Performance of a stock depends on a number of factors. While changes in company fundamentals directly impact the price movement, the broader industry and economy sometimes play a significant role too.
Though we bid goodbye to 2014, we lugged the struggling Russian economy, stagnating European financial system, ambiguity in China marring growth over structural deficiencies, plunging oil prices and several other important events with us to 2015. These events will no doubt continue to keep the stock market on shaky ground.
Moreover, the uncertainty related to the interest rate environment is likely to keep the volatility alive, making it difficult to take an investment decision. At the same time, the valuation of most stocks look expensive thanks to the Bull Run witnessed by the U.S. market last week.
While betting on undervalued stocks could be the right strategy in this situation, one may end up losing if the selected stocks have missed the boat due to their own fundamental issues or because they are part of underperforming industries.
Thus, a more apt strategy would be to pick undervalued stocks that belong to the top-performing industries and carry a favorable Zacks Rank.
A favorable Zacks Rank indicates that these stocks have been witnessing positive estimate revisions which generally translate into rapid price appreciation. The industry performance will add to it, too. Research says that about half the price performance of a stock can be attributed to the industry group that it belongs to.
Zacks Industry Rank
While finding out top-performing industries is not an easy task, the Zacks Industry Rank makes it simple.
A top Zacks Industry Rank signifies that more stocks within that group are likely to have upward earnings estimate revisions, implying a bullish outlook for the industry.
Historically, we have found that the top 50% of Zacks-Ranked Industries outperform the bottom 50% by a factor of more than 2 to 1. So it’s a good idea to leverage the Zacks Industry Rank to shortlist stocks.
The Zacks Industry classification divides the business world into 16 sectors comprising 60 medium or M-level industries and 260 plus or X-level industries. We rank all 260 plus X-level industries based on the earnings outlook for the constituent companies in each industry.
3 Top-Ranked Industries
We ran a screen to find out industries ranking in the top 15%. These are basically those that carry a Zacks Industry Rank of less than 35. It gave us three broader industries – Insurance, Medical Care and Telecommunications – among others.
Let’s take a quick look at the fundamentals of these three industries:
Insurance: With the probable reversal of the prevailing low interest rate environment and modest strengthening of the key economic indicators such as employment, real estate, GDP and the stock market, 2015 will likely witness accelerated recovery in the insurance industry. Moreover, an already strong liquidity profile, conservative product design and evolving coverage opportunity should lead the industry to an upside.
The commercial, property and personal lines of the P&C industry have been showing decent progress in recent quarters. Most importantly, ample underwriting capacity and heightened competition have helped P&C insurers to reach the market hardening phase, which is the key to improvement.
Moreover, insurance volume is expected to expand going forward on a speedier economic recovery. Though competition is cropping up both within the primary lines of the P&C space and with reinsurers’ expansion, proactive transformational measures, including adoption of technology solutions are advantages.
Medical Care: This industry is non-cyclical and recession-resistant in nature.
According to the Centers for Medicare and Medicaid Services, health expenditures in U.S. account for approximately 18% of the GDP. The World Health Organization stated that health care expenditure per person in the country is the highest in the world.
With the passage of time, the proportion of people living in poverty has declined and the need for medical care has increased. Moreover, emerging economies like Brazil, Russia, India and China (BRICs) and others have increased their focus on the medical care space with India and China leading the pack as the world's two most populous nations.
Moreover, with the rising world population, aging generations, increase in life-threatening diseases and rising awareness towards fitness, this industry is far from the risk of a downturn. Further, growing wealth, government focus on health care infrastructure as well as treatment and technology advances will keep the growth momentum alive in 2015.
Telecommunications: With the growing need for telecom in both rural and urban areas and its role in the infrastructure of both developed and developing markets, this industry as a whole offers a number of attributes that look attractive from the standpoint of investors.
The telecommunications industry is currently thriving on the expected innovative product launches in areas of m-Commerce, virtualization and cloud-based technology. The cloud-managed WiFi market has become a major growth driver for telecom operators as increasing number of large and mid-sized business enterprises are adopting this technology.
Moreover, the increasing traction of wireless networks and the consequent popularity of spectrum along with the projection of aggressive high-speed fiber-based network expansion, especially for video/TV offerings will contribute to the evolution of this industry.
There dwells ample scope for expansion as nearly a fifth of rural American households lack broadband access, as per the Federal Communications Commission. With the whole world turning towards digitalization, technological innovations, and enhanced network infrastructure and equipment will keep this industry flourishing as the year progresses.
3 Undervalued Stocks from These Industries
We chose three stocks – one each from the above mentioned industries – that are trading below their industry averages in terms of P/E and P/B ratios, returned well in the last one year, and have solid year-over-year earnings growth prospects.
NMI Holdings, Inc. (NMIH): This California-based firm, which went public in 2013, provides private mortgage guaranty insurance throughout the U.S. One of the seven companies in the country to offer mortgage insurance, this Zacks Rank #2 (Buy) is in the development stage.
Apart from being in the better-performing insurance industry that carries a Zacks Industry Rank #26 (top 10%), strength of this stock lies in its value. NMI Holdings trades at 1.0x on a price-to-book basis, a 33.3% discount to the industry average. Also, the shares currently trade at 10.3x the Zacks Consensus Estimate for 2015, a 20.2% discount to the industry average.
Adding to these attractive valuations, the company’s year-over-year revenue growth for 2015 has been forecasted at 155.6%, significantly higher than the industry expected growth rate of 2.7%. In addition, the year-over-year growth for earnings per share (EPS) for 2015 has been estimated at 44.9% compared to the industry projected negative growth rate of 8.7%.
This inherent potential of NMI Holdings has not been reflected in its stock price yet. The company lost over 27% in 2014 in spite of having the elemental leverage, which should ultimately translate into price appreciation going forward.
Concord Medical Services Holdings Ltd. (CCM): This Zacks Rank #1 (Strong Buy) company operates a large network of more than 80 radiotherapy and diagnostic imaging centers spanning over 35 cities in China.
We view this China-based company as a good investment driven by its notable valuation and growth metrics. While Concord Medical trades at a 56.5% discount on a price-to-book basis relative to the industry average, the shares currently trade at 12.3x the Zacks Consensus Estimate for 2015, a 15.2% discount to the industry average.
Concord Medical, which is part of the top-ranking medical care industry holding a Zacks Industry Rank #13 (top 5%), also exhibits promising earnings forecast for 2015. The company is expected to generate revenues at a growth rate of 10% in 2015 compared with the industry anticipated growth rate of 5%.
Moreover, the year-over-year EPS growth rate is projected to be 25.6% for 2015, higher than the industry expected growth rate of 13.0%. The company’s share earned a return of around 17% in 2014, leaving further scope for the share price to incorporate the potential of the fundamentals at display.
Spirent Communications Plc. (SPMYY): A global provider of state-of-the-art systems and solutions, this UK-based company is an international leader in test and measurement inspiring innovation within development labs, communication networks and IT organisations. Spirent Communications is well set to capitalize on the available opportunities in the networking and wireless space, being an expert on next-generation communication networks, devices and applications.
This Zacks Rank #2 stock, belonging to the top-ranking telecommunications industry that holds a Zacks Industry Rank #33 (top 12%) trades at 1.7x on a price-to-book basis, a 51.4% discount to the industry average. Also, the shares currently trade at 14.7x the Zacks Consensus Estimate for 2015, a 5.2% discount to the industry average.
Spirent Communications, which lost over 30% in shares last year, can prove to be a valuable asset in your portfolio given the significant future growth prospects reflected in its comparatively strong valuation multiples. The company’s year-over-year revenue generation for 2015 is expected to be 9.1% compared with the industry estimated growth rate of 0.6%.
Also, Spirent Communications is anticipated to beat the industry expected EPS growth rate of 13.5% in 2015 with the company’s growth rate estimated to be 40%. The fundamental strength of the company along with digitization of almost everything in life and work opens the door to massive growth opportunities.
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