We are in what is historically considered the slow season of the investing world. Mention the word October and investors can’t help thinking about the market crashes that took place in 1929 and 1987 during this month.
Prognostications about the market aside, there are still opportunities for the value-minded investors if they’re willing to turn over a rock or two. In August, we presented a few ideas and we’re back again with three more. Different industries will be in focus this month, and as we move forward with new articles, we’ll try to shine spotlights on fresh names each time. Before moving into October’s stocks, let’s first review how to identify undervalued stocks.
How To Identify Undervalued Stocks
Identifying an undervalued stock boils down to whether its current market price is lower than its intrinsic value. This can be a highly subjective endeavor, as the assumptions and thesis around an idea depend largely on an investor’s opinion. Investors also calculate differences in share prices using a variety of methods, but simply looking at popular valuation multiples is usually enough to get started on the hunt for value picks. Price-earnings ratio, price-to-book, enterprise value/Ebitda and price to adjusted funds from operations are common, useful metrics.
Once a measure has been picked, investors then need to decide on historical or relative comparisons. Historical comps are usually based on previous readings of a single company’s valuation multiples, while relative comps involve a side-by-side look of a company’s valuation multiples next to those of its peers. One approach isn’t necessarily superior to the other, although there are situations where investors should defer to best practices (i.e. REIT analysis).
Beyond the numbers, investors should also ask if there’s a fundamental reason for a stock’s undervaluation. Taking a holistic look at a company’s operations could reveal that its stock isn’t undervalued, but is actually experiencing a correction from being overvalued! Overall though, investors should try to form their own system for making portfolio picks. Extra layers of complexity like in-depth statistical modeling or unique fundamental research can help, but keeping their analysis simple and focused on core metrics can be just as functional for investors.
3 Undervalued Stocks For October 2023
- Take-Two Interactive
- Extra Space Storage
- Pfizer
When deciding on companies to analyze, I used a straightforward rubric based on simple fundamentals. First, the company has to be trading at a discount. Investors can select their preference for how to calculate this, but looking at revenue multiples, historical vs. relative share price comparisons, or even building a DCF model are all viable options. Next, I like to look at companies that have clear and meaningful revenue drivers for the near-future. This could be anything like a new product being offered or cost restructuring leading to increased operational efficiencies, but investors should try to identify these components when forming the qualitative argument for their picks. Last, I typically look at companies that are market leaders in some aspect relative to peers. This helps ensure that the discounted share price turns out to be an actual market mispricing and not a value trap, since reliable and established players in a given industry are more likely to execute turnarounds and/or maintain incumbency.
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Undervalued Stock #1: Take-Two Interactive (TTWO)
The gaming industry continues to be on a bit of a price rollercoaster since 2020, with many of its big companies currently trading right around their pre-Covid valuations. This industry is also defined by having big tech names that are only partially involved, like Microsoft and Sony. However, there are at least a few gaming-specific picks for investors looking to diversify: Take-Two is one such name. Remember though, this article is focused on finding undervalued stocks; this company meets this criteria for one simple but likely lucrative reason.
The name “Take-Two” probably doesn’t trigger recognition to a non-gamer or non-gaming investor. However, does Rockstar Games sound familiar? Possibly, but then the true cultural reference appears when the name Grand Theft Auto is mentioned. Easily one of the most popular game series ever, GTA has seen several releases and been a staple in Rockstar Games’ (now owned by TTWO) portfolio. What started as a straightforward narrative-driven game that allowed players to live the life of a criminal has now evolved into an open world online sandbox that allows gamers to build their own empire. The sheer amount of customization, game modes and replayability has made this game a cultural touchstone for gamers, despite the heavy criticism and sometimes controversy surrounding it. Regardless, its influence cannot be denied, and to describe the GTA series as a cash cow for Take-Two would be an understatement.
With Grand Theft Auto V alone, its most recent iteration, TTWO has made nearly $8 billion since its release a decade ago per the company’s filings. The opportunity to generate continuous revenue thanks to microtransactions means any similar title can have the same consistent financial impact, although some gamers don’t like the idea of paying for content.
What does this all mean for Take-Two? During the company’s most recent earnings call, there is a particular line delivered by the CFO
CFO
Even Bethesda Game Studios, owned by Microsoft and known for its Elder Scroll and Fallout series, released its new Starfield IP because they can only re-release Skyrim so many times. In recent years, the amount of new information, data and actual footage (although early) of GTA6 has started to crest. At this point, TTWO is having a harder and harder time keeping it under wraps, so it would make sense that they want to start hinting to both investors and fans that the newest game is on the way.
This is the crux of the undervalued argument here for TTWO: GTA6’s eventual financial impact on the company will be nothing short of tremendous. Can it replicate the $1 billion in sales in the first three days like GTAV did? Maybe, but it doesn’t need to either. Investors should recognize that the entry point for a successful investment in TTWO is sooner rather than later. Eventually, the company will give an exact timeline for the game’s release, this is a fundamental practice in the industry. Waiting until this occurs could limit your upside. The risk investors take now involves when that release will materialize and what might happen in the market, broader economy and to the company in the interim. There’s also a chance that the game itself fails to meet expectations, much like investing in a clinical stage biopharma company can be risky based on whether the company’s clinical candidate is approved or not. Also keep in mind that the company’s financials could be better.
Take Two’s most recent annual filing shows a net loss of $1.1 billion, a painfully different value from the previous year’s $418 million. This recent quarter isn’t necessarily off to a good start, with an earnings loss of $206 million. The balance sheet did improve, however, with the company’s current ratio going from 0.65 to 0.82. Overall, TTWO’s numbers could be better, but the sentiment around the company seems positive, as the share price is up nearly 40% year to date. Still, this movement hasn’t brought the company to its recent peak of $210.43; if GTA6’s release can push it to this point, investors would be looking at a return of 47% as of September 15. Investors wanting to build a model should consider the following drivers:
- Sales of newly released IP
- Recurring microtransaction revenue
- Consumer discretionary buying power
Undervalued Stock #2: Extra Space Storage (EXR)
Extra Space Storage is a storage REIT that investors could find in undervalued territory. The stock has shed nearly 30% in the last year, with earnings of $202.4 million in the last three months versus $232.1 million last year in the same period. However, given that EXR is a REIT, we need to consider funds from operations (FFO) for valuation purposes, usually a form of adjusted funds from operations (AFFO). This metric is good for a more consistent understanding of the company’s net income drawn from its expected or typical operating performance. So certain accounting methods (like depreciation and amortization) and one-time event items (like real estate transactions) are adjusted in or out of the calculation of that final earnings number.
Relative to last year, the baseline AFFO figure is about the same ($296 million vs. $304 million last year in the same period).
Is that 30% drop justified?
Maybe, but that depends on what investors decide to focus on. The recent M&A deal with Life Storage to become the largest self-storage operator in the U.S. market could be a reason for apprehension, as Life Storage investors are currently getting their shares bought at a premium. However, the deal is expected to be accretive, and given how similar the self-storage business is across regions in the U.S., management’s expected outcome for cost-saving synergies seems reasonable.
A rising interest rate environment could also be behind EXR’s declining share price. Companies that carry a large amount of debt (like many REITs) typically suffer in this kind of market environment, but EXR’s financials don’t present any obvious idiosyncratic risks. What could be an explanation is that EXR is simply moving down in sympathy with its peers, which wouldn’t be surprising or uncommon behavior from investors. Regardless of the reason, price momentum is not in EXR bulls’ favor. Can EXR’s FFO multiple return to its recent high of 91.8x in December 2021? Currently, investors are looking at a 60.9x multiple based on September figures, but when the turnaround could happen is part of the risk with this name.
From a technical perspective, EXR’s next support level is around the $110 mark, so this may be the moment to strike for investors looking for a near-term bottom. But overall, assuming that the deal with Life Storage pans out the way management expects, that macroeconomic conditions particularly in the U.S. improve/stabilize, and that EXR continues to perform as well as it has, then this may be a solid REIT for investors to consider for their portfolios. Key drivers for EXR moving forward include:
- Federal funds rate
- Same-store revenue
- Benefits from LSI merger (like cost savings)
Are you looking to invest in stocks? Don’t buy just yet—take a close look at these 7 undervalued stocks recommended by the Forbes investment team. This is the same team behind Forbes’ highly successful Forbes Investor premium newsletter, which has outperformed the S&P 500 by a staggering 3X since 2000. And they think these stocks are strong buys!
Undervalued Stock #3: Pfizer (PFE)
The final pick for this month is a stalwart selection for those looking for large-cap value: Pfizer. A popular portfolio addition for many reasons, this company could be considered a bellwether in the pharmaceutical industry. With plenty of experience taking clinical candidates from early trials to full commercial launches, PFE is a name that attracts both growth and value investors.
Growth bulls are typically betting on new drugs making it out of PFE’s pipeline, while value investors find interest in the stock’s safe, consistent fundamentals. Pfizer has low beta, a growing dividend and is currently trading at a multi-year low. The notable peak occurred, arguably, as a result of the Covid-19 pandemic, since the company became a vaccine supplier for a significant portion of this market. The boost in income also drew a fairly large amount of volatility (relative to the company’s recent share price at that time), but the current price as of September 20 is close to a key support level (around the $31-$32 mark). PFE’s current P/E ratio of a little under 9 also presents a deal relative to the market (taken as the S&P 500, currently trading around 25), but this value is also roughly in-line with PFE’s average over the last two years (approximately 10). The full year dividend target of $1.64 is on track to be met, a testament to PFE’s successful balance sheet stewardship over the last several years.
Value investors tend to favor stable returns alongside wanting to buy at a discount. Under these conditions, PFE currently represents a good pick among peers in its size and industry. Not every bet that its pharmaceutical business makes will be a winner, but larger players in this industry like PFE usually have stacked pipelines (built from both M&A and from the company’s in-house research).Bulls will note that so long as its R&D spending (a common P&L line item to monitor when investing in pharmaceutical companies) translates into more breakthrough therapies and successful commercial product launches, PFE’s share price growth in the near-future should reflect the original upward trend that began following the 2008 financial crisis. On the other hand, bears should note that PFE’s revenue and margins are still in recovery mode; while the dividend has been reliable in the last few years, the company does need to find a new blockbuster drug for its non-Covid portfolio. PFE’s cost-cutting program is also a closely followed operational concern, so any poor developments there would likely hurt the company’s share price. A few drivers for investors to watch include:
- Commercialization of clinical candidates
- Recurring revenue from current product portfolio
- Dividend growth
Bottom Line
New industries are present in this month’s undervalued list, which should help investors add a little more diversity to their portfolios. Of course, securing a discount is the whole point here, and each of the picks has their own argument for why they’re mispriced. We want to provide a launchpad for readers with articles like these, but as always, investors should perform their due diligence and form their own thesis on a given stock. Good luck!
Are you looking to invest in stocks? Don’t buy just yet—take a close look at these 7 undervalued stocks recommended by the Forbes investment team. This is the same team behind Forbes’ highly successful Forbes Investor premium newsletter, which has outperformed the S&P 500 by a staggering 3X since 2000. And they think these stocks are strong buys!
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