If you’re looking for undervalued stocks to hold for the long term, you might consider four selected by Morningstar's chief U.S. market strategist, Dave Sekera.
“These are deep-value names,” he said. “All have been on a long-term downward trend, trading at multiyear lows.”
The stocks have tanked for a good reason: weak short-term fundamentals, he said. But now “the market has overreacted to the downside.”
To be sure, “it could take some time for these stories to play out,” Sekera said. “Investors really need to understand what the underlying dynamics are before they take a position.”
That’s because “in some of these cases, it may get worse before it starts to get better.”
1. International Flavors & Fragrances (IFF) -), the world’s largest specialty-ingredients maker.
Morningstar moat (durable competitive advantage) rating: wide. Morningstar fair value estimate: $130. Wednesday price quote: $71.40.
“A lot of investors feel burned,” Sekera said. “It’s not just because of tough near-term fundamentals. Some investors are losing confidence in management.” The company has reduced its guidance three times over the past three quarters, he pointed out.
But Morningstar analyst Seth Goldstein sees “some positive indications,” Sekera said. That includes strength in the company’s specialty-ingredients products, despite weakness in its commodity-oriented ingredients.
2. Scotts Miracle-Gro (SMG) -), the lawn-care-products company
Morningstar moat rating: narrow. Morningstar fair value estimate: $100. Wednesday price quote: $38.80.
Scotts did well early in the pandemic, with demand picking up as homeowners spent more time at home, Sekera said.
Since then, the stock has dropped to prepandemic levels. Adjusted earnings before interest, taxes, depreciation and amortization fell 35% in the latest quarter.
But “over the long term, we think Scotts’s brand leadership in the lawn-and-garden segment is still intact,” Sekera said. “It’s still one of the best brands out there.”
3. Compass Minerals (CMP) -), a producer of salt and fertilizer
Morningstar moat rating: wide. Morningstar fair value estimate: $65. Wednesday price quote: $28.25.
Compass mines salt that's used mainly to deice roads. In that part of the business, “they are the low-cost producer and that’s the basis for assigning a wide economic moat,” Sekera said.
The deicing-salt business will be volatile year to year because winter temperatures will fluctuate, Sekera said. Last winter was mild, but Morningstar says winter weather will normalize over time.
4. Dollar General (DG) -), the discount retailer.
Morningstar moat rating: narrow. Morningstar fair value estimate: $179. Wednesday price quote: $113.90.
The stock did very well throughout the pandemic, but this year it has fallen back to 2019 levels.
“To some degree, this is really just a story of they have not been able to raise their prices fast enough to keep pace with inflation,” Sekera said.
“We’re looking for the operating margin to gradually rebound. It’s currently about 6.7%,” and Morningstar expects a rebound to 9.1%, though not until 2032.
The author of this story owns shares of International Flavors & Fragrances.
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