The Dow Jones Industrial Average is down 18.9% year-to-date through Sep. 28. Finding undervalued Dow stocks have gotten a lot easier as a result of the market correction.
The question is which of the 30 names to buy before Wall Street catches on.
According to Barron’s, the index’s price-to-earnings ratio is 17.15, 26% less than a year ago. A year from now, Birinyi Associates estimates that the P/E ratio will be slightly lower than today at 15.77.
As a result of the correction, the DJIA dividend yield is 2.44%, 58 basis points higher than a year ago.
So, for starters, if you’re looking for the best undervalued Dow stocks to buy, you might want to start with the ones with a P/E and dividend yield lower than Birinyi Associates’ estimates for the next 12 months.
That gives me 12 possible options. Here are my three picks.
|MRK||Merck & Co||$86.71|
Dow Inc. (DOW)
Dow Inc. (NYSE:DOW) is down 22% YTD, slightly worse than the DJIA, which is off 19.2% in 2022.
When I think of Dow Inc., I conjure up images of the company’s construction products, such as vapor barriers and weatherproofing. Between doing a lot of walking and my wife being in the construction industry, I’ve seen the Dow name plastered in much of Halifax, where I live.
However, its products are used in thousands of different applications, most of the brands tucked out of sight for the average person to recognize. However, with $55 billion in annual sales, Dow’s products impact virtually every industry and sector.
That’s right. The company has a unit called Dow Sports Marketing Solutions, which aims to partner with sports organizations and athletes to develop innovative, next-generation products to enhance sporting competitions worldwide.
Since the company was spun off from DowDuPont Inc. in April 2019, Dow’s business and finances have gotten exponentially stronger.
For example, the company’s three-year cumulative free cash flow (FCF) in April 2019 was $5.6 billion. At the end of the second quarter, it was $15.9 billion, or 2.8x higher. In the trailing 12 months through Q2 2022, its FCF was $7.1 billion. Based on a $32.2 billion market capitalization, Dow’s FCF yield is 22.0%. I consider anything above 8.0% to be in value territory.
Yielding 6.2%, income investors will be attracted to DOW stock.
Energy stocks of every description are tearing it up in 2022. Nine of 11 sectors of the S&P 500 are in negative territory except for energy (+28.4%) and utilities (+0.3%). It’s revenge for the underperformance of the past few years. It’s amazing what an $82 barrel of West Texas Intermediate has done for the industry’s confidence.
On Sept. 19, Chevron announced that it was selling the company’s three minority positions in Alaskan oil fields: Alaska Endicott (10%), Kuparuk (5%), and Prudhoe Bay (1.2%). Chevron estimates the total package could fetch nearly $1 billion. Others believe it’s closer to $500 million.
Whatever the price, it will be the second time the company has exited the Alaska oil industry. The first time was in 1992. The exit makes sense, given that the yearly oil production in Alaska has dropped from more than two million in 1988 to 437,000 in 2021.
It’s got bigger fish to fry.
In February, it announced the acquisition of Renewable Energy Group. Chevron paid $3.15 billion for the producer of high-quality, sustainable fuels. It paid a 57% premium to Renewable’s 30-day average closing price on Feb. 25. The deal closed in June making CVX one of the undervalued Dow stocks to keep your eyes on.
As a result of the acquisition, it is now the second-largest producer of bio and renewable diesel in the U.S. and third-largest worldwide.
Merck & Co. (MRK)
Merck & Co. (NYSE:MRK) is up 12% YTD, 200% higher than the S&P 500 healthcare sector.
I recently highlighted Merck’s Keytruda cancer drug as one reason investors should consider Merck stock. It generated $5.3 billion in the second quarter, 30% higher than a year earlier, and 41% of its $12.8 billion sales from its Human Health business.
The big thing for shareholders is that Keytruda uses are expanding into earlier-stage cancers. That will mean even higher growth rates in the quarters to come.
If one considers that Merck’s Human Health business grew sales by 21% in the second quarter — excluding currency and its Lagevrio drug, which is developing in partnership with Ridgeback Pharmaceuticals — and the company has a significant pipeline of medicines in Phase 2 and Phase 3 clinical trials, the upside is tremendous.
Although the company’s Animal Health business only generated 10% of Merck’s overall sales in the second quarter, it remains a valuable component of its business. Ultimately, like many animal health units, it could be spun off into its own separate company, although there’s been nothing definitive on this front.
Merck continues to invest in its business. Over the next five years, it intends to make $16 billion in capital investments to expand its manufacturing capacity for its oncology drugs, vaccines, and Animal Health business.
It can only do this if it’s generating healthy free cash flow. In the trailing 12 months, it generated $14.4 billion [key ratios]. That’s good for a 6.6% FCF yield [$14.4 billion divided by a market cap of $219.8 billion].
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.