Stocks across the board are looking pretty cheap these days, but that doesn't mean they're all bargains. Rafael Resendes, co-manager of the Toreador Large Cap Fund in Fresno, Calif., explains the difference: "A lot of things appear to be on sale, but we don't naively say a stock has value because it has a low PE [price-earnings ratio]. It's more about the company's ability to generate a sufficient amount of future cash flow to more than [justify] today's market price."
To be included in the fund, companies must also have solid balance sheets (Resendes avoids those that achieve flattering quarterly earnings by robbing from future quarters by, say, a hasty product rollout.) Good managers that know how to successfully deploy cash and make savvy acquisitions are another requirement. Essentially, Resendes' investment decisions reach far beyond the numbers. Here are five cheap stocks he thinks have strong growth potential for the next two or three years:
CVS Caremark Corp. Astute acquisitions are one reason Resendes likes CVS. In 2007, the company bought Caremark, a pharmacy benefits manager (PBM); in 2008, it acquired Longs Drug Stores, which strengthened CVS's foothold on the West Coast. The company, which is currently the nation's largest retail pharmacy chain, has another big advantage aside from its scale: a PBM business that provides services to health plans at large corporations, unions, and government employee groups. "With the change of philosophy in the administration and Congress and as health-care benefits expand, this is going to be important," he says. The company's stock (symbol CVS), which reached a record high of $43 in May, recently traded at $28.
Freeport MacMoRan Copper & Gold. Like a lot of basic materials stocks, Freeport MacMoRan took a beating in 2008, falling from more than $100 to $25 recently. Even so, the world's largest copper producer is a play on inflation and the weakening dollar, Resendes says. "As the stimulus package progresses and winds its way into reality, there will be an increased demand for metals and Freeport MacMoRan is in a nice spot to satisfy that demand. He adds: "It's not an obvious play in this economy, but shareholders will be rewarded in the long term."
IBM. Emerging markets are a big growth driver for this computer systems and software provider. Not only that, Resendes says, IBM has "a bullet-proof balance sheet that will allow it to weather the current storm and position it for superior growth and profitability in the long term." He thinks the stock, which recently traded at $93, is worth $120 a share: ''There are some obvious companies that offer much bigger discounts, but you have to incorporate the safety factor. You're getting a premium company here that's a good spot to be in within the tech space."
Kohl's. With its value-priced merchandise, private label, and brand-name goods, Kohl's is part department store and part discounter. "It's not quite as high-end as Macy's, or as low as Wal-Mart," says Resendes. The near-term outlook for retailers is gloomy, but Kohl's should be in a good position when the economy rebounds, he says. "A lot of consumers have migrated to Wal-Mart in terms of price, but they'll migrate back up, and a natural first stop is going to be Kohl's." Another plus: Kohl's doesn't offer store credit cards, "so defaults aren't hanging over its head," says Resendes. "That will be a great strength when we exit this economic turmoil." He sees a 25 percent upside to the company's shares, which recently traded at $38.
Oracle. This software service giant, which deals in a slew of databases, applications, product support, and other services, has also made some smart acquisitions, Resendes says. "The companies they've acquired--PeopleSoft, BEA, and Seibold--really round out the product line." What's more, Oracle's database business has been steadily gaining market share, he says, which is "a positive sign because they're starting to eat up competitors." Oracle's stock, recently $18, is trading slightly below what it was a year ago. Resendes thinks that share price could rise 25 percent.