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Avoiding Value Traps in a Rising Rate Environment – September 22, 2022

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Value stocks, as many people already know, are those that are undervalued at a given time. They may be undervalued because investors have somehow not discovered them, or because they fell out of favor at a certain time and their turnaround went unnoticed.

Stocks could also be undervalued because there are internal issues such as competitive weakness, lack of innovation and R&D, weak fundamentals, deteriorating asset base, increasing debt, poor cash flows, accounting irregularities or any number of other reasons. Such stocks tend to languish, never quite living up to investor expectations. These may be referred to as value traps.

Avoiding value traps in an environment of Fed-induced weakness is therefore tricky. What would you look for as indicators, for example? The Fed’s actions would be raising costs and hurting demand across sectors. So how could you tell if the weakness is attributable to weak fundamentals or the Fed?

There is no easy answer to this except that you must go deeper into the financials and also study what management says on calls. Right now, management of most companies are calling out the macro situation, and if they have international operations, they also refer to geopolitics or China shutdowns, and so on. Some are still seeing supply constraints and rising input costs that are again related to these factors.

Since high inflation and weak stock market returns are likely to stay for a while, one way of playing the market is by getting into stocks that benefit from the Fed’s actions. Financials immediately come to me. Energy is another hot spot despite recent actions that have helped price moderation. And in case of a recession, staples and essentials get the upper hand.

But simply picking the sectors that are relatively attractive isn’t enough. Because you could be missing an opportunity to buy value stocks that will pay off in the long term. Therefore, there is the need to look for other positives.

For example, otherwise strong companies could pay a dividend (or increase it) since the scope for growing the business is limited by current conditions. They could also decide to pay down their debt.

A look at analyst estimates also helps because they’re the ones that do the field research and can therefore tell what is actually going on with the company.

Today, I’ve picked five Zacks Rank #1 (Strong Buy) stocks that also have a Value Score of A. And true enough, the A is justified by their low valuation in terms of P/E, P/S and PEG. But as discussed above, a low valuation is not enough, particularly in the current environment. Therefore, a proper discussion on their pros and cons is in order:

First up is HF Sinclair Corporation (DINO Free Report), which has also got an A for Value, Growth and Momentum, according to the Zacks Style Score system. This is an indicator that the stock is attractive for all investor types. It belongs to the Alternative Energy – Other industry (top 27% of Zacks-classified industries), and benefits from the ongoing strength in the energy market.

HF Sinclair beat the Zacks Consensus Estimate by 24.2% in the last quarter. Analysts appear to be impressed with its prospects. They’ve raised the 2022 estimate by 15.5% in the last 60 days. The 2023 estimate also increased by 8.6%.

The company’s return on assets is showing an increasing trend while its debt-cap is showing a decreasing trend. The net cash position, while still negative, is also showing a positive trend.

Its dividend currently yields 3.17%.

With a P/E of 5.1X, PEG of 0.34 and P/S of 0.38, the shares are clearly undervalued. They are also trading at a significant discount to the median level over the last five and ten years because of steady price declines this year, especially since May.

Considering all of these factors, we can say that DINO stock is not a value trap. It really is worth buying.

Deutsche Telekom AG (DTEGY Free Report) is another stock with a number of positive metrics. Other than the #1 rank, the shares have an A for Value, B for Growth and C for Momentum. The Diversified Communication Services industry to which it belongs is in the top 38% of Zacks-ranked industries.

Earnings estimates on this stock are up slightly in the last 60 days. For 2022, they’re up an average of 6 cents (4.5%) while for 2023, they’re up 8 cents (5.6%). Therefore, analysts are optimistic about the company’s growth both this year and in the next. And that’s despite the fact that there’s a fair chance of a recession next year.

Its return on assets was impacted by the pandemic but has been rising in recent quarters. Its Debt-cap has been declining steadily and the current 56% level is not excessive. While negative, the net cash per share shows an improving trend in recent quarters.

It also pays an attractive dividend that currently yields 3.63%.

Its valuation too is cheap. Based on P/E, the shares are trading at a slight discount to their median level over the past year, as well as the last five years. The PEG of 0.76 and P/S of 0.69 also indicate that investors are discounting its earnings growth and sales.

#1 ranks Marubeni Corporation (MARUY Free Report) has a Value Score of A but D for both Growth and Momentum. It belongs to the Diversified Operations industry (top 22%).

In the last 60 days, analysts have raised their 2022 estimate by 35.6%. The 2023 estimate was raised by 32.3%. Therefore, the growth outlook is very good.

Its return on assets has been increasing for several quarters now while the debt-cap has been declining steadily. The net cash situation isn’t too great however, as most of its assets are fixed and liquidity is low. This is not a negative given that assets are fruitfully deployed.

Marubeni’s dividend currently yields 4.81%.

The P/S of 0.21 and PEG of 0.53 indicate significant undervaluation. On a P/E basis, valuation is in line with historical levels (lower than median value).

Marathon Petroleum Corporation (MPC Free Report) has an A for Value, Growth and Momentum. Plus, it belongs to the Oil and Gas – Refining and Marketing industry, which is in the top 4% of Zacks-classified industries.

The earnings beat in the last quarter was by 15.7%. In the last 60 days, the 2022 estimate increased 14.5% while the 2023 estimate increased 13.0%. As discussed above, this is encouraging.

Return on assets is showing an encouraging trend and the debt cap appears reasonable. Net cash is negative.

The company also pays a dividend that yields 2.45%.

Despite these positives, the shares are trading close to their lowest point over the past year on a P/E basis. The PEG is a mere 0.19 while the P/S is 0.29.

Unum Group (UNM Free Report) shares have Value, Growth and Momentum scores of A, C and A, respectively. They belong to the Insurance – Accident and Health industry (top 7%).

The company beat earnings estimates by 55.3% in the last quarter. In the last 60 days, the 2022 estimate is up 18.4% while the 2023 estimate is up 5.3%.

Like the others, its return on assets is setting an increasing trend line and the debt cap is at acceptable levels. Net cash is negative.

Its dividend currently yields 3.31%.

Conclusion

Although relatively difficult to hunt down, value stocks with a satisfactory growth outlook are safer bets. They can minimize the chances of falling into a value trap. And a proper study of the finances is also necessary.

One-Month Price Performance

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