When we think of value stocks, we don’t typically think of stocks that have risen sharply in price over the past year. Instead, many value investors tend to gravitate towards stocks that have recently fallen in price in order to profit from the price recovery once the business recovers from whatever headwind it is struggling with.
However, while stocks that have recently fallen in value can provide value opportunities, they could also continue falling. Likewise, just because a stock has gone up doesn’t mean it is certain to correct in the near future. What matters most in value investing is whether or not the stock is trading below what the business will be worth in the future.
The DCF model
One way to look for stocks that could be trading below the value of their future earnings potential is to use a discounted cash flow (DCF) model. The purpose of a DCF model is to estimate how much money can be made from an investment based on its expected future cash flows, adjusted for the time value of money (as each dollar is worth more now than it will be in the future).
There are three basic estimates involved with this valuation model: future cash flows, the ending value of the investment and an appropriate discount rate. Investors have many different calculations for DCF, but this is the basic principle behind the method.
In addition to a customizable user-defined DCF model that can be used to estimate the intrinsic value of specific stocks, GuruFocus also provides an option through the All-in-One Screener to screen for stocks that are trading at a discount to the intrinsic value estimated by a preset DCF model. The preset DCF model is based on the following assumptions:
- Growth rate at the growth stage: The average earnings growth rate of the past 10 years.
- Years of growth at the growth stage: 10
- Growth rate at the terminal stage: 4%
- Years of growth at the terminal stage: 10
- Discount rate: 8%
While the DCF model is only an estimate of the future and does not take into consideration the many unique factors, strategic changes or unexpected events that could affect individual companies, it can be a good place to start when looking for potential investment opportunities.
With this in mind, I used the GuruFocus All-in-One Screener to search for stocks trading below their intrinsic value calculated by the DCF model. I was surprised to find that several of the stocks that made it through this screen were names that had shown double-digit gains over the past year. It seems that these stocks could still represent value opportunities despite their recent runups, though investors should still do their own due diligence before deciding whether an investment is right for them.
Facebook Inc.
Social media giant Facebook Inc. (FB, Financial) traded around $364.06 per share on Sept. 17 compared to the intrinsic value of $568.63 calculated by GuruFocus’ earnings-based DCF model. This implies a 36% margin of safety.
Shares of Facebook have gained 41% over the past 12 months. The price-earnings ratio stands at 26.94, which is lower than the company's 10-year median of 37.33. The GuruFocus Value chart rates the stock as “fairly valued.”
The company has a financial strength rating of 7 out of 10, a profitability rating of 10 out of 10 and a business predictability rating of five out of five stars (the higher the business predictability rating, the more likely it is that the company will continue to grow).
Facebook has grown its top and bottom lines steadily in recent years. According to Morningstar analysts, the company is expected to grow its revenue to $118 billion in 2021 and $176 billion in 2024, while earnings per share (EPS) is expected to reach $14.07 in 2021 and $20.09 in 2024.
Ulta Beauty Inc.
Beauty retail chain Ulta Beauty Inc. (ULTA, Financial) traded around $379.07 per share on Sept. 17 compared to the intrinsic value of $510.99 calculated by GuruFocus’ earnings-based DCF model, implying a 26% margin of safety.
Shares of Ulta have gained 59% over the past 12 months. The price-earnings ratio stands at 29.22, which is lower than the company’s 10-year median of 35.11. The GuruFocus Value chart rates the stock as “fairly valued.”
The company has a financial strength rating of 6 out of 10, a profitability rating of 8 out of 10 and a business predictability rating of three out of five stars.
Ulta had been seeing strong top and bottom-line growth until the Covid-19 pandemic hit. According to Morningstar analysts, the company is expected to surpass pre-Covid levels in fiscal 2022, reaching revenue of $8.14 billion and EPS of 14.46. Revenue is expected to continue growing to $9.58 billion in fiscal 2024 while EPS reaches $18.35.
Lowe's Companies Inc.
Home improvement retailer Lowe's Companies Inc. (LOW, Financial) traded around $209.56 per share on Sept. 17 compared to the intrinsic value of $323.95 calculated by GuruFocus’ earnings-based DCF model. This implies a 35% margin of safety.
Shares of Lowe’s have gained 25% over the past 12 months. The price-earnings ratio stands at 21.62, which is slightly lower than the company’s 10-year median of 22.13. The GuruFocus Value chart rates the stock as “modestly overvalued.”
The company has a financial strength rating of 5 out of 10, a profitability rating of 8 out of 10 and a business predictability rating of five out of five stars.
Lowe’s has seen steady top and bottom-line growth throughout its history, with a higher-than-usual spike in fiscal 2021. According to Morningstar analysts, the company is expected to stagnate in terms of revenue growth, with the top line predicted to be $91.62 billion in fiscal 2022 and $92.65 billion in fiscal 2024. EPS is expected to continue growing to $11.13 in fiscal 2022 and $12.40 in fiscal 2024.
Whirlpool Corp
Home appliance manufacturer Whirlpool Corp (WHR, Financial) traded around $210.63 per share on Sept. 17 compared to the intrinsic value of $442.78 calculated by GuruFocus’ earnings-based DCF model, implying a 52% margin of safety.
Shares of Whirlpool have gained 18% over the past 12 months. The price-earnings ratio stands at 6.98, which is significantly lower than the company’s 10-year median of 15.31. The GuruFocus Value chart rates the stock as “significantly overvalued.”
The company has a financial strength rating of 5 out of 10, a profitability rating of 7 out of 10 and a business predictability rating of three out of five stars.
While the company’s top-line growth has been steady, its bottom line has been choppy in recent years as it struggled to adjust to rising costs and steeper tariffs on steel. The analysts surveyed by Morningstar do not seem to have a high opinion of this company, as they have projected revenue to increase to $22.75 billion in 2021 before dropping to $22.29 billion in 2022. Likewise, EPS is predicted to rise to $27.48 in 2021 before dropping to $20.69 in 2022.
Lam Research Corp
Wafer fabrication equipment company Lam Research Corp (LRCX, Financial) traded around $608.98 per share on Sept. 17 compared to the intrinsic value of $1,134.73 calculated by GuruFocus’ earnings-based DCF model, implying a 46% margin of safety.
Shares of Lam Research have gained 100% over the past 12 months. The price-earnings ratio stands at 22.48, which is higher than the company’s 10-year median of 18.81. The GuruFocus Value chart rates the stock as “modestly overvalued.”
The company has a financial strength rating of 6 out of 10, a profitability rating of 9 out of 10 and a business predictability rating of three out of five stars.
Lam Research has been growing its top and bottom lines fairly consistently, with an acceleration in growth in recent years. Analysts surveyed by Morningstar are expecting the strong growth trend to continue, projecting revenue to reach $18.15 billion in fiscal 2022 and $19.80 billion in fiscal 2024. EPS is projected to grow to $35.67 in fiscal 2022 and $42.49 in fiscal 2021.
