Forget Growth Stocks – Buy Those 2 Value Stocks Instead

Price didn’t matter in 2020, as investors bet on the fastest growing companies. Not that long ago, paying 20 times the annual turnover of a losing money software company seemed insane.

After a furious rally last year and despite a recent sell off, some software stocks are showing much higher price / sell multiples. Snowflake going for more than 100 times sales, for example, even as the business is recording massive losses.

Some non-tech growth stocks are also valued at exorbitant sales multiples. Pioneer of fake meat Beyond meat trades for about 20 times annual sales, despite a barrier of competition and the fact that its products aim to replace real meat, which is largely a commodity. Electric car company You’re here is valued at over 20 times annual sales, while the automotive giant Toyota goes for only 0.9 times the sales.

The prices of some growth stocks are so high that the performance of the underlying companies does not matter. Actions of Cisco Systems soared during the dot-com bubble, at one point hitting a price / sales multiple of a few dozen. The stock collapsed when the bubble burst and still has not returned to its all-time high despite two decades of market dominance and steady growth. The most expensive growth stocks of the pandemic era could suffer the same fate.

Instead of betting that expensive growth stocks will get even more expensive, maybe now is a good time to focus on value stocks. Growth stocks have already started to weaken as interest rates rise and the pandemic collides with the widespread availability of vaccines. Given the high value of some growth stocks, that’s a long way from here.

Two value stocks to consider are the telecommunications giant AT&T (NYSE: T) and tech giant International Business Machines (NYSE: IBM). These are unloved stocks, sure, but I bet both will outperform growth stocks that are currently trading at nosebleed levels for years to come.

Image source: Getty Images.

AT&T

AT & T’s efforts to become a media giant have not gone well. The company suffered a big loss on its acquisition of DirecTV, this year selling a stake in the pay-TV sector at a significant discount from what it paid in 2014. The jury is still out on its other big media acquisition, Time Warner, but these agreements have heavily indebted AT&T. balance sheet. The company had a total debt of around $ 157 billion at the end of 2020.

The good news is that AT&T generates a ton of cash from its core wireless business. The company generated free cash flow of $ 27.5 billion in 2020 and expects to generate approximately $ 26 billion in free cash flow in 2021. Along with the sale of assets, the company will be able to continue to reduce its indebtedness.

AT & T’s track record is certainly a risk factor for investors, but the price is fair. AT&T is currently valued at around $ 220 billion, or just 8.5 times free cash flow. The stock also has a dividend yield of nearly 7%, and the company expects the dividend to absorb less than 60% of its free cash flow this year.

AT&T is unlikely to produce much profit growth in the short term. But given the valuation low, the stock may still be doing well if investor sentiment moves in a positive direction.

IBM

IBM has a new CEO and an aggressive strategy based on market leadership in hybrid cloud computing. Arvind Krishna, former head of IBM’s cloud and cognitive software business, took the helm of the century-old tech giant last year. The company aims to leverage its $ 34 billion acquisition of software company Red Hat to tackle what he sees as a $ 1 trillion hybrid cloud market.

Part of the strategy is to get rid of a lot of the slow growing income. IBM announced last year that it plans to split of its managed infrastructure services business by the end of 2021. The company generates around $ 19 billion in sales per year, but the move will shift IBM’s business model towards higher margin software and solutions.

Services currently represent over 60% of IBM’s revenue. Once the spin-off is complete, software and solutions will be the most important component.

IBM’s results have been less than stellar in recent years as the company has focused on growing its cloud computing and artificial intelligence business. This performance earned the title a pessimistic assessment. Analysts expect IBM to produce adjusted earnings per share of around $ 11 this year, bringing the price-to-sell ratio to just 12. The stock also has a dividend yield of almost 5%. .

If IBM can return to steady growth, driven by its bet on hybrid cloud computing, a combination of earnings growth and expansion of earnings multiples can push the stock much higher. That’s no guarantee, of course, but investors are getting a good dividend for sticking around and seeing if the hybrid cloud strategy pays off.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

About Roberto Frank

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