3 Oversold Stocks that Could Double

Ryan Fuhrmann's picture

Wednesday, August 31, 2011 - 11:00am

by Ryan Fuhrmann

Since the end of the second quarter, the stock market has fallen fast and hard. The major market indexes, including the Dow Jones Industrial Average, S&P 500, and Nasdaq, are down more than 8%. This has wiped out gains for the year, though the Dow has recently rallied back to almost break-even.

Periods of unusual volatility, especially when it means a large stock market drop, can lead to indiscriminate selling and push quality stocks into the bargain bin. The current downturn has proved to be no exception. Below are three stocks that are ridiculously oversold because the underlying companies are performing well and have stellar growth prospects.
 
1. General Motors
Business: Automotive Manufacturer
Market Capitalization: $37.2 billion
P/E: 5

In November 2010, the "new" General Motors (NYSE: GM) went public at $33 per share. Today, the stock sells for almost $10 below this initial public offering (IPO) price. Many investors I talk to do not want to forgive GM, or "Government Motors" for taking bailout money from the government to help it return from bankruptcy. 

GM declared bankruptcy near the height of the credit crisis in June 2009 because the recession proved too much for it to handle. But rather than view it as a negative event, it actually allowed the company to revive its finances and become much more competitive. As of the second quarter, it boasted nearly $33 billion in cash on the balance sheet, enough to pay off its long-term debt and fulfill its pension obligations. This represents a stark contrast from before the filing, because  "legacy" pension and related costs used to add as much as $2,000 to the cost of every vehicle.

In addition to a more competitive cost structure, the latest vintage of GM vehicles is proving popular. Second quarter sales jumped 18% on the back of strong trends from cars, including the Chevy Cruze and Regal Buick. Archrival Toyota (NYSE: TM) is still seeing a backlash from a number of product recalls, and this has also worked in GM's favor.

Investors may not yet trust GM's reinvention, but the sales and profits are already there. For the full year, analysts currently project sales growth in excess of 10% for total sales of nearly $150 billion. They expect earnings of $4.40 per share, which would represent growth of 52% from last year's $2.89 per share. At the current share price, the stock trades at a rock-bottom P/E of about 5. With a stable economy, earnings could reach $6 per share or higher within three years. I see a future P/E closer to 8 as reasonable, meaning the stock price could easily double in this timeframe.     

2. Petrobras
Business: Brazilian oil and gas producer and distributor
Market Capitalization: $186 billion
P/E: 6.7

Back in December, I suggested Brazilian energy giant Petrobras (NYSE: PBR) could be the first company to reach a market capitalization of $1 trillion. The stock is down since I wrote the piece, but I also stated it could take Petrobras up to a decade to reach this lofty goal. Despite the near-term stock struggles, its historical growth track record and billions of barrels in oil reserves point to steady growth trends in the coming 10 years.

Specifically, Petrobras boasts 12.1 billion barrels of oil equivalent in reserves. The company estimates it will take at least 14 years to extract much of these oil and natural gas reserves, most of which is held offshore and miles beneath the ocean. It will also require at least $224 billion in spending to build the rigs and drilling wells to extract.

This astounding level of capital expenditure is nothing new to Petrobras. In the past decade, sales have risen from $24.5 billion to $120 billion, an average annual growth rate of 17%. Earnings growth has been even more impressive, rising 23% annually, from $0.80 to $3.88 per share.

For the coming year, analysts expect earnings of about $4.60 per share. At the current share price, the forward P/E is a ridiculously low 6.7. As with GM, certain investors are unhappy with the influence the Brazilian government has over Petrobras, but it's extremely difficult to ignore the vast reserves that will be extracted. Additionally, having the government in its pocket means the company has basically unlimited capital should it need more. Again, I see the stock at least doubling in price within three years as earnings advance and the market eventually awards a higher P/E multiple closer to 8, which is closer to the historical average. 
 
3. MetLife
Business: Insurance
Market Capitalization: $35.2 billion
Forward P/E: 5.7

With more than $4 trillion in policies, MetLife (NYSE: MET) is the largest life insurer in the United States. This leadership position provides domestic clout that few rivals can match. , and MetLife now has its sights set on replicating this strategy internationally. It used the credit crisis to its advantage by acquiring a valuable international insurance division from beleaguered rival AI (NYSE: AIG). The unit is known as Alico, and increased MetLife's overseas income to comprise 40% of total profits, up from 15% prior to the purchase.

Overseas exposure, especially in Asia, greatly boosts MetLife's growth prospects. Analysts project full year total sales growth of 24%, to $66 billion. They expect earnings of $5.20 per share, or 73% above the $3 it reported in 2010. Management also has a goal to boost return on equity to 15% within five years. This works out to about $6.63, based off current book value (or equity) of $44 per share. Once again, the stock has the potential to double as earnings grow and the P/E expands back closer to 10, which is MetLife's average multiple during the past decade.  

Risk to Consider: The biggest risk to these stocks is the possibility of another recession. In this case, earnings projections may need to come down, which would push the forward P/Es higher, even though each of these companies expects strong growth. That said, the valuations for these stocks are already so low, there is probably a bit of cushion in place for the prices.

Action to Take --> With a couple more years of strong sales and profit growth, concerns regarding the outlooks of the companies I just mentioned should eventually subside.

In the case of GM, investors may want to wait for proof that the global economy will not head back into recession, though the consensus currently sees this as unlikely. Demand for energy is also somewhat dependent on the economy, but in the case of Petrobras, Brazil has huge growth potential as one of the largest emerging markets. MetLife is also favorably positioned in fast-growing Asia, meaning each of these firms has solid growth prospects and is trading at ridiculously low earnings valuations.

You may do well to scoop up one of these stocks, because you could very well be sitting on a double in a couple years.

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Ryan Fuhrmann does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of GM, MET in one or more of its “real money” portfolios.