When I’m searching for stocks to invest in, I start with earnings growth. If a company’s earnings are expected to grow by double digits during the next couple of years, I know that lots of investors will be paying attention, thereby increasing the odds that they’ll buy the stock and push the share price up.
Then I look at valuation and price charts. I don’t want to be the last investor in America to buy the stock, and get caught holding the bag! Therefore, I focus on growth stocks with low P/Es—i.e. undervalued stocks.
There are quite a few stocks that fit that description within the building and construction industries right now. But there are also a few attractive possibilities among technology stocks.
Strong Earnings Growth, Low Valuation
Today, I want you to consider Applied Materials (AMAT), a worldwide leader in the manufacture of capital equipment within the semiconductor industry, operating in Europe, the Middle East, Asia and the U.S. The company’s size and product diversification help insulate it from downturns in the economic cycle, and its high quality products protect its market share.
In April 2015, Applied Materials called off its planned merger with Tokyo Electron due to regulatory concerns. At that time, Applied Materials promptly announced a new $3 billion share repurchase authorization, which was completed in 2016. Then in June 2016, the company announced a new $2 billion repurchase authorization.
Applied Materials operates on an October fiscal year. Revenue rose to $9.7 billion in 2015, and is expected to reach a range of $11 billion to $12 billion in 2017. Earnings per share (EPS) are expected to grow 28.6% and 22.9% in 2016 and 2017. That’s fantastic earnings growth, and somewhat rare to find in such a large company.
If you’re a value stock investor, your next important question becomes, “What does the stock valuation look like?” I like a stock’s price/earnings ratio (P/E) to be lower than the earnings growth rate, which is an indication of an undervalued stock.
In the case of AMAT, the projected 2016 and 2017 P/Es are 16.4 and 13.4 respectively. Those numbers are extraordinarily low relative to the company’s earnings growth rates. But it also helps to know a stock’s normal P/E range, so that you have more perspective on the stock’s potential upside.
Applied Materials has an erratic earnings history. While earnings have been steadily climbing in recent years, they’ve also been both higher and lower during the last decade. It would be fair to say that during years of similar earnings performance, the stock’s P/E has ranged between 13 and 23. That’s great news, considering that the current P/E is low within that range.
Therefore, the share price could rise 50% and AMAT would still be undervalued!
Applied Materials had $5 billion cash on its balance sheet in October 2015, and the company has a relatively low long-term debt-to-capitalization ratio of 27%. Its stock also offers investors a 1.6% dividend yield.
Chart Shows the Stock is Ready to Break Out
The share price spiked up to 57.44 in April 2000, then crashed with the tech bust. In more recent years, AMAT rose to 24-25 from November 2014 through March 2015. Then the stock fell to the mid-teens during the repeated market corrections in 2015 and 2016. The share price recovered this spring, barely receded during the June market correction, and now finally appears ready to break past upside price resistance.
AMAT is a volatile, large-cap aggressive growth stock, but it’s also a seriously undervalued stock with an attractive dividend yield and a strong balance sheet. AMAT could therefore attract a wide variety of investors, and importantly, there are no red flags on AMAT’s horizon.
I think AMAT is about to begin a sustainable run-up. Nobody has missed their opportunity to buy AMAT and capitalize on its increasingly bullish chart. There’s no recent higher trading range to give us clues on how high AMAT might climb, so decide in advance whether you want to own AMAT for a quick trade or for several years. I would be inclined to buy and hold this stock, and buy additional shares during pullbacks.
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