Don’t be fooled! These stocks aren’t the great values they seem to be

 

Over the last few weeks, I have taken multiple approaches to evaluating stocks, with one article focused on overvalued stocks, and another on undervalued stocks. In both articles, the research centered around determining valuation by looking at P/E ratios, but along the way I encountered a lot of stocks that looked undervalued at first glance, but wound up actually not being a good value at all.

This week I want to focus on a few of those companies. As I have discussed in the past, when I begin my searches for attractively-valued stocks, I like to begin narrowing down the overall stock universe to those stocks which have P/E ratios between 15 and 20. I have found through the years that this is typically where stocks find their natural trading range (obviously some sectors tend to trade at much higher or lower valuations), and that it how I began today's search.

Each of the following stocks has a P/E ratios lower than 20, but each also trades at a valuation greater than its industry's average. In some cases the valuations can be partially accepted due to upbeat earnings growth estimates, but in all cases there are better values to be found within each sector.

Let's be clear, the point of this article is not to suggest that current shareholders quickly move to close out their positions, but merely to suggest that investors looking to jump into these stocks may want to consider an alternate stock with a more attractive valuation and greater future stock appreciation potential.

Delta Air Lines

Atlanta-based airliner Delta Air Lines (DAL) has a decent P/E ratio of just 19, which looks even better when you consider that analyst have forecast the company to grow earnings by 20% in 2016 versus 2015. Typically this would be an easy pick for value investors, but when we look around the company's industry we see some better alternatives, one being JetBlue (JBLU). JBLU trades at a much lower valuation, with a P/E of just 14.7. JetBlue is not expected to grow earnings quite as much as Delta, but analysts do peg the company to enjoy 13% earnings growth in 2016. The extra earnings growth forecast for DAL does not warrant the stock trading at such a higher multiple, and with the overall industry averaging a P/E of 14.7, DAL appears to be a bit overvalued at the current level.

Charts courtesy of www.stockcharts.com 

Prudential Financial

Life insurance provider Prudential Financial (PRU) has a stock price of $87.09, and shares trade with a P/E of 18.5, slightly higher than the industry average of 17.2. Looking ahead, analysts do expect to see earnings growth, but the forecast calls for a modest 4 percent jump in earnings next year. Looking through the sector, there are multiple stocks with more attractive valuations. American International Group (AIG) has a much lower P/E of just 10.7. You would assume that the wide gap in valuations has to do with a weak earnings growth forecast for AIG, but that is not the case. AIG is forecast to grow its earnings by 13% next year, and combined with the lower valuation appears to be a much better value at the current time.

Charts courtesy of www.stockcharts.com 

Ford

I like Ford (F), and I am generally bullish on the overall auto sector, but even with the recent downtrend in F shares, the stock is valued well above the rest of its sector. F currently trades at $14.48, with a P/E of 18.5. The company is expected to grow earnings by 18% next year, which does account for the stock trading at a higher valuation the rest of the industry, but right now General Motors (GM) appears to be the better value. GM trades with a P/E of just 11.4, and the company's earnings growth estimates are still OK, although lower than Ford, with analysts forecasting GM to grow earnings by 7% next year. Both stocks have been trending lower over the last few months, but analysts expect the auto industry to show impressive sales numbers through at least 2018, and as sales rise, optimism will come back into the sector. When that occurs, traders will likely focus on those stocks with the lowest valuations, and I believe more money will come into GM than it will into F stock. The overall sector has an average P/E of 13.3, and until F's valuation falls closer to that level, at least down to around 15, I see the stock as being overpriced.

Charts courtesy of www.stockcharts.com 

Bank of America

Financial giant Bank of America (BAC) is trading at $17.74, with a P/E of 18.5. The stock is pulling back from a recent post-earnings spike, but the stock's valuation is still well above the industry average. On average, stocks in the industry trade with a P/E of 12.9. One thing working in Bank of America's favor is that analysts are bullish on the company's future earnings potential, forecasting earnings growth of 17% in 2016 versus 2015, so there is some rationale for the stock's valuation, but even with such an impressive growth forecast the stock should not trade at such a higher multiple to the overall sector. JP Morgan (JPM), for example, has a much lower P/E of just 12.2, and the company is forecast to grow its earnings by 9% in 2016. While JPM's growth estimates are lower than BAC's, the gap is not wide enough to warrant such a difference in the valuations. JPM appears to be a much better value at the current time, and until BAC falls a little further the stock will remain overvalued.

Charts courtesy of www.stockcharts.com 

Duke Energy Corp.

Utility stock Duke Energy Corp. (DUK) trades at $72.89, with a P/E ratio of 18.2. The industry as a whole averages a P/E of 15.7, so DUK's valuation looks a bit high, even with the stock trading sharply lower from its 52-week high. If analysts had an extremely bullish forecast for the company's ability to grow earnings, the valuation would make more sense, but analysts expect to see just 5% earnings growth next year. Looking at another big player in the sector, CenterPoint Energy (CNP), we see a much better value play. CNP has a P/E of just 14.3, and analysts forecast earnings growth of 9% next year. With a valuation that is lower than the industry average, and a more bullish growth forecast, CNP looks like the good buy in the sector, with Duke Energy appears to have more room to the downside.

Charts courtesy of www.stockcharts.com

Michael Fowlkes is a financial writer who has been with the Fresh Brewed Media family since 2004. Over the course of his tenure with Fresh Brewed Media, he has worn many hats, including portfolio manager, options analyst, and writer. Michael received his undergraduate degree from Virginia Tech in Accounting and got his start in finance working as a stock trader for six years at Chase Investment Counsel in Charlottesville, Va.


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