Everyone’s definition of bargain-basement stocks varies to some degree.
While there may be “cheaper” stocks on the markets, Union Pacific (UNP), Thor Industries (THO), and UFP Industries (UFPI) bring impressive returns on invested capital (ROIC) along with discounted valuations.
ROIC measures a company’s profitability compared to its debt and equity, with higher-ranking stocks outperforming their lower-scoring peers over time.
Taking note of this outperformance potential, let’s investigate each company and see why their low valuations and profitability make them excellent stocks for a future bull market.
1. Union Pacific
In a telling reaction in February, shares of Union Pacific rose 10% after CEO Lance Fritz announced his resignation. Seemingly spurred by a presentation from the activist investing group Soroban Capital Partners, the CEO parted ways after the company trailed the S&P 500 index’s total return by 14% over the last year.
The most jarring figures from Soroban’s presentation?
Union Pacific’s employees ranked it dead last among the stocks S&P 500 index in terms of overall rating (2.1 stars out of 5), recommend to a friend score (19%), and CEO approval (15%).
With workplace figures like those, it is impressive that the company kept pace with the market’s returns, highlighting the substantial power of its wide moat. Railroads in North America serve as critical transporters of goods at fractions of the cost of other modes of transport. Also, with so much industry consolidation (there are only six Class one railroads in North America), All of them enjoy significant geographic advantages.
With a price-to-earnings (P/E) ratio of 18, some may not consider the company a bargain-basement stock. However, this is the 19th-lowest P/E of the 69 stocks in the S&P 500’s industrial sector.
Furthermore, Union Pacific’s ROIC of 16% was the highest among its publicly traded railroad peers over the last year. This outsize profitability is even more impressive considering that the company’s average weekly carloads (railroad metric for volume) declined by 15% during the previous eight years.
Should a new CEO bring any spark to Union Pacific’s operations, this could be a reasonable entry point for investors seeking a lifelong holding. Paying a 2.4% dividend that has been increased for 16 consecutive years and only uses 45% of net income, the company will reward shareholders as they wait to see what happens.
2. Thor Industries
Despite operating in the heart of a cyclical industry, recreational vehicle (RV) manufacturer Thor Industries has posted profitability annually since 1980. Riding this incredible streak, Thor has delivered extraordinary total returns north of 18,000% since the 1980s — before seeing its stock struggle the last few years.
The company reported earnings on March 7 and this cyclicality struck again, as sales and earnings per share (EPS) dropped 39% and 90%, respectively. Yet, despite these alarming declines, the company showcased its financial flexibility, recording $27 million and $91 million in net income and operating cash flow, respectively.
Spurred by a slowdown in big-ticket consumer discretionary spending, partly thanks to higher interest rates, Thor had no chance to beat all-time-high figures from 2022 that were artificially high from its dealers restocking pandemic-depleted inventories.
Looking ahead to 2023, management expects conditions to remain challenging, guiding for a downside scenario of $10.5 billion in sales and $5.50 in EPS for the year.
So what exactly makes Thor interesting amid all this uncertainty?
If you assume management’s downside scenario comes to fruition, the stock would be trading with a price-to-sales (P/S) ratio of just 0.45 using today’s $4.8 billion market capitalization. Using this ratio and Thor’s average net income margin of 4.7% over the last decade, the stock would trade at just 10 times earnings once profits normalize, which isn’t too shabby for a downside scenario.
Holding a leadership position in each of its North American RV categories — with market shares between 38% and 54% in each — this valuation is too good to pass up with a bull market waiting further down the road. Moreover, armed with an average ROIC of 17% over the last 10 years and a long history of grinding out profits regardless of the economy, Thor is a superb selection in today’s tricky times.
3. UFP Industries
Like Thor, wood and wood alternative manufacturer UFP Industries has recorded 67 straight years of profitability, with total returns above 4,000% since the 1990s.
Operating through three business segments — retail, construction, and packaging — UFP offers roof trusses, floor joints, wood and composite decking, basic pallets, structural packaging boxes, and other industrial wood products. Similarly to Thor again, UFP set all-time highs in revenue and EPS during 2022, leaving its P/E ratio to drop to levels it hasn’t seen in over a decade.
Held back by trepidation surrounding the housing market — which could see new home construction drop by 15% to 20% in 2023 — UFP’s valuation has been reeled in as investors wait to see how things fare. Reporting fourth-quarter earnings in February, management stated that January’s sales and operating earnings declined 19% and 38% year over year — giving a glimpse of the income pullback.
So if things look rough for the upcoming quarters, what makes UFP interesting now?
First, even if earnings continued to nosedive and were cut in half from 2022, the company would still be trading below its average P/E ratio from the last decade.
On top of this, UFP’s leadership position helps it achieve a high and rising 26% ROIC, which is incredible for a manufacturer.
With most of the company’s sales coming from value-added products, its market leadership looks safe, as its customers can count on it to provide them with the specific items they need.
Finally, its 1.2% dividend only uses 9% of net income, paving the way for many more increases to come — making the company an excellent bargain-basement investment to buy and hold forever.
— John Kohn-Lindquist
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Source: The Motley Fool