6 Stocks That Can Outperform a Choppy Market

After years of lagging growth stocks, value stocks may be overdue for a return to market leadership. Among those who are confident about pivoting towards value stocks is Scott Blasdell, manager of the JPMorgan Large Cap Value Fund A (OLVAX). "I'm looking for stocks that rank favorably in terms of valuations but also have a bit of controversy around them," as Blasdell told Barron's. "I also like it when there's a back story that allows me to tell that other people think it is cheap too," he added. His top picks include Cigna Corp. (CI), Lennar Corp. (LEN), Occidental Petroleum Corp. (OXY), Southwest Airlines Co. (LUV), Bank of America Corp. (BAC), and KeyCorp (KEY).

Comparative Stock Data

  Industry 1-Year Gain
Cigna health insurance 8.6%
Lennar homebuilding 1.3%
Occidental Petroleum oil & gas production 37.1%
Southwest Airlines airlines (14.1%)
Bank of America money center bank 30.3%
KeyCorp regional bank 13.1%
S&P 500 Index   13.5%
Russell 1000 Value Index   6.5%

Sources: Barron's, Yahoo Finance (for Russell 1000 Value Index); data through May 24 closing prices.

Fund Track Record

Blasdell took charge of the JPMorgan Large Cap Value Fund in April 2013. It has a five-year average annual total return (including dividends) of 12.42%, better than 98% of the 918 funds in its peer group, according to Morningstar Inc., but trailing the growth-led S&P 500 Total Return Index by an average of 0.51 percentage points annually, through May 23. Barron's adds that the fund has beaten its benchmark, the Russell 1000 Value Index, during this period.

Recent returns have been bolstered by overweight positions in financial services and other cyclical stocks, Barron's notes. As of March 31, per Morningstar, financial services stocks were the biggest sector in the portfolio, at 31% of its value, while consumer cyclicals were second, at 17%.

'Very Interested in Relative Valuation'

As Blasdell told Barron's, the fund has used its own variant of the dividend discount model since the mid-1980s, to analyze cash flow forecasts. According to this model, he said, the greatest opportunities for value investing come when the valuation spreads between growth and value stocks are very wide, as they were during the tech bubble of the late 1990s and during the financial crisis of 2008.

Regarding recent market action, he observed: "The spread had come down to about average toward the end of last year. Many good things were being baked into stock prices—including a lot of anticipation of tax cuts, an acceleration of economic growth, and better growth in Europe." As the result of a pullback in value stock prices so far in 2018, the spread has widened somewhat, and he is "starting to get very interested in relative valuation again."

Lennar

Home prices are rising, due to insufficient supply of new dwellings, and the upward move in interest rates is making financing more onerous. Nonetheless, Blasdell sees a big demand boost, and an impetus for increased profit margins among builders, from millennials who are starting to buy. He also likes the company's recent acquisition of competing builder CalAtlantic, given Lennar's success rate with past deals. Based on his EPS forecast of $6.70 for the fiscal year ending in November 2019, that implies a bargain basement forward P/E ratio of less than 8 times 2019 earnings. Meanwhile, because new construction is lagging demand, "there is plenty of runway for the housing cycle to expand."

Cigna

Cigna has made a $67 billion bid for pharmacy benefit management (PBM) company Express Scripts Holding Co. (ESRX), which Blasdell thinks would be "terribly accretive for Cigna," despite his team's being "not huge fans of entering the PBM space." If the deal goes through, he indicated, Cigna's EPS would nearly double to $20 by 2020, giving it an attractive forward P/E ratio of less than 9 times 2020 earnings.

Acquiring Express Scripts would have the positive effect of giving Cigna "more heft," helping it to play catch-up with UnitedHealth Group Inc. (UNH), which has its own PBM unit. Integrating information about customers, as UnitedHealth does with its Optum division, is a key to healthcare cost containment, per Blasdell. If the deal doesn't close, he notes that Cigna still trades at about a 20% valuation discount to other HMOs, and expects this discount to evaporate. (For more, see also: 8 Longterm Winners For a Stormy Stock Market.)

Bank of America

Bank of America is the largest position in the fund, with a 4.1% weight as of March 31, per Morningstar. Citigroup Inc. (C) is second, at 3.2%, KeyCorp fifth, at 2.5%, and Morgan Stanley (MS) seventh, at 2.2%. The fund has been overweight in financials "for some time," anticipating rising interest rates that will increase net interest income, and thus profits. Blasdell's team projects EPS of $3 for BofA in 2020, giving the stock an enticing forward P/E ratio of just 10 times 2020 earnings.

He believes that the market is underestimating the potential for increased returns of capital to shareholders by BofA, especially through share repurchases. Also, the company is reducing expenses related to its massive clean-up effort after the financial crisis, and is starting to grow again. "We expect it to outperform the market and its peers from here," was Blasdell's concluding comment. (For more, see also: 4 Financial Stocks With 20% Upside: Goldman.)

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