The Dow Jones Industrial Average is down 14% year-to-date. Of the 30 stocks in the index, only five are in positive territory for the year. That should make it relatively easy to find undervalued Dow stocks to buy.
However, the index has made some positive gains in recent days. As I write this on Oct. 24, the Dow just closed up 1.4% on the day. That continues from last week, when it had its best week since June, gaining 4.9% in five days of trading.
A big reason for the recent gains is rumblings the U.S. economy may avoid a recession. Goldman Sachs said on Oct. 23 that it sees a 35% chance of a U.S. recession over the next year, considerably lower than the consensus estimate.
This assessment is contrary to many others who believe we are already in the grips of a recession. At least, that’s the thought of many of the big bank CEOs. I guess we’ll find out who’s right soon enough.
In the meantime, I’ve been asked to come up with three undervalued Dow stocks to buy before Wall Street catches on.
Of the 30 stocks, my quick screen found that 17 have a forward price-to-earnings ratio of less than 20. Of those, 5 have a PEG (price-to-earnings divided by earnings growth) ratio less than 2.
Here are my three choices of undervalued Dow stocks to buy.
| HD | Home Depot | $290.26 |
| MRK | Merck & Co | $97.98 |
| CAT | Caterpillar | $194.84 |
Home Depot (HD)
Home Depot (NYSE:HD) is down nearly 29% year to date, making it one of the more dicey undervalued Dow stocks to buy on the face of it. Still, those losses don’t make it the worst performer of the Dow in 2022, but it’s pretty close.
As for the long-term, I like Home Depot for many reasons. Here are two of them.
First, Home Depot is proactively helping its Pro customers find trades professionals. On Oct. 18, the company launched PathtoPro.com, a website that connects skilled trades job seekers with companies hiring.
“There is not a leading job seeker platform for the skilled trades and The Home Depot is committed to connecting skilled tradespeople with our Pro customers for jobs,” said Eric Schelling, vice president of global talent acquisition at The Home Depot.
My wife co-owns a construction company. I know how hard it is for her to find people to handle all the business she has on the go at the moment. Home Depot’s initiative makes good business sense.
After all, if their Pro customers fail because they don’t have the appropriate staffing, Home Depot loses business. It has the resources to make this work. It would be irresponsible not to.
My second reason for liking Home Depot is its financial strength. It currently has a return on assets of 23.04% and a return on invested capital of 38.99%, both very healthy numbers.
As for its valuation, it currently trades at 1.84x sales, its lowest valuation since 2016. The housing shortage in the U.S. will keep it doing well for shareholders for many years to come.
Merck & Co. (MRK)
Merck & Co. (NYSE:MRK) is the second best-performing stock in the index in 2022, up more than 27% year to date. That’s impressive when you consider the S&P 500 healthcare sector is down 10.3% while the energy sector is up nearly 58% on the year.
Of the 65 healthcare stocks in the S&P 500, according to Finviz.com, MRK is the fifth-best performer in 2022.
So, what’s it doing well that other healthcare stocks aren’t?
InvestorPlace contributor Josh Enomoto discussed earlier in October how its share price jumped 4% on positive news about its Phase 3 study for sodatercept, “an investigational fusion protein evaluated for the treatment of pulmonary arterial hypertension (PAH),” Enomoto wrote on Oct. 10.
The company believes the therapeutic fusion protein could be used in the future to treat pulmonary hypertension, a medical condition that millions of Americans suffer from. The latest data gets it one step closer to having the cardiovascular medication approved by the U.S. Food and Drug Administration.
A year ago, Merck paid $11.5 billion for Acceleron Pharma — sotarcept was one of Acceleron’s drugs — the latest results help confirm to investors that it wasn’t wrong to pay $11.5 billion for a company that had just $93 million in revenue in 2020.
With a healthy 2.84% dividend yield, a trailing 12-month free cash flow of $14.4 billion and a free cash flow yield of 5.8% [$14.4 billion divided by $246.3 billion market cap], you’re getting growth at a reasonable price.
Caterpillar (CAT)
At the end of September, Cowen analyst Matt Elkott had good things to say about Caterpillar (NYSE:CAT). Elkott, who has a Buy rating and a $225 price target on the stock, believes the company’s revenues will start to recover in late 2023 and into 2024.
“Growth in the company’s services revenue is on track to meet the goal of doubling by 2026 to $28B,” CNBC reported the analyst’s comments.
The company set this lofty goal for its annual revenue for its services business in its 2021 annual report. CEO Jim Umpleby believes the increased demand for minerals for a clean energy transition will translate into increased demand for its services. In 2021, Caterpillar generated $19 billion in services revenue. It’s got five years to add $9 billion more.
Halfway through fiscal 2022, Caterpillar’s sales were $27.84 billion, 12.3% higher than a year ago. On the bottom line, its profit was $3.21 billion, 9.1% higher than in the first six months of 2021.
The 28 analysts covering CAT stock give it an Overweight rating with a $211.91 average target price. The consensus earnings estimate is $12.60 a share in 2022 and $13.79 in 2023. That’s 15.2x 2022 sales and 13.9x 2023 sales.
Buy CAT on any weakness in its share price. It’s gained more than 19% in the past month. It could be slightly overbought at the moment.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.