Before getting into a discussion about value stocks, it’s important to point out what the label isn’t. Whenever a security – or anything for that matter – goes on sale, you must ask yourself why. If demand was robust to the point of overflowing, there would be little rational reason to provide a discount.
For example, many struggling restaurants will offer two-for-one deals and what not. While these bargains might be music to consumers’ ears, to investors, they should represent warning signs. Because restaurants often have razor-thin margins, promotions only exacerbate the situation. That would be an example of undervalued stocks that aren’t actually undervalued.
Instead, when you’re dealing with genuine value stocks, you want to look for non-core reasons why the underlying security printed red ink. Maybe it’s a temporary setback or an unexpected, non-recurring headwind. Or maybe it’s just market irrationality at play. Whatever the cause, the main question you should be asking is this: does a legitimate argument exist for a recovery?
If you can objectively answer “yes,” you may be dealing with real-deal value stocks.
Penske Automotive Group (PAG)
On the surface, Penske Automotive Group (NYSE:PAG) doesn’t appear a natural candidate for value stocks. For starters, PAG gained over 32% of equity value since the January opener. Then you have the much bigger problem of Penske’s business: operating an automotive and commercial truck dealership network. With inflation stubbornly elevated and borrowing costs through the roof, who’s going to buy a car?
Well, plenty if you think about it. Fundamentally, I’ve already laid out the case. Essentially, the average age of vehicles has soared to record highs so replacement demand should increase at some point. Now, the absolutely beautiful aspect of this argument is that it’s not theoretical speculation. Penske’s revenue continues to increase since 2020 but more importantly, the erosion of gross margin is arguably within acceptable ranges.
Back in the fiscal year that ended December 2019, Penske’s gross margin landed at 14.91%. On a trailing-12-month (TTM) basis, we’re looking at 16.84%, a modest erosion from 17.4% in 2022. That means consumers are still buying and Penske is mitigating the pain of the inflation/interest rate combo. In conclusion, PAG’s low earnings multiple of 8.92x is relatively credible, making it one of the genuinely undervalued stocks.
United Rentals (URI)
Moving over to United Rentals (NYSE:URI), the company makes a bit more intuitive sense as one of the value stocks. As the world’s largest equipment rental company, United offers enterprises a mechanism for business expansion without a heavy commitment to acquiring additional assets. Theoretically, this proposition should appeal to multiple enterprises because of the aforementioned inflation and high interest rate combo.
It must be stated that since the start of the year, URI gained almost 36% in the charts. Therefore, some might say that it doesn’t belong among undervalued stocks. Of course, I would disagree. For a start, United’s Q3 revenue popped at $3.77 billion, up over 23% YOY. Just as importantly, the margin contraction is very reasonable given the monetary policy.
Specifically, gross margin in Q3 landed at 42.1% (from 44.77% a year earlier). And operating margin was 29.32%, down from 30.15%. However, with all that said, net income clocked in at $703 million, up from $606 million one year ago.
Now, look at the low forward earnings multiple of 11.35x. Fundamentally and financially, United appears on solid ground. In my view, this ranks among the more credible value stocks to buy.
Eagle Materials (EXP)
Headquartered in Dallas, Texas, Eagle Materials (NYSE:EXP) is a producer of building materials. Per its public profile, it produces cement, concrete, construction aggregate, and other critical products. While the tricky economic environment might seem to impede EXP, so far, circumstances favor the underlying enterprise. Since the beginning of the year, EXP gained almost 40% of its equity value. So, how is it one of the discounted value stocks?
It’s all in the financials. While top-line growth has started to wane, the trajectory is still positive. In Q3, Eagle rang up $622 million in sales, up almost 3% YOY. However, what intrigued me was the gross margin of 33.59% in the latest quarter, an increase from the 32.1% posted one year earlier. Also, operating margin landed at 30.93%, a noticeable increase from 29.85% in Q3 2022.
Fundamentally, that’s a clue that Eagle is effectively mitigating the present economic weather, which features bouts of inclement events. Now, EXP isn’t the most discounted among undervalued stocks. Its earnings multiple of 13.78x is only a bit lower than the sector median of 15.09x.
However, if you’re looking for credible discounts you can trust, Eagle appears a proven commodity.
On the date of publication, Josh Enomoto did not have (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.
