Signing out of account, Standby…
If and when inflation subsides, many stocks will see their valuations trend higher. These three stocks could see some of the most pronounced multiple expansion.
From consumer spending to corporate earnings, inflation is impacting seemingly every aspect of the global economy.
So it’s not surprising that elevated prices are affecting stock valuations too.
Historically, when inflation flares up, equity price-to-earnings (P/E) ratios go down. When inflation is subdued, P/E ratios tend to rise. Why is that?
At the end of the day, a P/E ratio is simply what investors are willing to pay for a company’s profits. A given level of earnings becomes worth less when inflation diminishes purchasing power. Therefore, it is in these times that investors are willing to pay less for profits. Bid prices decline as do P/E ratios.
With the current market correction being driven by concerns around inflation and rising interest rates, growth and value stocks alike are seeing downward P/E revisions. In the S&P 500, more than 50 names have trailing P/E ratios under 10, a figure that seemed unfathomable heading into the new year.
If and when inflation subsides, many stocks will see their valuations trend higher. These three stocks could see some of the most pronounced multiple expansion.
Like most semiconductor names, Micron Technology, Inc. (NASDAQ: MU) is down significantly this year as is its P/E ratio. It is trading around 9x trailing earnings, which is well below its five-year historical average multiple of 13x—and miles away from the industry average of approximately 22x.
The country’s largest memory company, Micron is experiencing strong demand and pricing across the business—especially from data customers. This drove a sizable fiscal Q2 earnings beat that was accompanied by a bright outlook. Management guided to $8.7 billion in current-quarter revenue which implies 20% year-over-year growth.
It also suggests that Micron is managing supply chain challenges well to meet demand from its diverse enterprise and consumer end markets. The company has been staying ahead of the curve by securing new supply sources and inking long-term deals with customers.
The stock gets even more interesting from a forward earnings perspective. At 7x this year’s earnings estimate, investors may be in for a memorable P/E expansion.
Bread Financial Holdings Inc. (NYSE: BFH) is no stranger to low P/E ratios but the current multiple is low even for its standards. The former Alliance Data Systems goes for less than 4x trailing earnings compared to its historic average of 11x. The distant departure from the norm isn’t the result of a broken business model. In fact, the fundamentals are quite healthy.
The company’s private-label credit cards and related financial products are once again in demand from industries that were hard hit during the pandemic. Airlines, cruise lines, and retailers drove a 15% jump in first quarter revenue. These customers now face rising input costs and supply chain disruptions which have sliced Bread Financial’s recovery gains in half.
The longer-term picture looks clearer. Pent-up travel demand is one force that is likely to remain strong and, along with it, consumer interest in co-branded cards and unique financing options. Bread Financial also participates in the buy-now-pay-later space, which is being pressured by rising rates but has a bright future as an alternative to high interest credit.
Bread Financial won’t return to its glory days of trading near $300 anytime soon. Over time, however, expect the yeast to kick in and the valuation to rise.
Trading in Owens Corning (NYSE: OC) has been very choppy of late but there has been one constant—an attractive valuation. The building materials manufacturer is going for 8x this year’s earnings estimate, which is about half the historic P/E of both the company and its industry.
Even factoring in the inflation effects, this is a dirt-cheap price to pay for a company that just delivered 59% profit growth in the first quarter. The stock has since trended higher but the advance has been slow amid market concerns about a slowing residential housing market. Since Owens Corning derives a lot of revenue from insulation and roofing products, the stock’s fortunes are largely tied to mortgage rates and building activity.
Management expressed confidence in the resilience of U.S. housing demand. Combined with an upbeat view around the company’s commercial and industrial markets, it predicted solid growth in the current quarter despite the inflationary and supply chain pressures.
At a time when many cyclical companies are taking a cautious approach to dividend policy, Owens Corning is raising the roof. Earlier this year it hiked its dividend payout by 35%, marking the seventh consecutive year of dividend increases. A growing dividend and deeply discounted P/E make it a good time to build a foundation in Owens Corning stock.
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Emily Rella
Entrepreneur Staff
Jason Feifer
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