LEVI - Rediscovering Value: Top Picks For A Market On The Turn

2023-12-06 14:14:44 ET

Summary

• Undervalued Opportunities in Transition: We believe the stock market is currently ripe with undervalued opportunities, signaling a significant transition from high-flying growth stocks to more stable and reliable value stocks.
• Economic Shifts Favoring Value Stocks: The changing economic landscape, marked by rising interest rates and persistent inflation concerns, is driving investor sentiment toward the relative safety and stability of value.
• Value Investing's Rising Appeal: Amidst market volatility, value investing is gaining traction. Recent trends indicate that value funds are outperforming growth funds, marking a notable shift in investment strategies.
• Strategic Trade Ideas for Value Picks: The article presents strategic trade ideas within the apparel, technology, and commodities sectors, focusing on companies like Levi Strauss, Corning, and Vale S.A., which exemplify the principles of value investing.

While Thanksgiving leftovers might be a distant memory, the stock market still offers a feast of undervalued opportunities waiting to be savored. As we transition from the exuberance of growth stocks to the steady reliability of value stocks, it's time to rediscover the art of value investing in a market teetering on the edge of change.

The current market environment is a complex tapestry woven with threads of rising interest rates and persistent inflation concerns. The Federal Reserve's hawkish stance, with a series of interest rate hikes in 2023, has been a pivotal factor in reshaping investor sentiment. The Fed Funds Rate saw a significant increase in 2023, a stark contrast to the near-zero rates during the pandemic. This shift is nudging investors towards the relative safety of value stocks, known for their lower volatility and stable dividends.

Investor sentiment, once riding high on the growth stock wave, is now turning towards value investing. This strategy, often associated with long-term gains, appears increasingly attractive in today's volatile market. A report by Morningstar in late 2023 highlighted a notable pivot in investor preference, with value funds outperforming growth funds for the first time in years. This shift is not just a fleeting trend but a strategic realignment in response to the evolving economic landscape.

In this article, we'll delve deep into the realm of value stocks, exploring what makes a stock a ' value ' pick in the current context. We'll focus on sectors like Energy, Financials, and Consumer Staples, where value opportunities are particularly ripe. Moreover, we'll profile a select few companies that exemplify value investing in today's market, backed by robust financial health, market position, and growth potential. Our analysis will be grounded in solid data and market insights, offering a balanced perspective on how these value stocks stack up against their growth counterparts.

So, let's embark on this journey of rediscovery, where the overlooked gems of the stock market await those with the insight to see their true worth.

The Anatomy of a Value Stock

In the heart of value investing lies the principle of intrinsic worth - finding stocks that the market undervalues. These are the stocks trading at prices lower than their fundamentals would suggest. Key indicators to identify such stocks include:

• Price-to-Earnings (P/E) Ratios : A primary metric for value stocks. A lower P/E ratio can indicate a stock is undervalued compared to its earnings. For instance, as of late 2023, the average P/E ratio of the S&P 500 hovers around 27 times earnings, but value stocks often trade at significantly lower multiples.
• Dividend Yields : Value stocks frequently offer higher dividend yields. This not only provides a regular income stream but also signals a company's financial stability. The S&P 500's average dividend yield, as reported by the Wall Street Journal in late 2023, was around 1.5%, while many value stocks exceed this benchmark.
• Stable Earnings : Consistent and predictable earnings are hallmarks of value stocks. They typically belong to established companies with proven business models, as opposed to the high-growth but often volatile earnings of growth companies.

Sector Spotlight: Value Opportunities and Trade Ideas

We recently went through hundreds of stocks to find our 2024 Trade of the Year idea. Our Trade of the Year finalists not only exemplify value investing principles but also represent sectors that currently offer compelling value opportunities:

1) Apparel (Levi Strauss - LEVI) : The apparel sector, often perceived as vulnerable to economic cycles, holds hidden gems for value investors. Companies like Levi Strauss, with strong brand equity and a diversified product range, demonstrate resilience and adaptability. Despite the sector's susceptibility to consumer spending shifts, firms with a solid foundation and strategic vision can offer stable returns, making them attractive for value-focused portfolios.

2) Technology (Corning - GLW) : Technology is not typically the first sector that comes to mind for value investing, given its association with high growth and volatility. However, companies like Corning break this mold. Specializing in specialty glass and ceramics, Corning is integral to various tech applications, from smartphones to fiber optics. Its consistent innovation, coupled with a strong market position, makes it a standout value pick in the tech sector.

3) Commodities (Vale S.A. - VALE) : The commodities sector, particularly in the current economic climate, presents unique value opportunities. Companies like Vale S.A., with a strong foothold in essential commodities like iron ore, are well-positioned to capitalize on global economic recovery and infrastructure spending. Their role in the global supply chain, combined with robust demand for their core products, underscores their potential as value investments.

Trade Ideas Using Options

Of course, you can simply buy our picks but - if we are confident a stock is going to go up - then there's nothing wrong with using stock options to give ourselves a little bit of leverage, is there? For a trade of the year, we try to identify stocks where we can construct an option spread that is highly likely to return 300% on cash over the course of the year.

We like to find stocks that, most importantly, have a solid floor at the current price, and we then look for stocks that have a fairly bulletproof outlook for the next 12 months and then we look for stocks that have a likely catalyst that will lead other investors to them in the next 3-9 months.

With that in mind, these are the trade ideas we constructed for our Final 3:

1 - Levi Strauss (LEVI) $15.24 :

• P/E Ratio and Dividends : LEVI's P/E ratio stands at 11.7x, well below the sector average, signaling its undervaluation. The company also offers a dividend yield of 3.16%, showcasing its commitment to returning value to shareholders.
• Trade Idea :
  • Sell 10 LEVI 2026 $15 puts at $4.00 ($4,000)
  • Buy 20 LEVI 2026 $10 calls at $6.40 ($12,800)
  • Sell 20 LEVI 2026 $15 calls at $3.50 ($7,000)

This trade capitalizes on LEVI's solid fundamentals and brand strength in the apparel sector, offering a balanced risk-reward profile. The cash outlay is net $1,800 on the $10,000 spread, so the upside potential is $8,200 (455%).

The risk is being assigned 1,000 shares of LEVI at $15 ($15,000) and losing the $1,800 so net $16.80 per share ($16,800) is your worst case - a 10% premium to the current price but LEVI only has to HOLD $15 for us to make 455%. If you were to buy 1,000 shares for $15,240 you would need more than a 50% pop to make $8,000 and your risk is not much less to the downside - options win!

2 - Corning (GLW) $28.72 :

• P/E Ratio and Dividends : Corning's P/E ratio is 14.4, which is very attractive compared to tech industry averages. Its dividend yield of 3.94% further enhances its appeal as a value stock.
• Trade Idea :
  • Sell 10 GLW 2026 $32 puts for $5.40 ($5,400)
  • Buy 20 GLW 2026 $25 calls for $6.20 ($12,400)
  • Sell 20 GLW 2026 $37 calls for $2.75 ($5,500)

This options spread leverages GLW's innovation and market position in the tech sector, aiming for substantial upside with managed risk. In this case, our cash outlay is just $1,500 on the $24,000 spread that's $7,440 in the money to start!

The upside potential is $22,500 (1,500%) . Our worst-case scenario is owning 1,000 shares of VALE at $33,500 ($33.50) because we aggressively sold the puts but that's a reflection of how deeply undervalued we feel GLW is at $28.72.

• P/E Ratio and Dividends : Vale's P/E ratio is currently 6.1, indicating a potential undervaluation in the commodities market. The company's dividend yield stands at 8.6%, reflecting its financial health and profitability.

• Trade Idea for VALE :

1. Sell 15 VALE 2026 $17 puts for $4.10 ($6,150)
2. Buy 20 VALE 2026 $10 calls for $5.35 ($11,700)
3. Sell 20 VALE 2026 $15 calls for $2.45 ($4,900)

This trade idea is designed to capitalize on VALE's strong position in the commodities sector, offering significant upside potential with controlled risks. As with LEVI, we make our money even if the stock stays flat. We are spending a net $650 on the net $10,000 spread, so there's $9,350 (1,438%) upside potential (less buying back the short puts) if the stock simply holds $15.

Our worst case here is owning 1,500 shares of VALE at $17 ($25,500) and losing the $650 so $26,150/1,500 = $17.43/share is a number we can certainly live with if assigned. Imagine the stock is at $10 and we then double down, buying 1,500 more shares at $10, and we average $13.715/share. So, if we don't mind owning 3,000 shares of VALE for $13.715, which is 8.2% off the current price - that's our WORST case!

Each sector and corresponding company presents a unique value proposition, backed by solid financial metrics and strategic trade ideas. These picks not only align with the principles of value investing but also offer a diversified approach to portfolio construction in the current market environment.

Value vs. Growth: The Current State of Play

While growth stocks have had their moment in the sun, the current economic climate is casting a favorable light on value stocks. The key difference lies in their approach: growth stocks are about potential and rapid expansion, while value stocks are about stability and intrinsic worth. This distinction becomes crucial in times of economic uncertainty, where the promise of stability often trumps the allure of rapid growth.

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