Undervalued stocks with plenty of juice left in the tank

Despite the recent bull run, these names still trade below their fair value.

Vikram Barhat 29 August, 2018 | 5:00PM

Despite the ongoing volatility in the stock market and resultant fluctuations in stock prices, this has been another year of solid gains for equities, lead by the technology sector. Increasingly, barring a few corrective dips, stock valuations have steadily climbed, making it harder for investors to find quality stocks with some room to run. The S&P 500 Index has returned nearly 9% year-to-date, while the Technology Select Sector Index and the S&P 500 Information Technology index have each risen nearly more than 17%, as of Aug. 24, 2018.

The gains have further deepened the perception of bubbly valuations and investor concern. There has never been a greater need for investors, therefore, to evaluate individual stocks based on fundamentals and separate the wheat from the chaff. When it comes to a stock's value appraisal, its recent performance should have little bearing on the analysis.

This is the reason why Morningstar analysts focus on long-term intrinsic value based on the predictability of future cash flows. Using these metrics, it is possible to separate the equities that may have run out of steam from the ones whose fundamentals will continue to support the forward momentum for the foreseeable future.

The following stocks have had a great ride up so far this year and, as a result, may have become more expensive in absolute terms, but they still have plenty of unrealized upside given their prospects, according to Morningstar equity research.

Synaptics Inc.
Ticker: SYNA
Current yield: -
Forward P/E: 10.0
Price: US$46.21
Fair value: US$64
Value: 27.8% discount
Data as of Aug. 27, 2018

 Synaptics (SYNA) develops human interface solutions that allow users to interact with a range of electronic devices and Internet of Things products. Most commonly used in smartphones, its products include chips that enable touch-based interaction between user and device.

The firm has predominantly focused on mobile devices in recent years. "With web browsing, social media and other applications driving smartphone adoption, Synaptics is well positioned to capitalize on this opportunity with its advanced offerings," says a Morningstar equity report.

In a crowded market where competition is stiff and price wars common, mature component suppliers like Synaptics drive growth through acquisitions and consolidations. "After some well-executed acquisitions -- Validity Sensors (fingerprint) and Renesas SP (display drivers) -- Synaptics now boasts a broader portfolio with touch, display and fingerprint capabilities," says Morningstar equity analyst Abhinav Davuluri, who asserts the company "has the tools to drive innovation and increase its device content while staving off commoditization."

After innovating relentlessly in the touch and display driver integration (TDDI) space, Synaptics has recently begun to reap material financial benefits from the technology. The shift to OLED displays is another strong growth vector for the firm's products as the proliferation of OLED displays in smartphones will require more advanced touch and display driver chips, says Davuluri, who pegs the stock's fair value at US$64, pointing out that investors with tolerance for the volatile nature of the semiconductor component space may find current levels attractive.

Synaptics is also well positioned to leverage its fingerprint sensor in the display to drive growth in an environment of frequent data leaks. The need for secure devices has never been greater, says Davuluri.

Microsoft Corp.
Ticker: MSFT
Current yield: 1.55%
Forward P/E: 25.2
Price: US$108.65
Fair value: US$122
Value: 10.9% discount
Data as of Aug. 27, 2018

Global tech behemoth  Microsoft (MSFT) provides software, hardware and services in three segments: productivity and business processes (Microsoft Office and Dynamics), intelligent cloud (Azure and Windows Server OS) and personal computing (Windows Client, Xbox, Surface, phones and Bing).

The tech giant reported strong growth across all three key business segments in the most recent quarter. "We continue to see healthy demand for Microsoft's Office 365, Dynamics 365 and LinkedIn offerings, while the shifting IT infrastructure and consumption preferences of enterprises is expected to spur strong ongoing growth for the firm's server and cloud-based products and services," says a Morningstar report, noting that the company has been consistently evolving and innovating, embracing changes that position is well for long-term, sustained success.

Microsoft has made particularly long strides in its cloud business, capitalizing on the trend of enterprises shifting their workloads to the cloud. "Notably, we see Azure as having carved out a position as a global public cloud leader, which will help drive the Azure segment into Microsoft's largest business over the next 10 years," says Morningstar equity analyst Andrew Lange, whose US$122 fair value estimate for the stock reflects a "rosy long-term outlook" for growth.

The firm has emerged as one of the most important cloud computing contenders as Azure becomes the number-two player in the space behind  Amazon.com (AMZN), he adds.

Additionally, the wide-moat company's bouquet of software and tools attract and retain developers in the ecosystem. Its massive enterprise footprint across a rich array of products and services create a network effect around its productivity apps and operating systems, which Lange says result in significant customer switching costs.

Guidewire Software Inc.
Ticker: GWRE
Current yield: -
Forward P/E: 78.7
Price: US$100.33
Fair value: US$105
Value: 4.4% discount
Data as of Aug. 27, 2018

 Guidewire Software (GWRE) develops and publishes software for the property and casualty insurance industry. Guidewire reports revenue in three segments: licence, maintenance and services.

"As insurers look to shore up operational efficiency, data integrity and policyholder engagement, Guidewire has prospered as its modern software systems have started to replace P&C insurers' clunky, decades-old mainframes," says a Morningstar report, noting that the company has emerged as the global leader in replacing these legacy systems with newer, more nimble applications.

Guidewire has relationships with more than 25 of the roughly 70 global Tier 1 insurers, yielding a strong revenue base. Its products are scalable to the largest insurance organizations in the world, and its suite is deployable either on-premises or in the cloud through partnerships with major public cloud vendors including Amazon Web Services. Morningstar analyst William Fitzsimmons projects acceleration in licensing revenue over the next few years "as customers adopt Guidewire's cloud-based solutions."

The lengthy implementation process (12 to 36 months) makes Guidewire a long-term strategic partner of many customers, creating durable switching costs and sustainable competitive advantage. "Enterprise software vendors formulate economic moats through developing mission-critical products that deeply ingrain themselves in the customer's core operations," says Fitzsimmons, whose estimate puts the stock's value to at US$105.

With cloud products, international expansion and data tools as its primary growth drivers, the company's revenue is forecasted by Fitzsimmons to grow at 21% annually for the next five years, and 16% over the next 10 years.

Intercept Pharmaceuticals Inc.
Ticker: ICPT
Current yield: -
Forward P/E: -
Price: US$108.90
Fair value: US$150
Value: 27.4% discount
Data as of Aug. 27, 2018

 Intercept Pharmaceuticals (ICPT) develops and commercializes novel therapeutics to treat chronic liver diseases.

The biotech company's key program, obeticholic acid (OCA), is being evaluated in the potential mega-blockbuster indication of non-alcoholic steatohepatitis, or NASH. "NASH is a potential US$30 billion market opportunity as it is a common but serious liver disorder linked to obesity and diabetes with limited current treatment options," says a Morningstar report.

While other biotech firms are vying to address this market, OCA is a clear leader in the race. "We think OCA will see strong uptake initially given the limited treatment options for NASH patients, but with a crowded pipeline and strong near-term competitor, OCA needs to demonstrate stellar efficacy -- showing both antifibrotic impact and NASH resolution -- to maintain significant market share in the long run," says Morningstar sector strategist Karen Andersen, who cautions that stakes are high.

Although OCA has shown a strong efficacy profile, there are concerns over its safety -- particularly around the elevation of "bad" cholesterol levels -- which may restrict the treatment's uptake. However, Andersen maintains that severe NASH patients could substantially drive demand for the drug. "We still believe the later-stage NASH population presents a high unmet need and lucrative opportunity, and OCA's prospects in the NASH market are the key valuation driver," says Andersen, who projects the drug could reach peak sales of US$2.6 billion in 2023.

OCA was approved in 2016 by the U.S. FDA for the treatment of primary biliary cirrhosis, which Andersen says "is an attractive opportunity on its own."

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Amazon.com Inc1,740.48 USD-1.15
Guidewire Software Inc119.33 USD0.60
Intercept Pharmaceuticals Inc119.78 USD1.82
Microsoft Corp149.93 USD0.05
Synaptics Inc58.07 USD0.94

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Vikram Barhat

Vikram Barhat  Vikram Barhat is a freelance writer.