The U.S. stock market witnessed a predictable seasonality trend in the third quarter of 2023, with August and September reaffirming their notorious status as harsh months for U.S. equities. Historically, the fourth quarter has been the best for the U.S. stock market but it has started on a shaky note.
All the major U.S. indices closed lower yesterday as Treasury yields soared to their peak levels since 2007, stoking fears that higher interest rates could stall the housing market and potentially usher the economy into a recession. Specifically, the 10-year Treasury yield ascended to 4.8%, a high not witnessed in 16 years, while the 30-year yield reached 4.925% — the highest level since 2007.
Market players are now on tenterhooks as the Federal Reserve has hinted one more rate hike of 25 basis points by year-end, signaling a prolonged high-interest-rate environment. The first rate cut isn’t expected before the second quarter of 2024, while the elusive 2% inflation target of the central bank is projected to remain unmet until 2026.
Value Investing is the Key
Despite the statistical leanings toward a robust fourth-quarter rally, the initial pullback has cast doubts among some investors regarding its fruition. In times of uncertainty, value investing should be one of the most effective investment approaches. This approach can protect investors from market volatility and economic challenges as they navigate the final quarter of 2023.
Value investing takes a long-term view and seeks to gauge the intrinsic value of companies based on their fundamental strength, earnings potential and financials. It seeks to profit from investing in stocks that appear to be trading at a discount to their intrinsic values and eventually make handsome returns when the stock price rises toward that value, reflecting the actual fundamentals.
One of the most common valuation metrics to pick undervalued stocks with solid upside potential is the P/E ratio. However, there’s another interesting ratio that you can consider for ferreting out attractively valued stocks. And that is earnings yield. One could invest in high earnings yield stocks like Pilgrim’s Pride Corporation PPC, Urban Outfitters Inc. URBN, Plains GP Holdings, L.P. PAGP, DMC Global Inc. BOOM and Vistra Corp. VST to fetch handsome long-term rewards.
Earnings Yield More Illuminating Than P/E
Earnings yield is useful for investors concerned about the rate of return on investment. This metric, expressed in percentage, is calculated as annual earnings per share (EPS) divided by market price. This metric measures the anticipated yield (or return) from earnings for each dollar invested in a stock today. While comparing stocks, if other factors are similar, the ones with higher earnings yield are considered undervalued, while those with lower earnings yield are seen as overpriced.
While earnings yield is nothing but the reciprocal of the P/E ratio, it is a little more illuminating than the traditional P/E ratio as it also facilitates the comparison of stocks with fixed-income securities. Investors often compare the earnings yield of a stock to the prevailing interest rates, such as the current 10-year Treasury yield, to get a sense of the return on investment it offers compared to virtually risk-free returns.
If the yield on a stock is lower than the 10-year Treasury yield, it would be considered overvalued relative to bonds. Conversely, if the yield on the stock is higher, it would be considered undervalued. In this situation, investing in the stock market would be a better option for a value investor.
The Winning Strategy
We have set an Earnings Yield greater than 10% as our primary screening criterion but it alone cannot be used for picking stocks that have the potential to generate solid returns. So, we have added the following parameters to the screen:
Estimated EPS growth for the next 12 months greater than or equal to the S&P 500: This metric compares the 12-month forward EPS estimate with the 12-month actual EPS.
Average Daily Volume (20 Day) greater than or equal to 100,000: High trading volume implies that a stock has adequate liquidity.
Current Price greater than or equal to $5.
Buy-Rated Stocks: Stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have been known to outperform peers in any type of market environment.
Here we discuss five of the 36 stocks that qualified the screening:
Pilgrim’s Pride is engaged in the processing, production, marketing and distribution of frozen, fresh as well as value-added chicken products.The Zacks Consensus Estimate for PPC’s 2024 earnings implies year-over-year growth of 69.3%. Estimates for 2023 and 2024 earnings per share have moved up by 4 cents and 2 cents, respectively, over the past 60 days. Pilgrim’s Pride currently sports a Zacks Rank #1 and has a Value Score of B.
Urban Outfitters is a lifestyle specialty retailer that offers fashion apparel and accessories, footwear, home decor and gift products. The Zacks Consensus Estimate for URBN’s fiscal 2024 and 2025 earnings implies year-over-year growth of 83.4% and 5.1%, respectively. Estimates for 2023 and 2024 earnings per share have moved up by 41 cents and 36 cents, respectively, over the past 60 days. Vistra currently sports a Zacks Rank #1 and has a Value Score of A.
Plains GP is a leading midstream energy services provider, involved in the transportation of crude oil and natural gas liquids. The Zacks Consensus Estimate for PAGP’s 2023 and 2024 earnings implies year-over-year growth of 44.2% and 31.8%, respectively. Estimates for 2023 and 2024 earnings per share have moved up by 50 cents and $1.20, respectively, over the past 60 days. Plains GP currently sports a Zacks Rank #1 and has a Value Score of A.
DMC Global is one of the leading providers of engineered products used for construction, energy, industrial processing, and transportation markets worldwide. The Zacks Consensus Estimate for BOOM’s 2023 and 2024 earnings implies year-over-year growth of 197% and 24%, respectively. Estimates for 2023 and 2024 earnings per share have moved up by 22 cents and 19 cents, respectively, over the past 60 days. DMC Global currently sports a Zacks Rank #1 and has a Value Score of B.
Vistra operates as an integrated retail electricity and power generation company. The Zacks Consensus Estimate for VST’s 2023 and 2024 earnings implies year-over-year growth of 197% and 23.9%, respectively. Estimates for 2023 and 2024 earnings per share have moved up by 43 cents and 37 cents, respectively, over the past 60 days. Vistra currently sports a Zacks Rank #1 and has a Value Score of B.
Urban Outfitters, Inc. (URBN): Free Stock Analysis Report
Pilgrim’s Pride Corporation (PPC): Free Stock Analysis Report
DMC Global (BOOM): Free Stock Analysis Report
Plains Group Holdings, L.P. (PAGP): Free Stock Analysis Report
Vistra Corp. (VST): Free Stock Analysis Report
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Zacks Investment Research
This article originally appeared on Zacks
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