The S&P 500 Index and Nasdaq Index have both performed well this year to date. Many stocks are considered as fully valued and there are not many buy opportunities now.
So, how can you find new investment opportunities?
Here we share 5 US stocks that we think are still cheap and have been purchased by hedge fund managers recently:
1) Capital One Financial Corp (NYSE: COF)
Capital One was bought by not one but two of the most followed investors – Michael Burry and Warren Buffett.
Capital One is a large American bank with about $34 billion in revenue and $7 billion in net income in FY22, resulting in earnings per share (EPS) of nearly $18 and a mid single digit P/E ratio based on its share price of $98. It also pays a quarterly dividend of $0.60 which puts the yield at about 2.4%.
Banks are within Buffett’s circle of competence. So when he buys a new banking stock, it’s worth paying attention.
The recent regulatory disclosures revealed that Buffett bought $1 billion worth of Capital One in 1Q23. To make room, he sold out of another banking stock, US Bancorp, a top ten holding for ten years until the middle of last year.
Capital One started off as a credit card company and has expanded into a full fledged bank with a focus on credit cards, consumer and commercial banking.
With the US economy deteriorating, it is unlikely that Capital One will be spared from rising credit losses and lower net interest margins. We think Buffett purchased the stock because he likes the management who have been there for a long time and possibly also because he thinks that the company’s stock price has been unfairly affected by the recent banking crisis.
2) Paypal (NASDAQ: PYPL)
Paypal was added by Ray Dalio’s Bridgewater this quarter. Also noteworthy is activist investor Elliott Management’s stake in Paypal which was purchased nearly a year ago.
Paypal’s share price performance was actually flat for 1Q23 but the share price has since declined roughly 19% since the start of 2Q23. Most of the decline happened in the recent 2 weeks after Paypal released its 1Q23 earnings.
Paypal’s 1Q23 results beat its previous forecasts on all major fronts with revenues up 10% vs the 7% forecast and EPS at $0.70 vs $0.64 forecast. Paypal revised its FY23 guidance for its EPS up from $3.27 to $3.42 and provided more clarity on its share repurchase plans, expecting repurchases to reach $4 billion which is nearly 6% of total shares outstanding based on a share price of $61 / market cap of $68 billion.
Paypal’s 1Q23’s operating margin was 14.2%, lower then 4Q22’s of 16.8% but higher than 1Q22’s of 11.0%. This was likely the reason the share price dropped as the market expected higher margins and a stronger revised forecast.
Valuations have also declined for Paypal amidst competition from Apple and Square, stifling Paypal’s growth. Paypal is also going through a leadership transition as its CEO indicated that he would retire at the end of this year and there has not yet been a successor appointed.
Paypal currently trades at a P/S ratio of 2.4 times and a P/E ratio of about 20 times based on its FY23 EPS guidance.
Putting things into perspective, Paypal’s revenue is still growing at high single digit percentages. Paypal is also working towards improving its margins from cost initiatives and carrying out share repurchases with its healthy free cash flow. Hence, there is a possibility that the market has over discounted this stock.
3) Paramount Global (NASDAQ: PARA)
Warren Buffett added a little more Paramount shares despite saying during Berkshire’s recent annual general meeting that streaming remains a challenging business as Paramount Global is in the midst of a transition from legacy businesses in cable TV and movies to a streaming future.
Buffett commented that it’s not good news when any company cuts its dividend dramatically after Paramount shares dropped 28% on 5th May following a disastrous quarterly earnings report that included a large loss and a slash to the company’s dividend.
He noted that the streaming business remains challenging, with numerous competitors keeping prices low, adding that it is easy to cancel a streaming subscription and move to a competing service. Competition is also harsh with many strong well capitalised players in the game who are ready to invest to gain market share.
Other large hedge funds such as Blackrock and Capital world also added share of Paramount global.
At Paramount’s last share price of $15.17, its market cap fell below $10 billion on annual revenues of about $28 billion.
Hence it is clear from the onset that this was a value play, with investors looking for a turnaround as the streaming business gradually moves to a mature stage with stabilized margins.
4) Disney (NYSE: DIS)
Activist investor Nelson Peltz, who runs the hedge fund Trian Fund Management, disclosed that he cut his stake in Walt Disney (NYSE:DIS) during Q1 but bought more shares since the end of Q1.
In the 1Q23’s filing, it was reported that Peltz reduced his stake from 9.4 million shares to 5.9 million shares. He then acquired about 0.5 million shares and now owns about 6.4 million shares.
This could be because Disney shares gained 15% in the quarter but fell after the Q1 earnings report which showed a decrease in the number of paid Disney+ members.
In January 2023, Peltz sought for a board seat on Disney, claiming that shareholder value has been eroded and raised issue with Disney’s acquisition of Fox in 2019. He also criticized Disney for poor corporate governance and succession planning.
In February, after Disney announced a restructuring that would cut 7,000 jobs and $5.5 billion in costs. Should the cost cuts be achieved, it would effectively double Disney’s income levels and return Disney’s profitability to its highs in 2018/2019 where Disney recorded earnings per share of above $6.
At Disney’s current share price of $91, should Disney be successful in maintaining its post covid revenue recovery as well as its restructuring plans, Disney’s P/E ratio would fall below 15 times which would potentially make Disney a cheap stock.
5) Target Corporation (NYSE: TGT)
Capital World, an investment management firm with more than $2.6 trillion in AUM bought 31.8 million shares of Target in 4Q22 and added another 4.3 million shares in 1Q23, bringing total holdings to 36.1 million shares valued at $5.5 billion or about 7.8% of Target.
Total revenue for 1Q23 was $25.3 billion, an increase of 0.6% compared with 1Q22. Operating income of $1.3 billion in first quarter 2023, was down 1.4% from last year, driven by an increase in SG&A expenses.
Inventory at the end of 1Q23 was 16% than last year, reflecting more than a 25% reduction in discretionary categories, partially offset by inventory investments to support rapidly-growing frequency categories, and strategic investments to support long-term market-share opportunities.
1Q23’s operating margin was 5.2%, 0.1% lower than 1Q22 but much higher than 4Q22’s margin of 3.7%.
Based on softening sales trends in the first quarter, Target provided a wide range for its forecast, expecting a low-single digit percentage decline in comparable sales and EPS to range from $1.30 to $1.70.
Over the next three years, Target expects its operating income margin rate will reach, and begin to move beyond, its pre-pandemic rate of 6%, and believes it could reach an operating income margin rate of 6% as early as next year, depending on the speed of recovery for the economy and consumer demand.
The Company did not repurchase any stock in 1Q23 despite having approximately $9.7 billion of remaining capacity under the repurchase program approved in August 2021. This is likely because Target has cash of $1.3 billion and long term debts of $16 billion.
For the full year, Target maintained its prior guidance, which includes expected comparable sales in a wide range from a low-single digit percentage decline to a low-single digit percentage increase, operating income growth of more than $1 billion, and EPS of $7.75 to $8.75 putting its forecast P/E ratio between 17.4 times and 19.6 times, a valuation not seen since 2019.
Target’s share price fell from a Nov 2021 high of $260 and Apr 2022 high of $240 to $150 currently. It is currently just off its 52 week low of $137 recorded in Dec 2022.
Cheap Stocks Still Exist
It is important to note that while there are reasons to purchase these cheap stocks, these cheap stocks are laggards due to certain reasons.
As such, if the overall market goes down, they may also decline in line with the broader market. However, the margin of safety and upside potential is probably much more for these stocks as compared to stocks that are viewed as fully valued.
