5 Stocks to Buy While They’re Trading at Big Discounts

Susan Dziubinski: Hello and welcome to The Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday morning, I sit down with Morningstar Research Services’ chief US market strategist Dave Sekera to discuss what’s on his radar this week, some new Morningstar research, and a few stock picks or pans for the week ahead. So, hi, Dave, perhaps the biggest thing on radar this week for many investors is Nvidia’s earnings.

Last I checked, the stock was up about 86% so far just this year. So, what’s Morningstar think of Nvidia NVDA ahead of earnings from a valuation perspective? And what’s Morningstar’s forecast for the business?

David Sekera: Good morning, Susan. Nvidia is definitely going to be the most watched earnings report this earnings season. Currently, we rate the stock with 3 stars. I think it trades just a hair over our $910 per share fair value estimate. When I think about the stock at this point, in order for it to rise any further from here, I think not only is it going to have to beat the revenue and the earnings consensus out there, but I think they’re also going to have to provide very strong guidance for this next quarter.

If they miss either earnings or they fail to provide that strong guidance, I’d say look out below on this one. As far as what we forecast, again this is probably one of the strongest growth stories I’ve seen over the course of my career. For a company that was already this large for revenue, we’re looking for sales to double this fiscal year, and that’s on top of doubling the prior fiscal year.

When we look at the revenue here, for fiscal 2023, revenue is $27 billion. We’re forecasting that to grow to $212 billion by fiscal year 2029. As far as earnings, we’re forecasting $26.11 per share this year going to $34.44 next year. When I look at this on a multiple basis, I know that it does trade at over 34 times this year’s expected earnings. But that drops to a more reasonable 26 times next year’s earnings per share estimate. But again, this is a stock that we do rate with a Very High Uncertainty Rating, which is the second from the highest rating that we assign. So, that does mean at the end of the day, we do think that with Nvidia there is going to just be an especially wide range of potential outcomes.

Dziubinski: Sticking with tech, Palo Alto PANW also reports this week. And this cybersecurity stock’s done pretty well during the past 12 months. It’s having kind of a ho-hum 2024. What’s Morningstar’s take on the stock heading into earnings?

Sekera: Well, first of all, just from an investing point of view, I really like the cybersecurity industry. I published an article back in June 2022 that outlined why we had such a positive view on cybersecurity. And since then, the underlying fundamentals still remain a positive for the cybersecurity providers. Again, when you think about it, geopolitical risk, ransomware hacking, they all still remain on an upswing.

Now, one of the things I really like about this industry is that cybersecurity spending in and of itself is a relatively a small percentage of the overall IT budget. But, of course, it has huge downside risks. If a company is hit by a cyberattack. So, in my view, this is not an area where you have to worry about management trying to cut costs.

Palo Alto itself, it is a bellwether cybersecurity stock. We currently rate it with 3 stars. That puts it within the range that we consider to be fairly valued. It is a company that we rate with a wide moat, although it is a High Uncertainty, which, of course, you expect for most tech companies. For investors looking for exposure in tech, I would just point out Fortinet FTNT, that’s a 4-star-rated stock at a 20% discount. They did report earlier in the in May, and we did maintain our $77 per share fair value estimate at that point in time.

Dziubinski: Zoom Video Communications ZM also reports earnings this week. And this is a name we’ve talked about before on The Morning Filter. The stock is off more than 80% from its 2020 highs. What does Morningstar think of the stock today?

Sekera: I think this is just a really good example that over time how you can see stocks in the stock market really act like a pendulum, swinging too far in one direction, and then correcting and then swinging too far in the other direction. So, as you mentioned, Zoom just skyrocketed in 2020.

Huge growth as the pandemic kind of drove employees to working from home, and people needed communication software. So, again, just the stock I can’t even remember how much it went up in 2020. Now, at that point in time, it traded way too high as far as its intrinsic value, was well into 1-star territory. But then once that pandemic-instigated growth started to slow, that stock did start on a pretty strong long-term downward trend.

In fact, the stock has already round-tripped all the way back to prepandemic levels. And at this point, we’re only forecasting what I consider to be relatively modest growth over the next five years. And based on where that stock is trading today versus our intrinsic valuation, it is rated 4 stars and trades at a 28% discount to fair value. So, it’s only trading at about maybe 12 to 13 times adjusted earnings estimates.

Dziubinski: Among the nontech names reporting this week that you’re watching, we have Medtronic MDT, which is another name you’ve talked about before on the show. It’s an example of another undervalued stock kind of having a ho-hum year. What’s the story on this one, Dave?

Sekera: Medtronic is the largest pure-play medical-device maker. We think it’s actually one of the best positioned in the medtech industry to be able to benefit from the continued aging of the baby boomer generation. When we look at their portfolio, they make a lot of different types of medical devices, typically for more chronic type of diseases, think pacemakers, defibrillators, heart valves, stents, insulin pumps, and so forth.

We do rate the company with a wide economic moat, meaning we do think it has long-term durable competitive advantages and only rate it with a Medium Uncertainty. Currently, the stock is a 4-star-rated stock, trades at a 25% discount, and has a relatively healthy dividend yield at 3.3%. When I look at our model here, our five-year compound annual growth rate for revenue only averages 4.5%. But we are looking for some good earnings-growth leverage on top of that. That’s about 11%. Currently, it’s trading at about 5 times our 2024 earnings estimates for this year. And a little bit over 14 times next year’s estimates.

Dziubinski: And then the last company reporting this week that’s on your radar is Dollar Tree DLTR. Why is this one you’re watching? And what does Morningstar think of the stock?

Sekera: As far as the stock goes, since mid-2021, this thing’s bounced around quite a bit. But essentially at the end of the day it’s kind of gone nowhere. It’s currently rated 3 stars. I’m not so interested in this stock in and of itself, but I really want to listen to management’s comments on the earnings call and get an idea from them, what they’re seeing as far as consumer strengths and weaknesses. Over the past few weeks on our show, we’ve talked a couple of times about how that compound impact of inflation over the past two years, it already started to hit the low-end consumer last year. But I think this past quarter or two, we’re really now starting to see that compound impact of inflation really starting to squeeze the middle-income consumer.

Now at Dollar Tree itself, last quarter foot traffic actually increased 7%. Comp store sales were up 6.3%. And that’s on top of an already strong 8% to 9% increase the prior year. I’m really curious to hear if they can maintain these higher-foot-traffic levels. And if so, I think that’s going to be indicative of more middle-income consumers trading down to the discount stores from the full-priced retailers.

Dziubinski: On the economic front, we have durable goods numbers coming out this week. Why is this something that you’re watching? And could the number trigger either some market volatility to the upside or the downside this week?

Sekera: The consensus is projecting a half a percent increase on a month-over-month basis. And that compares to a very healthy 2.6% jump last month. In my view, I don’t think it’s going to be a market-moving event. As you note, it’s just a very volatile number from month to month. I think really what you want to do is look at some of the individual components of durables and get a sense of how those individual components are doing.

Specifically, I want to watch auto sales and the transportation equipment. I think as far as the market really kind of the next economic indicator that has the potential for being market moving is going to be personal consumption expenditures. Of course, that’s the Fed’s preferred gauge for inflation. And that’s scheduled to come out on Friday, May 31.

Dziubinski: Speaking of the consumer, we’re also going to see final consumer sentiment numbers this week. Is that something that you watch, Dave? Should this be on investors radars?

Sekera: Nah. I mean reporters like to write about consumer sentiment a lot. But having been a consumer analyst for much of my career, I never found sentiment really to be statistically significant as far as what actually happens in the market. In my view, there’s just always a big difference between what consumers say versus what they actually do.

Dziubinski: All right. Let’s move on to some new research from Morningstar. Starting on the economic front, the April CPI number came out last week below consensus, which was some good news. What’s Morningstar’s takeaways from the report?

Sekera: Really, at the end of the day, not much. The April CPI report did offer some slight relief from the bad news that we’ve had on inflation in the past couple of months. But largely it came in in line with expectations, which was just one tick better than what it was the prior month. So, the only part of CPI that came in that was better than expected was headline CPI.

That came in at three tenths of a percent on a month-over-month basis, compared to four tenths of a percent in the prior report. So, in my view, I think the stock market upside reaction was probably overblown. When I looked at the market-implied probability for federal-funds rate cuts in July, it’s still only a 30% probability.

So, we don’t think that’s going to happen here in the near term. Looking further out, the probability for a cut in September did increase slightly but not by all that much. Currently, the market’s only pricing in a 25-basis-point cut with a 50% probability, and for 50 basis points of cuts, only a 15% probability.

Dziubinski: As you mentioned earlier, the inflation metric that the Fed really pays most attention to is the PCE, which is coming out at the end of May. Where is Morningstar expecting that number to come in and why?

Sekera: Our US economics team right now is projecting core PCE price index increase of a quarter percent on a month-over-month basis for April. So, on an annualized rate, that equates to about 3%. And really, what we’re following most closely will be that six-month annualized core PCE, which we’re projecting to come in at 3.2%.

Dziubinski: Given that, when does Morningstar expect the first Fed rate cut to occur?

Sekera: We don’t think the Fed is going to really contemplate cutting rates until that six-month annualized core PC growth number comes in well under 3%, and our US economics team forecasts that will probably start to occur in the July report. We do think that sets up for that first rate cut to be likely in September. We then look for a second cut in the December meeting and then ongoing cuts in 2025.

Dziubinski: Let’s talk a little bit about some new research about companies that reported last week. We’ll start with Home Depot HD. Morningstar didn’t change its fair value estimate on the stock after earnings. How did things look? And do we think the stock is a buy today?

Sekera: When I look at Home Depot, we note that comp-store sales, or comparable store sales, were down at 2.8%. And to put that in context, inflation, or CPI, was up over 3.0%. And then when they break those comp-store sales down, I’d note the number of transactions was down 1.5%. And the average spend per transaction was down 1.3%.

But really, the key takeaway noted by Jaime [Katz], who’s the analyst that covers this name, orders over $1,000 were down 6.5%. I think that really indicates the softness that we’re seeing in those larger discretionary projects. Looking forward, we do forecast sales will begin to start turning positive later this year. We’re looking for revenue to be flat to maybe up just under 1% in 2024.

That’s after dropping 3.0% last year. And then going forward, I think we’re modeling in 4.0% top-line growth. But we are looking for the earnings growth rate of 7.6% on average over the next five years. At the end of the day, no change to our fair value. That’s $263 per share. That’s equal to a relatively average 7 times 2024 earnings.

But it’s now trading in the marketplace at 22 times 2024 earnings. So, that puts it in the 2-star category. And it’s trading at a 30% premium to that fair value estimate.

Dziubinski: Sort of sticking with the consumer here, Walmart WMT put up some good results, and the stock rallied. What did our analysts think of the results? Any changes to the fair value? And is there opportunity here today?

Sekera: As we’ve talked about the past couple of weeks, and we’ve looked at the results from companies like Starbucks SBUX, McDonald’s MCD, and Tyson TSN, they’ve really indicated a combination of a stagnating economy over this past couple of quarters and that compound impact of inflation over the past two years, not only pressuring the lower-income consumer, but that pressure really now starting to move into the middle-income consumer as well.

And I think Walmart’s results just provide even more evidence of that. For example, Walmart reported a 3.8% increase in their comp-store sales. And we thought that was pretty impressive, considering that it was 7.0% comp-store sales the year before. And I also noticed this quarter that was really driven entirely by traffic growth.

That means that there is just more and more consumers trading down to Walmart. Our analyst notes that following these results, he does anticipate raising his fair value estimate, I think by the mid-single-digit percentage. But really, I think it’s going to be much more interesting to see what happens to Target TGT when they report on May 22.

We do rate Walmart with a wide economic moat. We don’t rate Target with any economic moat as well at all. We believe Target’s value proposition really doesn’t warrant a long-term durable competitive advantage rating here. As such, in this environment of higher inflation, the middle-income consumer that Target really tries to attract, I do think Target could be squeezed here this quarter.

Dziubinski: Applied Materials AMAT stock is having a good year and looks like earnings came out looking good, too. What did Morningstar think of earnings. And has there been any change to the fair value estimate on this one?

Sekera: It was just a solid beat on both the top line and bottom line. Guidance was above our expectations. We did bump up our fair value by 10% to $168 per share, which equates to, I think, 20 times this year’s earnings. But we still think the mark is probably getting ahead of itself on market valuation.

Some of the recent results here were bolstered by high orders from Chinese customers. We think it’s unlikely that these are going to remain at these levels over the long term. We are expecting earnings this year to increase only 3% versus last year. We’re looking for a compound annual growth rate over the next five years of 12%.

The stock is currently trading at over 25 times earnings. It’s at a 26% premium to our fair value, which puts it in the 2-star-rating category.

Dziubinski: Let’s talk about Deere DE. Here’s a stock that looked overvalued heading into earnings. And it fell after the company cut its full-year forecasts. What’s Morningstar’s take on the stock today?

Sekera: If you remember in last week’s show, we noted that Deere was rated 2 stars and was trading at a 20% premium to our fair value. I think the real takeaway here is we were looking for a 14% decline in revenue this year and for margins to contract. Unfortunately for the company, it appears that both of these assertions not only are coming to fruition but actually were even worse than what we expected.

We lowered our 2024 revenue forecast to an 18% decline. We also lowered our adjusted operating margin assumption to 18%. That’s a contraction of 130 basis points from our prior estimate. The changes did lead us to cut our fair value down to $339 per share. The stock sold off after earnings, I think a little bit over 5%. But even after the selloff, the stock is still a 2-star-rated stock trading at a 17% premium.

Dziubinski: It’s time to move on to everyone’s favorite the picks portion of our program. In your May market outlook, which viewers can access beneath this video via a link, you point out that value stocks remain an attractive part of the market, and you suggest that, given valuations, investors should overweight their value stock allocations based on whatever that allocation range may be for them.

So, this week you’ve brought viewers five value stocks you like today. The first is APA APA, which we’ve talked about on the show before. Remind viewers why you like the stock.

Sekera: I think we first highlighted that one as one of our picks on our Jan. 22 show. The stock did move up earlier this year but then sold off and, at this point, is essentially unchanged since we first started talking about it. But currently it is a 4-star-rated stock, trades at about a 43% discount to our fair value pace, and has a 3.2% dividend yield.

But it is a company that we rate right now with no economic moat. They reported earnings in early May. They missed earnings expectations. That was really driven by the write-off of two exploration locations that they had. We did decrease our fair value estimate to $54 from $55. But really it was the removal of one rig from acquired acreage and some changes to our near-term commodity forecast that drove that slight downtick in the fair value.

But to me, the real upside here isn’t so much the existing business. This is really what I consider to be a catalyst-driven situation. APA has a joint venture with Total in Suriname, and we think the evidence there currently indicates that that could be a potentially very large oil field. And we think it’s likely that one or more of these discoveries will progress to the production stage potentially later this year.

I do have to caution that none of these have been officially sanctioned by the company just yet; we are waiting for that final investment decision. We think that comes at the end of this year. And if they do move forward, the first oil production from those fields still won’t occur until 2028.

However, according to Stephen Ellis, he’s the equity analyst that cover this for us, he thinks this is potentially just a game changer for APA. If they move forward, based on the evidence, he thinks this could double the firm’s production over the next 10 years. But according to our valuations, we just don’t think that this is included in the stock price. So, at the end of the day, it kind of looks like a free option to us.

Dziubinski: Your second value stock pick this week is Kraft Heinz KHC. And Berkshire Hathaway BRK.B owns about 25% of the company’s stock. So, you’re in pretty good company on this one, Dave.

Sekera: This was a stock pick back on our August 21 show. It looks like the stock is up 7% since then. Plus, I think you’ve collected a couple of pretty decent dividends since then. They did report earnings at the beginning of May. And I would note that those earnings just barely met consensus. The stock market didn’t really like that.

I think the stock market was hoping for them to beat. So, the stock did drop 6%. But we reaffirmed our $54 per share fair value. It’s currently rated at 5 stars, trades at a 33% discount, and pays a 4.4% dividend yield. Although in the food industry, this is a company that we rate with no economic moat.

But again, as much of a fair value discount it’s trading at, we think that provides enough margin of safety to make this one investable. When I take a look at our financial model, we’re only projecting an average of 2% top-line growth over the next five years. But we are looking for 6% earnings per share growth based on some margin expansion.

We’re forecasting that, from margins of 20.0% this year, expanding to 21.5% by 2032. So, just a gradual increase over the next couple of years. In comparison, the average operating margin over the past 10 years was %21.7, so it really just kind of gets them back to where they were prepandemic. Taking all that into consideration, the stock’s only currently trading at I think just under 12 times our 2024 earnings estimates.

Dziubinski: Your next three picks are all from the healthcare sector. And before we get to them, talk a little bit about the sector’s valuations today. In many ways, it seems that healthcare is the sector of the haves and the have-nots.

Sekera: That’s definitely true. Healthcare overall as a sector, it was starting to get a bit expensive at the end of March. It’s pulled back about 4% since then. But as you mentioned, healthcare has some very large market-cap names that we think are just very overvalued, specifically talking about Eli Lilly LLY and Novo Nordisk NVO.

Those are 2-star-rated stocks, both trading at about 50% premiums to fair value. Those stocks have just had huge runs over the past year to year and a half. The market is chasing those up because of the weight-loss drugs that, of course, everyone expects to have very large revenue growth over the next couple of years.

But with so much attention in the healthcare industry paid to those weight-loss drugs, it feels like a lot of these other areas are just out of favor. I think that’s why we’re seeing some of the attractive value plays today. Now each of these three stocks that we’re going to discuss are what I consider to be story stocks.

There’s a lot that’s going on with each one. I think investors really need to understand the story before they think about buying into any of these three stocks. And I think you’re going to need to be comfortable owning these for a while. I think it could take some time for these really to start working out.

Definitely not what I would consider to be short-term trade ideas, but longer-term investments. But they do pay some pretty respectable dividends. So, at least you get paid while you’re waiting for them to start to work.

Dziubinski: Let’s get to the stories. Baxter International BAX is a pick from that sector this week. The stock’s pretty deeply undervalued. And the stock’s lost more than 14% in the past 12 months. What’s the story?

Sekera: Baxter makes a wide range of medical instruments and supplies, things for acute and chronic kidney failure, injectable therapies, IV pumps, and some other hospital-focused offerings. Here’s the story on this one. First, they got hit by supply chain issues pretty hard in 2022. And they’re still working through a lot of those.

Then, on top of that, they got hit by inflation, which really hit their margins. Based on their pricing in their contracts, they were unable to pass through a lot of those higher costs. And a number of investors over the past couple of years really just kind of felt burned by this stock. And it’s definitely left a bad taste in their mouths.

Now, we do think supply chains are normalizing. The company is getting back on track. The stock did start to recover earlier this year. But then when they reported earnings in early May, that stock did sell off again. Let me go over the bad news in that earnings report first. Their subsidiary Hillrom reported a 9% decline.

This subsidiary makes what we consider to be more higher-cost, more-capital-intensive-type products as opposed to kind of the other businesses, which are more lower-cost consumables. I talked to Julie [Utterback], who’s the equity analyst on this one. She thinks that what happened here with that subsidiary is that we saw the sales decline in February through April because UNH, which is UnitedHealth, their claims reimbursement system, the Change system, was taken off line.

I think there was maybe some kind of like cybersecurity attack there. So, a lot of these healthcare providers that use that Change system were under liquidity pressure because they weren’t getting reimbursed for the different types of healthcare they were providing. So I do think that these healthcare providers ended up delaying a lot of these purchases because of those liquidity constraints.

We think that now that that system is back online, people are getting paid. That should start to pick back up again. But again, with the already negative sentiment surrounding this company, investors just are not willing to give management the benefit of the doubt. Let’s turn to the good news here. When we do look at the underlying results, we thought the underlying fundamentals were relatively positive.

We are seeing increases in medical utilization. Slowing inflation should help drive margins. In fact, management actually increased their 2024 guidance by $0.03 to $2.88 to $2.98 per share. Looking forward, Julie also noted a substantial number of their three-year sales contracts are coming up for renewal.

And she thinks that they’re going to be able to negotiate a better contract, specifically put some costs through, language in there. So again, that should help them going forward as far as making sure that they can put those inflationary costs through.

Net-net, at the end of the day, it trades at a 47% discount, it’s a 5-star-rated stock, and pays a 3.3% dividend yield. So, the estimated P/E right now is 12 times, which in and of itself I think that appears relatively cheap. But that’s on top of what we consider to be depressed near-term earnings. When I look at that forward P/E multiple based on our 2025 earnings estimate, it drops all the way down to 10 times.

Dziubinski: Your next, healthcare pick here that’s a value play is drugmaker Gilead Sciences GILD: wide-moat company, core of its portfolio focused on HIV and hepatitis B and C. Another healthcare stock that’s lost money during the past 12 months. What’s the story on this one?

Sekera: Let me apologize. But it is a long story here, so let me kind of work our way through it. But it’s a 5-star-rated stock, trades at a 30% discount to fair value, and has almost a 4.5% dividend yield. It is a company we rate with a wide economic moat and has a Medium Uncertainty level.

And when I look at our wide moat here, as you note, it’s really going to be based on the stability of their HIV and their liver disease business, plus some growth potential we see in their oncology business. Now they reported earnings at the end of April. And looking at the stock trading pattern here, it looks like maybe the stock has finally started to bottom out.

What we’ve seen is that competition has been weighing on their more rapidly growing oncology products. And we think that Gilead does need to report positive data for some upcoming multiple myeloma and lung cancer studies in order to retain that strong oncology growth. But offsetting these drawbacks, Gilead’s liver disease portfolio we think is well positioned to generate growth going forward.

It saw a 9% growth in that past quarter. And we’re also looking for progress in their new long-acting HIV treatments. the phase 3 trials have been encouraging thus far. But one aspect of this stock that really caught my eye is that, Karen [Andersen], who covers the stock, has noted she thinks that this company’s portfolio of products really is poised for what she considers to be maintainable growth.

Currently, the payout ratio for dividends is only 50%. We don’t think they’re going to have a problem maintaining that dividend. We really like the combination of a good margin of safety from their long-term intrinsic value, as well as that high dividend yield. And this is another one where I think you need to be careful when you take a look at the P/E ratio.

We’re looking for average earnings growth to be relatively flat over the next five years. And it’s trading at about 18 times this year’s earnings, which for a situation with relatively flat growth that may look somewhat expensive. However, earnings this year are impaired. There were a number of different write-downs. They had to write down some in-process R&D from an acquisition, as well as some impairment charges on some other research and development.

But when I look at this company, it only trades at 10 times 2025 earnings. And I think that’s a more accurate indication as far as the long-term earnings power for this company.

Dziubinski: And then your last pick this week is Bristol-Myers Squibb BMY. Damien Conover, who heads our healthcare sector team, points out that this company has one of the larger patent cliffs by 2028. And the stock also has one of the larger losses over the trailing one-year period in its industry, too. Why is this one one of your picks?

Sekera: You make it sound so bad, Susan. So, it’s a 4-star-rated stock, trades at a 30% discount to our fair value, and provides a 5.4% dividend yield. But it is a company we rate with a wide economic moat and a Medium Uncertainty. It’s been on a downward trend for the past year. It got hit pretty hard after the earnings report at the end of April.

In fact, that stock is all the way down at its lowest level since 2019. When you look at sales and earnings, they were largely in line with expectations. I think some of the newer product sales here were a little bit below our expectations but not enough to cause us to change our longer-term forecast.

So, Damien did reaffirm our fair value at $63 a share. Now, as you noted, Bristol does face one of the largest patent cliffs over the course of the next five years. But when we look at their new product pipeline, we believe they have enough new products that they’ll help partially mitigate the pressures from the patent cliffs that will help offset some of the generic drugs that will come online.

And we do forecast revenue to decline at about a 4% average run rate over the next five years. But at the end of the day, we think the market is underestimating the strength of their next-generation drugs. So, I think with this one, the story is you need to look past this year’s earnings, the accounting treatment for an acquisition is temporarily lowering earnings.

So, when you look at 2025 earnings as a more normalized level of their longer-term earnings, power, the stock is only trading at 7 times our 2025 projected earnings per share estimates.

Dziubinski: Well, thanks for your time this morning, Dave. One programing note: Dave and I will be enjoying Memorial Day next Monday, so we will not be airing a new episode of The Morning Filter. But we’ll be back on Monday, June 3, at 9 a.m. Eastern, 8 a.m. Central, and we hope you’ll join us then. Thanks for tuning in.