A good screener for picking undervalued stocks is the forward price-earnings ratio. Of course, when it comes to growth stocks, it makes sense to look at the price-earnings-to-growth ratio (PEG ratio). I am, however, focused on blue-chip names in this column trading at a valuation gap and could witness a strong reversal.
The broad market sentiment seems positive, with the S&P 500 index trending higher by 6.8% for year-to-date. The index currently trades at a price-earnings ratio of 27.5. I am positive about the markets, as there is a likelihood of rate cuts in the coming quarters. The blue-chip undervalued stocks discussed trade at a forward price-earnings ratio significantly lower than the index P/E.
The reason includes industry or company-specific headwinds. However, investors should take note whenever any blue-chip stock trades at a valuation gap. In my view, these ideas will likely deliver high total returns in the next 24 to 36 months.
Let’s discuss the reasons to be bullish on these ideas.
Vale (VALE)
Vale (NYSE:VALE) is among the most undervalued stocks to consider. In the last six months, VALE stock has remained sideways and trades at a forward price-earnings ratio of 4.9. Further, the stock offers a dividend yield of 7.26%. I believe a breakout on the upside is imminent from current valuations.
A potential trigger for a big rally is the likelihood of rate cuts in the second half of 2024. Expansionary policies will support growth, and industrial commodities are likely to trend higher.
It’s worth noting that for Q4 2023, Vale reported an adjusted EBITDA of $6.7 billion. If iron ore remains in an uptrend, the annualized EBITDA potential for the year is likely to be in the range of $28 to $30 billion. That would imply robust free cash flow potential.
Another reason to like Vale is the company’s investment in metals that will support the global energy transition. That includes copper and nickel. In the next five years, Vale is likely to have a diversified portfolio of commodities delivering growth and cash flow upside.
AT&T (T)
AT&T (NYSE:T) is another massively undervalued stock that currently trades at a forward price-earnings ratio of 7.5. Besides the undervaluation, T stock offers an attractive dividend yield of 6.6%. With business developments being positive, it’s a matter of time before the stock surges higher.
It’s worth noting that AT&T continues to report steady growth in phone and fiber subscribers. The reason is the company invested more than $140 billion in U.S. wireless and wireline networks between 2018 and 2022. These investments will continue to yield positive results in the coming years. I am particularly bullish on the company’s 5G subscriber growth.
Another important point to note is that AT&T reported free cash flow of $16.8 billion last year. For the current year, the FCF guidance is higher at $17 to $18 billion. Robust cash flows ensure deleveraging, and as credit metrics improve, I expect T stock to trend higher.
AGCO (AGCO)
AGCO (NYSE:AGCO) stock has been in a broad consolidation range since February 2021. I am bullish on a strong breakout on the upside, with the stock trading at a forward price-earnings ratio of 8.2. With the global food shortage, the agriculture sector needs investments, and I believe AGCO will be among the beneficiaries. As an overview, AGCO is a manufacturer of agricultural machinery and provides precision agriculture technology.
For 2023, the company reported 13.9% growth in revenue on a year-on-year basis to $14.4 billion. However, the company expects challenging markets this year due to lower farm income. I am, however, positive for the next few years considering the following factors.
First, with weak GDP growth, there is a strong case for expansionary monetary policies globally. As interest rates decline, the demand for agricultural equipment is likely to increase. Further, AGCO is investing in technology along with investment in patented value-added products for farmers. That factor will likely help the company maintain and potentially gain market share.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
