S&P strategist Mark Arbeter predicts that the S&P 500 “could surrender 3 percent to 5 percent in a mild pullback,” which would mean a decline to its 50-day moving average of around 1,370, or even to its 65-day average near 1,350, “before resuming its upward trajectory.” The S&P is at 1,385 now.
With that in mind, I screened the Morningstar database of its highest-rated stocks (five-star ratings) to find which among them are trading at the biggest discount to Morningstar’s “fair value” estimate.
The premise of this approach is that these high-quality stocks are less volatile and have lots of potential upside when a rising tide lifts all the boats.
Morningstar analysts assign fair-value targets based on discounted cash-flow models. Their model assumes that the stock’s value is equal to the total of the free cash flows the company is expected to generate in the future, discounted back to the present. It is not the same metric used by Wall Street firm’s sell-side analysts to determine a 12-month price target, as they typically use their earnings estimates and apply a predetermined ratio to come up with a price-to-earnings price, coupled with other market factors.
“Fair values are meant to provide an estimate of what the stock is worth, irrespective of what investors are willing to pay for it,” says Morningstar, and therefore they tend to be lower since the approach is more conservative.
The stocks I highlight below have price-to-fair-value ratios below 50 percent, which means Morningstar’s analysts expect that these stocks are now trading at less than half their value, per the fair value metric.
Here are 10 of Morningstar’s five-star stocks with the biggest discount to the firm’s fair-value estimate listed in order of highest to lowest discount:
10. Baker Hughes
Company profile: Baker Hughes, with a market value of $18 billion, is a provider of a wide variety of oil-field services, such as directional drilling, oil field chemicals, drill bits, and electronic submersible pumping systems.
Dividend Yield: 1.4%
Investor takeaway: Its shares are down 15 percent this year, but have a three-year, average annual return of 11 percent. Analysts give its shares 13 “buy” ratings, nine “buy/holds,” 11 “holds,” and one “weak hold,” according to a survey of analysts by S&P. Morningstar says its shares, now trading at $40.59, are trading at 46 percent of their fair-value estimate of $86.
9. AMN Healthcare Services
Company profile: AMN Healthcare Services, with a market value of $248 million, is the largest health-care staffing firm in the U.S. About two-thirds of its business is generated from its temporary nursing division, but it also provides medical professionals of all ranks.
Investor takeaway: Its shares are up 41 percent this year, including 22 percent in the past month, and have a three-year, average annual return of 1 percent. Analysts give its shares three “buy” ratings and four “holds,” according to a survey of analysts by S&P. Morningstar analyst Vishnu Lekraj says the company is in place to benefit long-term, from strong secular industry tailwinds. Morningstar says the shares, recently at $5.90, are trading at 45 percent of their fair-value estimate of $13.
8. Halliburton
Company profile: Halliburton, with a market value of $30 billion, provides a variety of oil-field services, from pressure pumping to drilling, across North America and about 80 countries.
Dividend Yield: 1.1%
Investor takeaway: Its shares are down 4.8 percent this year, but have a three-year, average annual return of 25 percent. Morningstar says its shares, now trading at $32.37, are trading at 45 percent of their fair-value estimate of $72. Analysts tracked by S&P give its shares 16 “buy” ratings, 13 “buy/holds,” and four “holds,” according to a survey of analysts by S&P.
7. GenOn Energy
Company profile: GenOn Energy, with a market value of $1.5 billion, is an independent power producer operating in the Mid-Atlantic and Northeast regions and also in California. The company was formed by the result of the December 2010 merger of RRI Energy and Mirant.
Investor takeaway: Its shares are down 22 percent this year and have a three-year, average annual loss of 19 percent. Morningstar says that its shares, now trading at $2, are trading at 44 percent of fair value of $4.50. Analysts give its shares five “buy” ratings, one “buy/holds,” three “holds,” and three “sells,” according to a survey of analysts by S&P. S&P, which has it rated “buy” says the merger will result in geographic diversity and reduces its reliance on coal-fired assets.
6. Exelixis
Company profile: Exelixis, with a market value of $754 million, is development-stage biotechnology company with a focus on therapeutics for the treatment of cancer and other serious diseases.
Investor takeaway: Its shares are up 7.3 percent this year and have a three-year, average annual return of 1.5 percent. Morningstar says its shares, now at $4.94, are trading at 44 percent of its fair-value estimate of $11. Analysts give its shares three “buy” ratings, one “buy/hold,” and six “holds,” according to a survey of analysts by S&P.
5. NRG Energy
Company profile: NRG Energy, with a market value of $3.5 billion, is a wholesale power generation company that operates power generation facilities and sells energy.
Investor takeaway: Its shares are down 16 percent this year and have a three-year, average annual decline of 8 percent. Morningstar says its shares, now at $14.84, are trading at 43 percent of their fair-value estimate of $35. Analysts give its shares seven “buy” ratings, three “buy/holds,” and five “holds,” according to a survey of analysts by S&P.
4. Ultra Petroleum
Company profile: Ultra Petroleum, with a market value of $3 billion, is an independent oil and natural gas exploration and production company with operations from Wyoming and to Pennsylvania.
Investor takeaway: Its shares are down 30 percent this year and have a three-year, average annual loss of 20 percent. Morningstar says its shares, now trading at $20.17, are at 40 percent of their fair-value estimate of $50. Analysts give its shares five “buy” ratings, one “buy/hold,” and 19 “holds,” according to a survey of analysts by S&P.
3. Patterson-UTI Energy
Company profile: Patterson-UTI Energy, with a market value of $2.6 billion, is North America’s second largest operator of land-based drilling rigs.
Investor takeaway: Its shares are down 15 percent this year and have a three-year, average annual return of 17 percent. Morningstar says its shares, now trade at 39 percent of fair value of $43. Analysts give its shares nine “buy” ratings, eight “buy/holds,” nine “buy/holds,” one “weak hold,” and one “sell,” according to a survey of analysts by S&P.
2. ArcelorMittal
Company profile: ArcelorMittal, with a market value of $28 billion, is the world’s largest steel producer, with an established presence in all major steel markets and steelmaking operations in 20 countries
Investor takeaway: Its shares are down 1.8 percent this year and have a three-year, average annual decline of 7 percent. Morningstar says its shares, now at $17.60, are trading at 36 percent of its fair value estimate of $48. Analysts give its shares three “buy” ratings, three “buy/holds,” and two “holds,” according to a survey of analysts by S&P.
1. Savient Pharmaceuticals
Company profile: Savient Pharmaceuticals, with a market value of $138 million, is a specialty biopharmaceutical company with one meaningful drug, Krystexxa, which treats chronic gout refractory to conventional therapy.
Investor takeaway: Its shares are down 9 percent this year and have a three-year, average annual loss of 26 percent. Morningstar says its shares, now at $1.92, are trading at 35 percent of their fair-value estimate of $5.50. Analysts give its shares one “buy” rating, six “holds,” two “weak holds,” and one “sell,” according to a survey of analysts by S&P.
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