The Valuentum Buying Index (VBI) is a philosophy that considers the valuation of a company and the likelihood that a company’s stock will converge to a cash-flow derived fair value estimate. The VBI accepts the view that value is based on the sum of a company’s future expected discounted free cash flows and the excess cash on its balance sheet, while acknowledging that market participants must eventually agree with a firm’s underpricing (and buy the stock) in order to drive the stock’s price to fair value. An underpriced stock with no buying support is not poised to generate good returns, nor is an overpriced stock with good momentum as it will eventually succumb to panic selling once euphoria fades.
Stocks that are both undervalued and are generating strong buying interest have shown to be some of the best performers on the market, and the Valuentum Buying Index gives high ratings to these types of stocks: undervalued ones with good momentum (value-ntum) characteristics. In alphabetical order, please find below 4 stocks to consider buying in 2015, each having registered a high rating on the Valuentum Buying Index in the past!
More on the Valuentum Buying Index .
Coach (COH)
The aspirational luxury handbag maker is at a crossroads. The firm’s North American women’s handbag business continues to be under significant pressure, and while its rest-of-world operations and expansion into men’s accessories indicate promising potential, any investment thesis on Coach depends on a recovery of its struggling North American women’s handbag business. Rivalries from the likes of Michael Kors (KORS), Kate Spade, and Tory Burch, among others, won’t be going away anytime soon, but Coach has a war chest of net cash on the balance sheet that not only affords it valuable time, but also low-cost funds to reignite the brand.
Coach may not have to go it alone, however. The company’s recent product line-up has recently caught the eye of a potential suitor in the likes of LVMH Moet Hennessy (LVMHF), and though all reports are unconfirmed, we would not be surprised to see Coach fold itself into a larger luxury goods provider’s portfolio in coming years. In the meantime, the firm pays a nice dividend to investors that are willing to be patient. We think its near-4% annual dividend yield is safe on the basis of its strong free cash flow generation and robust balance-sheet net cash position. We’re expecting better things from Coach in coming years, and we value shares at just shy of $50 each, implying material pricing upside from its current mid-$30s price tag. Downside appears to be limited, buoyed by valuation and potential merger talk.
Eastman Chemical (EMN)
Though we generally don’t like chemical companies due in part to the industry structure and their volatile product pricing, Eastman Chemical generates an impressive two thirds of its sales from product lines in which it has a leading market position, from additives (cellulose polymers, insoluble sulfers) to advanced materials (copolyester, PVB resin) to fibers (acetate tow, acetate yarn). This translates into some cost advantages relative to smaller peers. The company stands to benefit from long-term global trends such as energy efficiency, a rising middle class in emerging economies, and increased health and wellness.
As for recent performance, the executive suite raised its fiscal year 2014 earnings-per-share outlook to $7.00 from the previous range of $6.70-$7.00 per share and noted in late October that raw material and energy costs will be a tailwind, a particularly important dynamic given plunging commodity prices. Assuming 10% earnings expansion in 2015, in-line with management’s target calling for 10%-15% earnings per share growth for the year, the company is trading at less than 10 times this year’s earnings, too punitive of a multiple for a growing entity, even if the industry in which it operates is ultra-competitive. We value shares at well over $100 each, implying significant pricing upside. Eastman Chemical boasts an attractive Economic Castle rating.
Gilead Sciences (GILD)
This hepatitis C powerhouse has been under fire as of late due to encroaching competition from AbbVie (ABBV) and pricing pressure from pharmacy benefit managers (PBMs) such as Express Scripts (ESRX). The threats are real and not to be taken lightly. However, Gilead’s Harvoni hepatitis C therapy is not only more efficacious than AbbVie’s Viekira Pak on the basis of our interpretation of the test studies, but physicians generally may prefer the single-pill Harvoni over the four-to-six pill Viekira Pak given that the primary market for hepatitis C, the baby-boomer generation, may already be on a number of subscriptions for other ailments. Without a doubt, cure rates for both Gilead’s and AbbVie’s hep-C drugs are fantastic, but Gilead’s Harvoni has a tighter cure-rate range (94%-99%), indicating the potential for a more consistent outcome for patients versus the Viekira Pak, where the low end of cure rates are at 91% (nothing, of course, to scoff at).
Assuming a fair market multiple of 20 times this year’s earnings, to arrive at Gilead’s current share price, investors are factoring in a 50%-65% permanent reduction in run-rate profits and a structural change where pricing pressure from PBMs becomes increasingly more cutthroat over the next few years. These assumptions are too punitive, in our view, even if they might be tangible threats. At best, we think AbbVie will capture a quarter’s worth of Harvoni sales for all of 2015 (but the market is growing), and we think PBMs will eventually have to address physician pressure regarding more treatment options. At the moment, we believe the hep-C market is a rational oligopoly with Johnson & Johnson (JNJ), AbbVie and Gilead all playing nicely “in the sandbox.” There is no price war.
Gilead is a risky company, but a good investment is one in which the market incorrectly prices a firm’s intrinsic worth. Under a base-case scenario, which is not too different than consensus forecasts, we think Gilead’s shares are worth north of $150 each. In this light, the firm’s current share price (low $90s) offers investors a nice margin of safety. Under a bear-case scenario, we don’t see much downside risk from present levels, and if shares of Gilead do get cheaper, one might expect a suitor to become very interested.
Who might be interested? Valeant (VRX) could take a stab after losing its bid to scoop up Allergan (AGN), and even Teva Pharma (TEVA) could look to bolster its portfolio given impending generics competition on its multiple-sclerosis drug Copaxone. Bristol-Myers (BMY) has a stated interest in penetrating the hep-C market, and Pfizer (PFE) was just rebuffed by AstraZeneca (AZN) despite bidding aggressively for shares. These are just a few of the many potential opportunistic and strategic buyers should Gilead become even more of a bargain.
Microsoft (MSFT)
Speaking of bargains, software giant Microsoft continues to defy gravity. The beauty about the Microsoft story is that, in our view, it has been, for the most part, a pure valuation play, which often runs counter to the widely-held belief that a catalyst is needed to uncover a great stock or a pre-requisite of a strong pricing advance. Sometimes, valuation can be its own catalyst to share price gains. Things at Microsoft have improved in recent years, and we think investors continue to come around to recognizing shares are undervalued.
What’s more, very few, if any, other firms in our coverage universe have as strong of dividend growth potential as Microsoft. The software giant sports a ~2.7% dividend yield and a Dividend Cushion ratio of 3.3, a combination that is simply incredible, buoyed not only by its strong free cash flow generation but also by its mountain of net cash on the balance sheet. Microsoft, in our view, will have one of the best dividend growth CAGRs (compound annual growth rates) during the next decade or so. The company remains a top holding in the Dividend Growth portfolio, and we value shares at $58 apiece.
For more ideas, please visit the Best Ideas portfolio and Dividend Growth portfolio.