Jefferies says these value stocks will catch up the most as economy reopens

Published Tue, Jun 9 20207:51 AM EDT

Jefferies found a number of cheap stocks it believes are poised to outperform as the economy emerges from the coronavirus crisis. The bank believes the stage is set for certain value stocks to participate in the market rebound in a big way. One of the catalysts for the potential outperformance: The recent rally in growth stocks has stretched their valuation to historic levels compared to value names, which signals a rotation in leadership ahead, Jefferies said. "Valuation gap between growth and value at record high levels," Desh Peramunetilleke, global head of microstrategy at Jefferies, said in a note. "The most supportive argument in favor of value over quality/growth is the record high valuation dispersion between the two baskets." The tech-heavy Nasdaq Composite touched an all-time high on Friday, the first of the major U.S. equity indexes to wipe out its losses during the pandemic. However, growth stocks appeared to have taken a pause after their swift comeback from their March lows. On Monday, popular tech stocks Netflix, Microsoft and Alphabet underperformed once again. "We are now witnessing an extreme confluence of various technical factors that are set to drive a significant upswing in traditional value stocks," Peramunetilleke said. "Macro, earnings revisions, valuations and mean-reversion are all supportive of a sharp rebound in value stocks." For long-term investors hunting for value, Jefferies used its so-called systematic value process to eliminate value traps and screen for winners. Here's how the bank picked top value stocks. Jefferies started with a universe U.S. companies with market cap over $2 billion and screened for names with forward earnings yield, forward dividend yield or free cash flow yield in the top 30% of companies. Then the bank excluded stocks with the following risks: Remove forecast risk: Below median earnings revision and net earnings revisions Remove sentiment risk: Below median recommendation revenue and 12-month price momentum Remove value destroyers: Below median Return on Equity and Return on Invested Capital Remove balance sheet and cash flow risk: Bottom 20% of free cash flow conversion and top 20% of debt to equity Walgreens is one of the value names Jefferies recommended. The stock, trading at 7.5 times forward earnings, is still down nearly 20% this year. The drug store previously saw a significant sale decline with less foot traffic and fewer sales of discretionary items like beauty products during the pandemic. However, the company started to rebound with the gradual reopenings in all 50 states. Dell Technologies , which has outperformed the broader market this year, is still undervalued, according to Jefferies. The company has benefited from workstation purchases by companies moving more employees to home-based work. Last week, Dell reported better-than-expected quarterly earnings and revenue. Verizon and AT & T were also relatively cheap at their current levels. Both telecom operators took a hit this year as the coronavirus lockdowns resulted in subscriber losses. Verizon is down 5% this year, while AT & T lost about 15%. Jefferies' list also include a handful of insurance names: Pfizer , Anthem , Centene and Cigna .

New York Stock Exchange (NYSE) building is seen with the Fearless Girl Statue during Covid-19 pandemic in Lower Manhattan, New York City, United States on May 26, 2020.

Tayfun Coskun | Anadolu Agency | Getty Images

Jefferies found a number of cheap stocks it believes are poised to outperform as the economy emerges from the coronavirus crisis.

The bank believes the stage is set for certain value stocks to participate in the market rebound in a big way. One of the catalysts for the potential outperformance: The recent rally in growth stocks has stretched their valuation to historic levels compared to value names, which signals a rotation in leadership ahead, Jefferies said.

"Valuation gap between growth and value at record high levels," Desh Peramunetilleke, global head of microstrategy at Jefferies, said in a note. "The most supportive argument in favor of value over quality/growth is the record high valuation dispersion between the two baskets."