConocoPhillips, Paccar, Schlumberger, D.R. Horton, M&T Bank, and Nucor Corp. demonstrate that value investing remains a viable strategy even in an expensive market. These companies, operating in different sectors, share common characteristics: solid financials, reasonable valuations, and the potential for future growth. By focusing on these undervalued opportunities, investors can position themselves to benefit from market inefficiencies and potentially outperform the broader market.
The author’s previous attempt to identify undervalued stocks, the “Regular Seven,” highlights the challenges of predicting market performance. While the intention was to showcase stocks that could outperform the market’s high-flyers, the “Regular Seven” significantly underperformed both the “Magnificent Seven” and the broader S&P 500 index. This underscores the inherent unpredictability of the stock market and the importance of a long-term investment horizon.
Despite the setback with the “Regular Seven,” the core principle of value investing remains valid. By diligently researching and identifying undervalued companies with strong fundamentals, investors can create a portfolio positioned for long-term growth. The current market environment, while perceived as expensive, still offers opportunities for value-oriented investors willing to explore overlooked sectors and companies. The key is to remain patient, disciplined, and focused on the long-term potential of these undervalued investments.
