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Inside the Market Stock bargains for the optimists during market’s troubled times

Periods of market turmoil can be times of opportunity for the bold at heart. The trick, of course, is buying during a brief dip, rather than in the first steps of a long, painful trip downward.

Which of these are we in? In August's share swoon, it seemed like the latter, but it quickly turned into the former. This time, it may be different: Major investment houses started rolling back their targets for the S&P 500 this week, noting the forecasts, compiled roughly six weeks ago, that assumed oil at $50 (U.S.) a barrel or more. However, with recent crude prices in the low $30s, a gain on the order of 60 per cent or more would be required for that.

Even the panelists on Fast Money on the U.S. business cable channel CNBC, normally a collection of optimists, voted unanimously for the "bear" side of the market outlook at the end of Thursday's market carnage.

With all those warnings, then, we now offer some numbers and names for the optimists, who are willing to, despite the recent action, scour the market for bargains.

When markets fall so broadly, the declining share prices push down price-to-earnings ratios while also pushing up dividend yields. One metric I've looked at repeatedly in this long-term, low-interest-rate environment is the number of large stocks whose dividend yield begins to outstrip 10-year government notes as the market falls.

Despite the recent rate increase by the U.S. Federal Reserve, this phenomenon is still in play. To illustrate, let's look back to Dec. 29. (Despite the attention to the first five trading days of 2016, both the U.S. and Canadian stock markets have been on a downward trend since the 29th.)

On Tuesday, Dec. 29, with the 10-year U.S. Treasury yielding 2.32 per cent, there were 210 stocks in the S&P 500 that had dividend yields in excess of the government note. By Thursday, as the yield on the Treasury tumbled to 2.15 per cent and stocks fell, there were 257 stocks whose dividend yields beat the Treasury – an increase of 22 per cent in the number of large-capitalization stocks that out-yielded the government note.

Examples of some of the fresh members of the club: Defence contractors Raytheon Co., L-3 Communications Holdings Inc., Honeywell International Inc. and Halliburton Co.; insurers Lincoln National Corp., Progressive Corp. and Travelers Cos. Inc.; and consumer-focused companies such as bottler Coca-Cola Enterprises Inc., Carnival Corp. and, yes, Apple Inc.

The phenomenon is not as great among members of the dividend-heavy S&P/TSX 60, where 44 of the 56 dividend payers were already beating the 1.41-per-cent yield on the Canadian 10-year government note on Dec. 29. Two more companies now beat the government yield as a result of the recent market action: First Quantum Minerals Ltd. and Tim Hortons' parent Restaurant Brands International Inc.

More broadly, we decided to look at the cheapest stocks in the large-cap U.S. and Canadian indexes. To be among the cheapest 20 per cent of stocks based on a forward price-to-earnings ratio (analysts' estimates of the next 12 months of earnings), a stock needs, roughly, to be below a 12 P/E. On another metric – enterprise value, or market capitalization plus net debt, to EBITDA, or earnings before interest, taxes, depreciation and amortization – the cheapest 20 per cent of stocks clock in below a roughly 7.5 multiple. (The numbers are surprisingly consistent in the S&P 500 and the S&P/TSX 60.)

To generate a particularly interesting list, we asked S&P Capital IQ for companies on the S&P 500 and S&P/TSX 60 that are cheap by both measures – and have a 2-per-cent dividend yield, to boot.

Care to fish among the stocks that have been most damaged in the past few trading days? Magna International Inc. is down 13 per cent since Dec. 29. Potash Corp. of Saskatchewan Inc. is off 7 per cent – and it's the best performer among the major fertilizer stocks, as CF Industries Holdings Inc. and Mosaic Co. are down by nearly 21 per cent and nearly 14 per cent, respectively. (It is no surprise that the fertilizer companies, which benefited so greatly from the Chinese economic expansion, are the big losers in a China-induced panic.)

Other losers include (unsurprisingly) energy companies such as Ensco PLC, Transocean Ltd. and Marathon Petroleum Corp.; and legacy tech companies Cisco Systems Inc., Xerox Corp., NetApp Inc. and, yes, Apple Inc.

The winners, if they can be called that, are, perhaps surprisingly, major U.S. retailers. The best performers on the list include Gap Inc., Kohl's Corp., Macy's Inc., Staples Inc., GameStop Corp. and Best Buy Co. Inc.

When you generate a list of cheap stocks, of course, you may find many that are cheap for a reason, from sector-specific factors to company underperformance. Here's a different list that also illustrates how many companies have been slipping into more-intriguing price levels.

Research firm Morningstar rates more than 1,450 stocks globally and assesses their "fair value" based on estimates of future cash flows. Then, the firm compares that fair value to the stock's market price. Stocks trading at the biggest discount to fair value earn five stars from Morningstar on a five-star scale. (Stocks with greater risk require a bigger discount to attain five-star status.)

And, it follows, as share prices decline, more stocks see their star ratings increase because the discount is increasing. A total of three stocks moved up to five-star status Monday and Tuesday; then, seven more joined the list Wednesday and eight more Thursday. (The Friday additions were unavailable at press time.)

Among the new five-star stocks: Four railways, led by Canadian Pacific Railway Ltd. and including Union Pacific Corp., CSX Corp. and Guangshen Railway Co. Ltd.; watch maker Swatch Group AG; biotech Amgen Inc.; and energy companies Devon Energy Corp., Oasis Petroleum Inc. and Antero Resources Corp.

Cheap stocks

To generate a list of cheap stocks in the wake of this week’s market carnage, we used S&P Capital IQ to find stocks on the S&P 500 or S&P/TSX 60 that were cheap by not one, but two measures of future earnings — P/E and EV/EBITDA. The stocks also had to have a dividend yield of at least 2 per cent. Here are the 10 (of 44 total) that have performed the worst since Dec. 29, when the markets truly began their slide:

Company and TickerDiv. Yld %EV/ EBITDAP/E% Rtn since 12/29
CF Industries Hold. Inc. CF-N3.515.99.1-20.7
Ensco PLC ESV-N4.615.15.1-16.4
General Motors Co. GM-N4.805.15.7-14.4
NetApp Inc. NTAP-Q3.083.39.5-13.8
The Mosaic Co. MOS-N4.315.910.5-13.7
Transocean Ltd. RIG-N5.455.79.5-13.5
Magna Int'l Inc. MG-T2.494.27.7-13.0
Lincoln Nat'l Corp. LNC-N2.203.47.3-13.0
Principal Fin. Group Inc. PFG-N3.787.49.9-12.8
Seagate Tech. PLC STX-Q7.306.79.9-12.4
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