Today, I want to recommend a couple mega-cap value stocks that look quite attractive at the moment. But first, let’s talk about this market.
We’ve all experienced the sharp decline in the S&P 500 Index this year. It’s easy to worry that the market will continue to slide, either abruptly or in a slow grind, as rising interest rates, a possibly looming recession, global geopolitical turmoil and a host of other issues weigh on share prices.
For long-term investing success, it is important to maintain a long-term perspective. Much of the market’s decline is due to the collapse in prices of hyper-growth tech stocks. Most of these companies offered short-term share price excitement but have unstable business models. These companies rely on a steady inflow of fresh capital to fund their large operating losses while they pursue revenue growth literally at all costs. Unfortunately for these companies, one of those costs could very well be their existence, as capital is no longer cheap nor plentiful but rather expensive and scarce.
As value investors, we separate the fundamental prospects of a company, which drives its value, from the day-to-day movement of its stock price. Share prices are notoriously volatile, but the underlying fundamentals of good companies change only slowly. Large, well-run and properly financed companies with solid franchises, highly relevant products and services and reasonable profit margins are highly likely to continue to produce solid profits and some growth – even if their share prices may give the appearance of an unstable underlying company.
One way to find these stalwart companies is to look for those with strong credit ratings. Ratings agencies like Standard & Poor’s and Moody’s measure a company’s ability to fund its debt obligations as well as its ability to fund its growth and development. These agencies have access to inside information that Wall Street analysts do not, so they are able to explore more deeply the nuances of a company’s finances. By focusing on companies with top-shelf credit ratings, we might find relative bargains among the most financially stable businesses.
Only two companies, Microsoft (MSFT) and Johnson & Johnson (JNJ), have AAA credit ratings, the highest on the scale and above that of the U.S. Federal Government. Microsoft and Johnson & Johnson have enduring value and solid franchises but their shares are not bargains. So, we looked one step down the ratings scale at companies with AA credit ratings. Of this select group, we highlight two mega-cap stocks with shares that trade at reasonable valuations.
2 AA-Rated Mega-Cap Value Stocks
Mega-Cap Value Stock #1: JPMorgan (JPM)
Shares of JPMorgan (JPM) have slipped 32% from their high last November, and now trade below their pre-pandemic, year-end 2019 price. Yet, compared to its 2019 results, the bank is generating higher profits and has a stronger capital base. As outlined at its recent Investor Day, the first in three years, JPMorgan continues to advance its already-impressive growth, profitability and technology initiatives to further develop and expand its franchise, which extends from retail banking to raising capital for businesses to the inner workings of the financial system. JPMorgan’s initiatives and financial strength are backed by its strong profitability and capital generation. Led by Jamie Dimon, perhaps the most disciplined and capable CEO in corporate America, the bank looks well positioned to prosper for years to come. The shares trade at a 1.9x price/tangible book value and 10.4x estimated 2022 earnings – both quite reasonable given the bank’s quality. Maintaining the dividend is a top capital allocation priority and the shares pay an attractive 3.5% dividend yield.
Mega-Cap Value Stock #2: Walmart (WMT)
It would be challenging to find a company more embedded in the daily fabric of the typical American consumer. Nearly 90% of the U.S. population lives within 10 miles of a Walmart store, its website sees up to 100 million unique customers a month and the company employs one out of every 200 Americans. Its broad and deep array of products and services – from food, gasoline, clothes and household products to pharmacy and fintech – is nearly unmatched and capable of providing everything that a household might need. Its Walmart Connect advertising business could bring a new source of high-margin revenue growth. Overall, the company continues to build upon its relevance with new in-store and online initiatives.
Like all retailers, Walmart is wrestling with inflation, supply chain complexities and a rapidly changing consumer environment, but we view these as readily, if not immediately, manageable problems. Led by a highly capable management team, Walmart has the resilience, cash flow and balance sheet to endure and grow. The recent 25% drop in WMT’s share price (from 2022 highs) returns the stock to its pre-pandemic 2019 level, even as Walmart is producing higher profits. The valuation at 17.7x estimated earnings is reasonable given the company’s impressive franchise, while the 1.9% dividend yield, which appears highly sustainable, is competitive with AA-rated US Treasury bonds.
In the Cabot Turnaround Letter and Cabot Undervalued Stocks Advisor newsletters, we help investors navigate the equity markets using a common sense approach that emphasizes out-of-favor stocks of companies with real value. Let us help you sort through the market to find them. Click here to learn more.
Do you own any mega-cap stocks you think are undervalued right now?