In their fourth quarter commentary, portfolio managers at Heartland Advisors, a value fund shop, discussed the opportunities for value stocks in 2025.
The portfolio managers also cited three value stocks that are well positioned to outperform in this overvalued market.
“The euphoria in today’s equity market is breathtaking and unsustainable in our view,” CEO Will Nasgovitz and chairman Bill Nasgovitz, who manage the Heartland Value Fund, wrote in the Q4 commentary. “Since the election, Bitcoin jumped 34% ($2 trillion in market value) in anticipation of fewer regulations under the Trump administration. That same theme put more wind in the sails of mega-cap tech stocks, with Amazon (NASDAQ:AMZN) up around 10%, Alphabet (NASDAQ:GOOGL) and Apple (NASDAQ:AAPL) gaining about 12%, and Tesla (NASDAQ:TSLA) soaring over 60% since Nov. 5.”
That euphoria has created opportunities for good values, they added.
“By almost every measure, large cap glamours are over-valued, over-owned, and have overly lofty expectations,” they wrote. “More than a quarter of U.S. companies, based on market capitalization, are trading at more than 10X enterprise value to sales, a level not seen since the dotcom bubble. Investor confidence shot up even higher than it was prior to the tech wreck in 2000.”
Wide gap between stock market and consumer confidence
Will and Bill Nasgovitz cited data from the Conference Board that shows how stock market expectations don’t jibe with consumer confidence. Historically, the two have mirrored one another’s movements, but currently they have “diverged wildly” with stock market confidence at a recent-year high and consumer confidence at or below recent historical averages.
The portfolio managers at Heartland seek to capitalize on this discrepancy by looking for “pockets of opportunities in lagging areas that have historically had a strong correlation to what is currently working.” One sector they have focused on in particular is materials, which has largely moved in tandem with industrials as materials are often used in manufacturing. But that has not been the case lately as industrials have far outperformed materials.
One area within material that the Heartland managers saw as overlooked was packaging, which is where they found a good value in Sealed Air (NYSE:SEE) Corporation.
Sealed Air is a global packaging company that Heartland found to be substantially undervalued relative to its intrinsic worth and less than half the market’s price/earnings ratio. Sealed Air stock is down about 7% over the past 12 months to around $33 per share, while its P/E ratio has dropped from 17 a year ago to 12 now. The median price target among Wall Street analysts for Sealed Air is $42 per share, which would suggest a 25% increase.
Considering the risks with Delek US Holdings
Heartland’s stock evaluation process involves setting four price targets based on various potential market and economic scenarios. That allows them to account for risks and remain patient if all signals are not clear. That was the case with Delek US Energy Inc (NYSE:DK).
Delek is an energy company that produces petroleum products for the transportation industry. The stock is down about 23% over the past 12 months, hurt by weakening diesel demand and tighter refining margins. Heartland opened a position at the start of last year, accounting for the downside risks, which materialized. But they held through the downturn, expecting the trucking industry to recover in 2025.
Further, Delek recently announced that it was selling some 249 gas stations and convenience stores, with the proceeds going toward a $400 million share repurchase program.
“Admittedly, we were too early in initiating a position in DK at the start of this year,” they wrote. “When we moved the company from our watchlist to the portfolio, we set a max downside loss price target of $16 a share. While disappointed in the stocks slide to $17, it was an extreme valuation level that we anticipated might occur.”
Heartland portfolio managers believe its value is $31 per share, which is some 60% higher than the current price. It is currently trading at just 4 times earnings.
Patterson Companies trading below its value
The third value name that Heartland called out is Patterson Companies Inc (NASDAQ:PDCO), a supply and equipment distributor for dental practices and veterinary clinics. The portfolio managers found Patterson to be trading at about half the value of a competitor in its dental unit, Henry Schein (NASDAQ:HSIC), even though it has performed similarly. The stock may be somewhat discounted by its smaller and less profitable animal health segment, but they still see it as undervalued.
“In our view, Patterson shares were grossly undervalued, so we held on even as the stock lost more than a quarter of its value from January through the end of November,” they wrote. “We were ultimately rewarded when the company was acquired in mid-December by a private equity health investment firm for $31.35 a share, representing a 36% premium.”
The stock gained about 42% since the state of Q4 and is trading now at about $31 per share.
“In a market priced for perfection, we believe it is prudent to rigorously assess upside potential and downside risks,” Will and Bill Nasgovitz wrote. “But that’s not what most investors are doing today — speculation is rampant. Momentum is in. Valuation is not. This could be a replay of the early 2000s, when small and midcaps led the way after years of concentrated bets on shiny ‘New Era’ darlings.”