Looking at the Cheapest Stock in Each Sector
Posted: April 25, 2016
Investment professionals often divide the world of stocks into 10 sectors, using a classification system from Standard & Poor’s.
What if you simply bought the cheapest stock in each sector? That approach might seem foolishly mechanistic, but you could do worse.
I’ve written eight columns on this approach, which I have dubbed the Cheapskate Portfolio. Among the 500 stocks in the Standard & Poor’s 500 Index, the portfolio consists of 10 stocks — the one in each sector with the lowest ratio of stock price to per-share earnings.
Past Results
On a one-year buy-and-hold basis, the Cheapskate Portfolio has done slightly better than the Standard & Poor’s 500 Index, returning a little more than 11 percent a year, compared to a bit less than 10 percent for the index.
On a three-year buy-and-hold basis, the Cheapskate Portfolio is up an average of 31.4 percent versus 23.5 percent for the benchmark index. Figures are total returns including dividends, and three-year results are available for only six columns.
Bear in mind that results for my column picks are theoretical and don’t reflect actual trades, trading costs or taxes. The record of my column selections shouldn’t be confused with the performance I achieve for clients. And past performance doesn’t guarantee future results.
The Cheapskate Portfolio has beaten the S&P 500 only half the time, but its wins have been by wider margins than its losses. I figure that the members of this portfolio at least deserve a look.
Hurt but gaining
The stock with the lowest price/earnings ratio in the consumer discretionary sector is General Motors Corp. (GM), selling for less than five times earnings. The company has been rocked by a scandal involving faulty ignition systems, but it has gained market share lately.
In consumer staples, Mondelez International Inc. (MDLZ), the maker of Oreo cookies and Nabisco crackers, is the cheapest, selling for nine times earnings. The company has been hurt by the trend toward healthier eating, but it is still highly profitable, with a 26 percent return on stockholders’ equity last year.
Many energy companies are losing money now, so no price/earnings ratio can be calculated for them. Among those still profitable, the cheapest is Transocean Ltd., selling for a mere five times earnings. Shale oil and abundant Saudi oil production have hurt Transocean, but at $11 — down from about $170 in 2007 — it may be a bargain.
Familiar picks
Navient Corp. (NAVI), a student lending company based in Wilmington, Del., is the cheapest financial stock, as it was a year ago. Its price/earnings ratio is six, and the stock fell 32 percent in the past year. The company is struggling under a heavy debt load.
Gilead Sciences Inc. (GILD), a biotech firm from Foster City, Calif., repeats from last year as the cheapest stock in the health care sector. Its P/E is 12. The main worry is that the government and insurers may force it to cut prices on some drugs. I like the company’s drug lineup and pipeline.
In the industrial sector, no member of the S&P 500 is cheaper than United Continental Holdings Inc. (UAL), which sports a P/E of three. UAL posted losses in eight of the past 15 years, but has strung together three profitable years in a row, and 2015 was its best year since 2006.
Better profits
The materials sector, like the energy sector, is full of companies with recent losses. Among profitable companies, the cheapest is Dow Chemical Co. (DOW) with a P/E of less than nine. It has shown a gradual decline in revenue over the past decade, but has improved profitability.
In technology, the possible bargain is HP Inc. (HPQ). This is the legacy business from Hewlett-Packard, consisting mostly of personal computers, printers and accessories. The more profitable consulting business was spun off. The P/E is six.
The “winner” in the telecommunications sector is Level Three Communications Inc. (LVLT) with a multiple of six. The Internet and voice carrier has been profitable for the past two years after more than a decade of losses. It faces lots of competition.
Finally, in the utility sector, the cheapest S&P 500 stock is Scana Corp., an electric utility in South Carolina (SCG). To my surprise, it carries a P/E of 13, the highest in the Cheapskate Portfolio this year.
I think investors are paying too much for utility stocks now because they are paranoid about the economy and seeking safety.
In general, stocks advance by exceeding prevailing expectations. Since low expectations are easier to exceed, unpopular stocks are usually a better bet than popular ones. That’s why the Cheapskate Portfolio has done reasonably well over the years, and why I think it will do well this year.
Disclosure: I own shares of Gilead Sciences for most of my clients and personally.