9 Shades Of Dow

by Trefis Team
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While the Dow Jones Industrial Average fell by over 35% from the beginning of the year through late March due to the spread of the Coronavirus pandemic, it has rebounded by over 40% from these lows, driven by the Fed’s stimulus and a reduction in the rate of new Covid-19 infections from their April highs. However, stock picking might appear tricky at current levels, as the economy is still under pressure, with a larger second wave of Covid-19 infections remaining a real possibility.

That said, we’ve done a comprehensive analysis, and believe 3 stocks in the Dow look undervalued. We’ve found underlying traits that tie these stocks together. Each has moderate revenue growth, lots of market power – evident in strong margins of over 15%, and relatively attractive valuations. Each company also has a strong balance sheet, and we see this group of 3 recovering and surpassing its Dow peers in the next 6 to 12 months.

Our analysis 9 Shades of Dow 30 Components breaks down the components of the Dow Jones Industrial Average into nine categories, based on Revenue Growth and Net Margins.

1) Merck

Merck stock is down by more than 15% year-to-date, as the lockdown in various parts of the world has had a negative impact on the pharma space, due to the postponement of elective surgeries and hospital visits for non-emergency cases, resulting in lower prescriptions issued. Merck has been further impacted by its exposure to Animal Health and Vaccines business, which will see more impact due to the current Covid-19 pandemic.

However, Merck looks well poised to weather this downturn. The growth in Merck’s blockbuster drug, Keytruda, will likely offset the Covid-19 related decline, if any, from the above two businesses and we believe that the medium to long-term picture for the company looks strong. Keytruda has been on a stellar run posting a whopping 20x sales growth from $0.6 billion to $11.1 billion between 2015 and 2019. To add, the drug’s sales grew 45% even in Q1 2020, when most of the businesses started to face headwinds from the Covid-19 crisis.

Merck stock currently trades at about 20x trailing earnings – the lowest level it has traded it in over 3 years. Moreover, the company could offer a significant upside assuming that Keytruda could garner a leadership position in other therapeutic areas. View our analysis for Keytruda Upside which outlines a case for the drug to be valued at around $200 billion.

2) Cisco

While Cisco stock is down by about 4% year-to-date, faring better than the broader Dow, it has underperformed its peers in the technology space, as revenues are projected to fall this fiscal year, as the pandemic impacts the company’s campus-networking business.

However, things look good for the stock in the medium to long term.  Covid-19 is likely to cause a permanent behavioral shift as people spend more time online to work, learn, shop, and entertain themselves. This could, in turn, call for better connectivity and bandwidth driving demand for Cisco’s networking software, switches, and routers. Separately, Cisco should also see strong demand for its video conferencing and virtual private network (VPN) software through the pandemic, as many enterprises move entirely online. The ongoing upgrade to 5G wireless networks in the U.S. and other developed markets should also prove positive for Cisco.

Cisco’s net margins have trended higher in recent years, driven by a transition toward a software-focused and subscription-driven business and this trend could further accelerate when the company reports Q4 results in August, as the full impact of increased VPN and video conferencing software sales become visible. Considering that Cisco’s P/E multiple is currently at the lowest level it has been in over 3 years, this could make for a good entry point into the stock.

3) Verizon

Verizon’s stock is down by about 7% year-to-date, as lower economic growth and consumer spending weigh on demand for the company’s traditional wireless plans to a certain extent, as people spend more time at home due to the pandemic. However, there are a couple of trends that make the stock attractive at current levels.

Firstly, the roll-out of 5G should prove a major tailwind for the stock, as the next-gen wireless technology helps to boost revenue growth and widens the applications of Verizon’s network beyond personal wireless devices. Unlike rival AT&T, which invested in expanding into media and pay-TV, Verizon has focused more heavily on network upgrades and this should pay dividends as the industry migrates to 5G. Separately, Verizon’s tie-up with Disney for its latest streaming platform, Disney+, is also expected to help it retain and potentially grow its customer base.

While Verizon stock has fallen less than the broader markets, the company could be a relatively low-risk choice, with a meaningful trigger in terms of its coming 5G upgrades. ( What Factors Drove 19% Change In Verizon Stock Between 2017 And Now?)

Apple and Microsoft are the largest components of the Dow. However, we think Google’s parent Alphabet could actually make a better investment. Find out more in our analyses Google vs Microsoft and Apple Vs. Google

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