The U.S. stock market briefly entered correction territory today, though it later staged a spectacular recovery. When the day’s trading closed, the S&P 500 was down only 8% so far this month.
While this isn’t a big drop in the grand scheme of things – the index was trading around the same level just three months ago – this latest drop has brought some pandemic darlings like Netflix Inc. (NFLX, Financial) back in line with pre-Covid valuations.
I like to keep an eye on the components of the S&P 500 in order to get a breakdown on which names are sending the index higher and which ones are dragging it down. This is constantly changing, and even though there are many S&P 500 stocks with sky-high valuations, there are almost always some names that look undervalued as well.
We will take a look at three quality stocks in the S&P 500 that have become beaten down recently – Netflix, MarketAxess Holdings Inc. (MKTX, Financial) and PayPal Holdings Inc. (PYPL, Financial). These stocks all have high profitability and financial strength ratings from GuruFocus and long-term competitive advantages.
Netflix
Video streaming pioneer Netflix (NFLX, Financial) is down 35% year to date, seeing more than a third of its value shaved off in less than a month. The year-over-year drop is slightly lower at 30%. With a price-to-GF Value ratio of 0.60, the stock is now trading so far below its GF Value estimate that the system has flagged it as a possible value trap.
The stock closed at $379.94 on Jan. 24 for a market cap of $165.51 billion and a price-earnings ratio of 34.87, which is significantly below its historical median of 127.61.
The company has a financial strength rating of 5 out of 10 and a profitability rating of 8 out of 10. Assets are growing faster than revenue, which is a potential warning sign, but Netflix’s revenue per share is still growing and its operating margin is expanding.
Investors who have been keeping tabs on the news and Netflix’s earnings results have been well aware that such a correction was only a matter of time due to the pull-forward in demand caused by the pandemic. It was always a question of when, not if, and it seems the time for the price correction has finally arrived.
As of the end of 2021, Netflix had 222 million subscribers, having added only 18 million subscribers for the year versus the 37 million it gained in 2020. Once this revelation hit the headlines, investors started heading for the exits. The company also issued weak guidance, expecting 2.5 million new subscribers in the first quarter of 2022.
Netflix undeniably faces some headwinds that it didn’t face a decade ago, such as fiercer competition, the aftermath of Covid-related demand pull-forward and localization struggles in international markets. However, the subscription business model is still hugely profitable and, in addition to third-party content, Netflix is also expanding its original content library. As long as the company keeps growing subscribers in the millions every quarter without overspending to acquire those customers, the outlook seems good.
MarketAxess Holdings
MarketAxess Holdings (MKTX, Financial), a fintech company that operates an electronic trading platform for institutional credit markets and also provides market data, is down nearly 8% year to date and 28% over the past 12 months. The price-to-GF Value ratio is 0.68, earning the stock a rating of significantly undervalued.
The stock closed at $365.22 on Jan. 24 for a market cap of $13.89 billion and a price-earnings ratio of 49.96, which is slightly above its historical median of 46.52.
The company has a financial strength rating of 8 out of 10 and a profitability rating of 9 out of 10. GuruFocus has flagged assets growing faster than revenue growth as a red flag. Positive signs for the company include price-earnings and price-sales ratios close to their three-year lows.
Over the past decade, MarketAxess’ operating margin has ranged between 44% and 54%, a stunning achievement even for the highly lucrative capital markets industry. Revenue per share has a three-year growth rate of 20.4%, while Ebitda per share has a three-year growth rate of 24%.
MarketAxess often sees its stock price tied to market enthusiasm for bond trading, since this is where the majority of its revenue comes from. With a global network of more than 1,800 companies, the company leverages its electronic platform to expand liquidity offerings for companies around the world, delivering cost savings in global fixed-income markets.
Analysts expect interest in bonds to begin picking up again as the U.S. Federal Reserve plans to hike interest rates this year, signaling a reduction in the historic easy-money policy that has prevailed for the past couple of years. MarketAxess also cites emerging markets as a key source of growth. Higher bond trading in both developed and emerging markets would mark a positive sign for the company’s revenue growth, and thus its stock price.
PayPal Holdings Inc.
Online payments processor PayPal Holdings Inc. (PYPL, Financial) has dropped 16% year to date and 34% year over year, bringing it back in line with its pre-Covid valuation metrics. With a price-to-GF Value ratio of 0.76, GuruFocus rates PayPal’s stock as modestly undervalued.
The stock closed at $162.17 on Jan. 24 for a market cap of $190.54 billion and a price-earnings ratio of 38.97, which is below its historical median of 50.99.
The company has a financial strength rating of 5 out of 10 and a profitability rating of 8 out of 10. The GuruFocus system shows one severe warning sign for declining gross margins. Positive signals include recent insider buys and return on capital of 300.72%.
The stocks of payment processors were a popular pandemic play as higher inflation combined with stimulus checks, greater online transaction volume, higher average household debt, higher wages and many other macro factors drove payment volumes. PayPal especially gained market clout as the go-to third-party online payments processor in the U.S.
The company has begun to lose some of its steam, however, due to increased competition. Several analysts have downgraded the stock, concerned that all of the big e-commerce sites will eventually have their own internal payment processing systems and will ban the use of third-party platforms like PayPal entirely. Moreover, direct competition is increasing as more pure-play payment processors open their doors, especially in international markets, where PayPal hopes to expand but where it also loses the home-field advantage.
It seems likely that the market could be overestimating the headwinds that PayPal faces, though. It has managed to ingrain itself as a trusted third-party processor that provides an extra layer of security and trust for buyers and sellers alike, which is extremely valuable to transaction ecosystems and which would be lost with e-commerce companies that decided to control all of their payments internally. PayPal’s brand recognition is a big part of that competitive advantage.
