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In late February, when the stock market was in a frenzy climbing to new high levels, this column asked if it was “Too late to join the stock rally?” The answer then: “Maybe not.” Several months later, investors again face the same dilemma as the Dow Jones industrial average keeps flying to fresh record highs along with the other broad market indexes. The Dow closed on Monday at 22,118 (its ninth consecutive record-high close), the S&P 500 at 2,481 (a new record close) and the Nasdaq composite at 6,384.
The question for investors of whether to bail or continue buying stocks is a most complex issue, considering that the S&P 500 has racked up 30 new all-time highs year-to-date through Aug. 7. Many are concerned that with stocks in the eighth year of a bull market, it may be time to go defensive, until a 5 percent to 10 percent correction, or worse, comes — and goes.
Market history also plays a role: The months of August and September are when stocks usually slump. Many investors worry that “they may be vulnerable to ‘August Angst’ since the S&P 500 has recorded its second-worst post-World War II average monthly performance [in August], with September’s return being less envious,” said Sam Stovall, chief equity strategist at CFRA Global Research.
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Yet investors have been encouraged, he pointed out in his latest market appraisal, “by better-than-expected earnings per share in the second quarter this year, as they have done in each of the last 22 quarters.”
The S&P 500’s posting of five new highs in July alone suggests that “the market may not to be ready to give up on momentum,” argued Stovall. So it may not be surprising that year-to-date through July 28, the S&P 1500 high-momentum subindustries are outpacing the broader benchmark, as they’ve done in 70 percent of all calendar years since 1997, he noted.
And many analysts still believe some stocks in select sectors are attractively valued despite the market’s broad advance. Year-to-date, the S&P 500 has gained around 11 percent, with technology group leading the advance with a more than 18 percent climb, followed by health care with 16 percent. The financials so far are up 6 percent.
True, these sectors have become quite overvalued according to some metrics, “but interestingly, we still see some bargains in the three leading sectors today,” said Karen Wallace, senior editor at Morningstar. “You can unearth some bargains if you do a little digging.”
To do that digging, Morningstar created a screen to find “wide and narrow-moat stocks” that have had the wind on their back but still look undervalued. The screen found 19 stocks trading at least at a 10 percent discount to Morningstar analysts’ fair value estimates.
Of those 19 stocks in the technology, health care and financial services sectors, three are standouts: Microsoft (MSFT) among technology stocks, Vertex Pharmaceuticals (VRTX) in health care, and Blackstone Group (BX) in financial services.
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Microsoft is currently trading at 72 a share, but analysts predict the giant software, computer and electronic device maker’s stock will climb to $82 in a year. They see it rising in part on Microsoft’s strong execution across every segment of its operations, especially its cloud-computing unit, which produced a 97 percent revenue growth in its latest quarter.
The Microsoft bulls believe investors aren’t fully appreciating the company’s opportunities in its cloud business and its Office 365 segment.
Michael Nemeroff, equity analyst at Credit Suisse, who rates Microsoft as “outperform,” says the bullish case for owning the stock is the company’s strong earnings power potential over the next few years. Microsoft will carry this earnings momentum forward on “the significant growth opportunity in the cloud, along with higher cloud gross margins over time,” said Nemeroff in a report.
Vertex, which focuses on developing and commercializing therapies for treating cystic fibrosis, has been a strong performer, largely due to positive results from recent clinical trials for one of its drugs. Its stock has climbed to $156 a share from $129 on July 11.
As a result, Jason McCarthy, equity analyst at research firm Maxim, who rates the stock a “buy,” raised his price target to $195 a share from $143. He believes Vertex is “poised to unlock 90 percent of the cystic fibrosis market.”
Blackstone, a leading alternative asset manager globally, with assets under management of $367 billion, is rated as “outperform” by Glenn Schorr, equity analyst at investment firm Evercore ISI. “We continue to be big fans of what they have built and are very confident the growth will continue,” he said in his latest analysis of the company’s performance.
Devi Ryan, analyst at JMP Securities, recommends the stock as “outperform,” with a price target of $38 a share. Currently trading just under $34, “we remain comfortable with the long-term fundamentals,” he said, despite the “soft” second-quarter results that still came out in line with his expectations. He believes core business trends remain generally healthy.
“Despite modest headwinds, distribution remains strong,” said Daniel T. Fannon, analyst at investment firm Jefferies, who rates Blackstone a “buy” with a price target of $38 a share. Foreign exchange- and energy-related headwinds, he noted, led to the lower-than-forecast results. However, Fannon added, “performance remained positive across majority of strategies.”
These analysts’ bullish argument for buying Blackstone shares is partly based on the stock’s current weakness, which makes it more attractively valued.
In sum, all the three stocks aren’t only still undervalued but are also potentially big winners in a stock market that has been regularly flying to new all-time highs.