Value Or Value Trap? A Closer Look At 4 Cheap Stocks
For value investors like Warren Buffett, Benjamin Graham and Peter Lynch, it doesn’t get much better than a low PE ratio and a high-yielding dividend. Unfortunately, not every stock that gets cheap becomes a value for investors.
Frontier Communications Corp (NASDAQ:FTR), Mattel, Inc. (NASDAQ:MAT), Macy’s Inc (NYSE:M) and Ford Motor Company (NYSE:F) are all big-name stocks that pay generous dividends and have endured selloffs of at least 10 percent in the past year.
Should value investors be buying the dip? Here’s a closer look.
Frontier Communications shares are now down more that 65 percent in the past year, but a cheaper price didn’t keep Goldman Sachs from downgrading the stock to Sell back in March. Frontier currently pays a dividend that yields 10.8 percent, but seasoned traders know a yield that high is often too good to be true. “We believe FTR may choose to suspend its dividend after the first quarter of 2017 in order to delever and build liquidity to address significant debt maturities in 2020–2022, even if it is not required to do so per its bonds’ covenants,” Goldman wrote.
It’s difficult to maintain any dividend when your company isn’t profitable, much less a 10 percent payout. At this point, Frontier is showing all the signs of a dividend value trap.
Mattel shares are down 25 percent in the past year, and the stock now pays out an appealing 7.0 percent dividend yield. With a reasonable forward PE ratio of 14.5, Mattel is a bit more convincing as a possible value play than Frontier. However, there is good reason for the market’s skepticism about Mattel. The toy maker has endured a 15.9 percent drop in revenue and a 65.9 percent drop in EPS in the past three years. If those two metrics keep trending in the wrong direction, Mattel will remain a value trap rather than a value.
Retailer Macy’s shares are now down more than 22 percent in the past year. With a forward PE ratio of only 10.0 and a dividend yield of 5.1 percent, Macy’s is certainly starting to draw some attention from value investors like Greenlight Capital’s David Einhorn.
Unfortunately, a closer look reveals a similar problem to Mattel’s. Macy’s revenue is down 8.0 percent in the past three years, and EPS is down 25.5 percent in that time. In addition, Macy’s has been closing down stores and laying off employees on a regular basis in recent years in an attempt to survive and compete against a new generation of online retailers.
It’s clear that Macy’s stock is a good value relative to its current business, but its bleak longer-term prospects make the stock a potential value trap for bulls.
Despite record U.S. auto sales in recent years, Ford shares are down 13.1 percent in the past 12 months. The auto giant’s forward PE now sits at only 6.6, and its dividend stands at 5.4 percent. Of all the four stocks mentioned, Ford has the weakest value trap argument.
Ford bears argue that the U.S. auto market has peaked and is now in decline. Ford EPS is down 84.0 percent in the past five years. However, total revenue is up 15.5 percent in that time. At a forward PE of under 7.0, the market clearly seems to have already priced in a declining U.S. auto market. In addition, Ford’s current payout ratio is a comfortable 63.9 percent, suggesting the dividend is completely safe.
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