Where Investors Can Find Value Stocks

When economies across the country went into lockdown mode earlier this year, many market watchers expected the worst. And initially, that’s what they got, as the S&P 500 lost nearly a third of its early January value by mid-March.

Fast forward six months: Those losses have vanished and the index is now up for the year, despite large-scale job losses and miserable second-quarter GDP numbers.

The tech sector, which is a beneficiary of, and relatively immune to, some of the current challenges facing the physical economy, has been responsible for a large proportion of the overall gains. The S&P 500 Information Technology Index is up near 40% this year.

[Read: 6 Upstart Tesla Competitors to Watch]

Even in the face of headwinds ranging from advertiser boycotts to increased regulatory scrutiny, some of the biggest tech names have enjoyed sharp increases. Amazon (ticker: AMZN) and Apple ( AAPL) have each soared by more than 70% year to date, while Microsoft ( MSFT) is up more than 40% this year.

Videoconferencing and electronic signature service providers on the front lines of the shift to the work-from-home economy have experienced big spikes as well. Zoom ( ZM), Docusign ( DOCU) and RingCentral ( RNG) have all more than doubled in value since mid-March, when many of the lockdowns first went into place.

With some societal and workplace trends adopted in recent months likely to become entrenched, most, if not all, of the above companies, may continue to thrive. So even as many of them have hefty multiples, the price could be worth paying.

Others within tech, however, may not offer as much value. When tech multiples start to compress, a good rule of thumb is to avoid any company with relatively high multiples and negative operating margins of 5% or more.

A few sector peers falling short of expectations, which have become outsized even as the economy is just embarking on a recovery, is all it would take to see stocks like that take a tumble. If the economic data continue to improve and the labor market mends further, those expectations could become even rosier, making it more difficult for companies to meet them.

That may help spur a rotation out of tech and into value cyclicals, which have already started to rebound. Progress on a vaccine could further hasten that process.

If this type of rotation does take place, here are some companies that could have some upside:

PPG Industries (PPG): A global manufacturer of paint, sealants and coatings, PPG was especially hard hit when economies around the world began to shut down. In a span of two months starting Jan. 20, it lost nearly half its market value. It has since recovered some, but has more room to grow once conditions improve further. It will benefit from a car market that has rebounded far more quickly than expected.

Axalta (AXTA): Another coating manufacturer, Axalta’s customer base is narrower, focused on owners of commercial vehicles and industrial buildings. It saw its stock get sliced in half earlier this year, but an improving economy means more traffic and congestion on the roadways. That not only produces additional wear and tear, but a rising number of fender benders, which means more vehicles could be in line for new paint jobs in the coming months. Perhaps the biggest reason Axalta is attractive is the price. It trades at just above nine times earnings. That compares favorably with S&P 500 companies, which currently are trading at just under 15 times earnings.

[SEE: 8 Great Stocks to Buy From Female-Led Firms.]

CF Industries (CF): A large, predominantly North American-based producer of nitrogen fertilizers, this company has historically benefited from inexpensive U.S. natural gas to produce ammonia, urea and other products. It generates sustainable, double-digit free cash flow and pays a 3.5% dividend yield. Urea prices are on the rise due to increased demand from India and Brazil, while nitrogen fertilizer prices are also increasing.

First Republic Bank (FRC): Many national and regional banks are poorly run, bogged down by souring loan portfolios, or both. By contrast, First Republic Bank benefits from a strong management team. While it does issue home and car loans, it is not a credit card provider, which reduces its risk levels. The San Francisco-based bank has a highly desirable footprint, centered on areas of the country where the deposit base is high and defaults are low, like the northern and southern California coasts and the Northeast corridor.

Tech is king. That’s been clear since before the pandemic. At the same time, the sector is relatively expensive and becoming increasingly crowded.

Going forward, if the economic environment continues to improve, the priciest tech names with negative operating margins could begin to falter, with cyclicals being the beneficiaries.

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Where Investors Can Find Value Stocks originally appeared on usnews.com

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