The past few years have been difficult for value investors. Technological disruption, combined with low interest rates, have seen high-growth stocks bid up to very high — some would say bubble-like — valuations. Meanwhile, many companies with low or inconsistent growth actually trade at very low valuations. And the gap between the haves and have-nots has been widening for an unprecedented amount of time.
Yet over the long term, the stock market is a weighing machine, not a voting machine, with every company’s value being equal to the present value of all its future cash flows. Given the vast underperformance of value stocks to date and the sky-high valuations of growth stocks, investors may want to give top-quality value stocks a chance as the economy recovers into 2021.
That’s why, even as the overall market sits near all-time highs, Micron Technology (NASDAQ: MU), Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL), and Bank of America (NYSE: BAC) all look like rock-solid buys at bargain-level valuations today.
Micron Technology: The cheapest way to play technology megatrends
There aren’t many value stocks that play into the big tech megatrends of 5G, artificial intelligence, and the Internet of Things, but memory leader Micron Technology is perhaps the cheapest. Micron is one of three large producers of DRAM memory and one of six large producers of NAND flash storage. Each are key building blocks of computing and storage and are set to grow exponentially over the next decade. Micron management estimates that demand for DRAM will grow at a mid- to high-teens rate over the long term, while NAND flash demand will grow around 30% annually.
So why is Micron so cheap? Well, DRAM and NAND are somewhat commodity-like, so prices per bit fluctuate according to supply and demand. The NAND industry still appears to be too crowded with too many suppliers, so it’s been hard to make money in that business; however, only 28% of Micron’s revenue was in NAND last quarter, with 72% from DRAM. DRAM’s three-company oligopoly is exercising discipline, leading to good profits, even in the recent downcycle.
Micron and others in the industry suffered an unprecedented downcycle beginning in mid-2018, when the U.S.-China trade war all of a sudden cut off demand after two boom years. And just when things began to turn around, the COVID-19 pandemic is prolonging that downturn. Yet both headwinds are set to ebb going into 2021, as not one but several new growth catalysts are expected to boost demand across 5G, cloud, PCs and new gaming consoles. As a result, the memory industry, especially DRAM, is set for another up-cycle.
Meanwhile, Micron’s stock is very cheap. It currently trades at just 1.4 times book value and 21 times its trailing net income. Keep in mind that trailing earnings figure should be the trough of the current memory cycle. Meanwhile, Micron is trading at just 13.8 times 2021 earnings expectations and a ridiculous 4.3 times its 2018 EPS, which was the most recent cyclical peak.
Assuming the DRAM market maintains its discipline, Micron’s stock looks absurdly cheap when looking out over the next few years.
Alphabet: The best value in FAANG
The big FAANG stocks are typically regarded as growth stocks that trade at relatively high valuations; however, I’d argue that Alphabet, the parent of Google, is a value stock at the current moment.
Sure, Alphabet doesn’t look like a value stock based on its 33.3 P/E ratio. However, consider the following:
- Alphabet has over $120 billion in cash sitting on its balance sheet, or about 12% of its market capitalization.
- Alphabet’s “other bets” segment, which consists of futuristic products and services such as Waymo self-driving cars and Verily life-sciences services, operated at a $4.8 billion loss in 2019, decreasing operating income by about 12%.
- Alphabet’s Google Cloud Platform grew 43.2% at a $12 billion run rate last quarter; however, because of heavy investments, it’s likely that the cloud business generated minimal profits, even though it would probably be valued at $300 billion or so as a standalone business.
When you therefore look at the sum of the parts of Alphabet, you find that its core digital advertising business may be valued at only around a low-to-mid-teens multiple. That’s absurdly cheap for the world’s dominant search engine, YouTube digital video properties, and Alphabet’s associated hardware products.
One reason for Alphabet’s absurd discount could be antitrust fears, with the U.S. Justice Department set to bring a lawsuit against Google soon. However, I have a hard time seeing how that would threaten Google’s core business in a material way, and any sort of antitrust regulation will probably take years to come to fruition.
Meanwhile, Alphabet is taking advantage by ramping up share repurchases relative to its past. It all adds up to a high-quality company at a huge discount, which is rare in this market.
Bank of America: America’s safest bank at a discount to book value
Next up is Warren Buffett’s favorite bank, Bank of America. In fact, Warren Buffett loves Bank of America so much that while he was selling most of his other bank stocks in the second quarter, he subsequently bought more Bank of America.
Why, may you ask? Well, more so than any other bank, Bank of America under CEO Brian Moynihan has pursued a strategy of “responsible growth.” That means Bank of America has pursued growth in a low-risk way, lending mainly to high-quality credits and prime consumer customers. While the company hasn’t exactly shot the lights out in terms of top-line growth over the years, its steady growth and increased cost efficiencies have led to terrific profitability. That’s allowed the company to return cash to shareholders in the form of repurchases and dividend growth.
Of course, with the coronavirus pandemic wreaking havoc on the economy, the Federal Reserve has prevented banks from repurchasing shares for the time being. In addition, all banks are now subject to restrictions on dividend payments that must line up with a bank’s trailing-12-month net income.
While many large banks may have to cut their dividend at some point this year — and a few already have — Bank of America’s responsible growth strategy has set it up for moments just like these, and its 2.84% dividend yield appears bulletproof. Even after taking large reserves for loan losses in the first and second quarters, Bank of America still earned $0.40 per share in Q1 and $0.37 per share in Q2, which already covered its $0.72 dividend.
Meanwhile, the first and second quarters should mark the low point for bank earnings, so things seem only as if they can improve from here as the economy recovers. Meanwhile, Bank of America is still trading at just 0.9 times book value and 12.2 times next year’s earnings estimates. That’s quite cheap for perhaps America’s safest big bank stock.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Billy Duberstein owns shares of Alphabet (C shares), Bank of America, and Micron Technology and has the following options: short January 2022 $30 puts on Micron Technology, short January 2021 $18 puts on Micron Technology, short January 2021 $25 puts on Micron Technology, and short January 2022 $35 puts on Micron Technology. His clients may own shares of the companies mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares) and Alphabet (C shares). The Motley Fool has a disclosure policy.
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