5 Stocks to Buy Instead of Overpriced US Equities

Susan Dziubinski: Hello, and welcome to The Morning Filter. I’m Susan Dziubinksi with Morningstar. Every Monday morning, I talk with Morningstar Research Services Chief US Market Strategist Dave Sekera about what investors should have on their radars, some new Morningstar research, and a few stock picks or plans for the week ahead. So good morning, Dave. We’re heading into October already. After the Fed’s 50-basis-point cut in September, what do you think the market’s really going to be focused on short term?

David Sekera: Good morning, Susan. I think really the key right now is just going to be on the economy: How much is it slowing? For how long is it going to continue to keep slowing? And when is it going to be that the fed-funds rate, the easing monetary policy, when is that really going to start flowing through into the real economy?

So depending on how much the economy is slowing and for how long it’s slowing, I think that’s to some degree going to influence earnings guidance. Now it does look like earnings season begins here, middle of the month, on Oct. 15. And taking a look at our own economic forecasts, we’re currently projecting that third-quarter GDP is going to be 2.3%. So actually still probably stronger than we had originally forecasted. But it is slower than the 3% that we saw last quarter. So in my opinion, I don’t think it’s going to be a problem for companies to either meet and or beat their third-quarter numbers. But for the fourth quarter, we’re only forecasting GDP of 1.3%.

So there is some risk that management teams may look to lower expectations for their fourth-quarter earnings.

Dziubinski: Now, given the market’s concerns about the economy, investors will be watching the jobs data coming out this week, right?

Sekera: Exactly. So we’ve got nonfarm payrolls and unemployment, and those are going to be very closely watched and, in my view, potentially market-moving. So I think the greater risk here is likely going to be to the downside. As you noted, with the fed embarking on a monetary easing policy of a 50-basis-point cut instead of that typical 25-basis-point cut, I think the question really is is the fed seeing more softness in jobs and unemployment than maybe what the market is expecting?

Dziubinski: Now we have a couple of high-profile, high-quality companies reporting earnings this week that you’re keeping an eye on. The first being Nike. Now Nike’s stock is down more than 20% since the start of 2023. So tell viewers what’s been going on here.

Sekera: Well, I think the short story is that Nike’s just been under a lot more pressure from competition from brands like Hoka and On than I think people had expected. Those have really come on the scene over the past year or two and to some degree is really been eating into Nike’s revenue. And in fact I think our analysts noted that Nike had no sales growth in fiscal 2024.

And I think either last quarter or the quarter before the company already guided toward a revenue decline in 2025. In fact, to some degree, it looks like the situation here is bad enough they are replacing their CEO. They’re bringing back a former Nike executive. Now his experience looks pretty good to me. He’s got 32 years of experience at Nike.

He was the president of the consumer and the marketing groups before retiring in 2020. But we’re expecting things here probably to get worse before they start to get better. And in fact, looking at our note here, this quarter we are forecasting a 10% decline from last quarter.

Dziubinski: Let’s talk a little bit longer term then, Dave, about Nike. What’s Morningstar expecting? Can this ship be righted?

Sekera: Well, we shall see. Now the stock is undervalued based on our forecast over the long term. We do think that Nike will be able to revitalize its product portfolio, but it’s going to take some time. And our equity analyst forecasts over the next five years do take this into account. We think that over a couple of years Nike does get back to, call it, that mid-single-digit sales growth and should then be able to start expanding its operating margins, getting them back to more like a high teens level, more of like a historical operating average as opposed to the 12% that they’re running at right now.

Dziubinski: So given those expectations, does Morningstar think Nike is a buy ahead of earnings?

Sekera: So right now it is a 5-star-rated stock, trades at a 28% discount to fair value. Although I’d note they only yield about like 1.7% based on its dividend. Now, in my mind, I think this might be one of these stocks where even though it’s undervalued, it might take some time for this stock to start to work.

I think investors are going to want to see evidence of that turnaround before they give the company credit for really getting back to those forecasts that we’re looking for several years out. So this might be one of those situations whereas an investor, if you do have an interest in the company and an interest in the stock in particular, maybe just start off with a partial position in order to buy, leave yourself some room.

And then the first thing I always do is I set a limit as to how much that stock can fall before I would look to potentially buy some more at a dollar-cost average in. When it hits that target price, first thing to do is just to reevaluate, just understand why is that stock falling further.

Do you still believe in your long-term investment thesis? Is it really more like technicals why the stock is down or just some short-term fluctuations, or is there something really different going on here? And then of course depending on that reevaluation, if your investment thesis still holds true, that’s just an opportunity to be able to then buy some more stock and dollar-cost average down.

And of course, if things have changed and you no longer believe in that long-term investment thesis, then that’s one of those situations where just go ahead and sell that stock. Usually your first loss is your best loss.

Dziubinski: Yeah. You haven’t gone all in quite yet, so that’s a good strategy. We also have two high-quality consumer defensive companies reporting this week. Those are McCormick and Constellation Brands. So let’s start with McCormick. What are the headlines here, Dave?

Sekera: Well, McCormick is just a great, high-quality, company. Wide economic moat. But this is just one of those stocks that the market has been willing to overpay for for quite a long time. In fact, when I look at the chart here, the stock price is essentially at the same price it was all the way back in 2019, which at that point in time we had rated it with 1 star.

Currently it’s still overvalued according to our projections. It’s a 2-star-rated stock. Trades at a 24% premium. Has a 2% dividend yield. And just as an indication of how expensive we think that stock is today, it trades at 29 times our projected earnings for this year. But when I look at our financial model, our earnings forecast is for the company only to grow at slightly under 12% compound annual growth rate over the next five years.

Dziubinski: So then it’s fair to say that McCormick is an example of a great company that maybe isn’t a great stock.

Sekera: Exactly. Based on our valuations today, that just naturally tells us that we would expect investors will earn less than McCormick’s cost of equity over the long term based on where that stock’s trading today.

Dziubinski: Now we also have Constellation Brands reporting earnings this week. And here’s another high-quality company. But we’ve got a slightly different story here with this one that McCormick.

Sekera: Yeah. And I think you and I have talked about this company several times over the past a couple of years. It’s a company I’ve long been impressed by—the company and the management team. And this is one I always keep on our watchlist for when there are those instances that the stock dips.

The company has a wide economic moat. For those of you that aren’t familiar with it, they own the distribution rights to Modelo and Corona here in the US. Now it is currently rated 4 stars, but it only trades at a 8% discount to fair value, only pays a 1.6% dividend yield. So in my mind there’s probably not as much a margin of safety here as I would like to see.

But when I look at our model here, we are forecasting a little bit over 12% five-year compound annual growth rate for earnings, which interestingly is actually pretty similar to the growth expectations at McCormick. Yet Constellation Brands stock only trades at 18 times our earnings projection for this year, as opposed to McCormick’s 29 times.

Dziubinski: Much better opportunity there. So before we move on to some new research from Morningstar, I want to ask Dave about a new book I see behind him. Not surprisingly, I have the very same book. It’s from our colleague Christine Benz at Morningstar—How to Retire: 20 Lessons for a Happy, Successful, and Wealthy Retirement. It’s a great new book.

Have you read it yet, Dave?

Sekera: Actually, to be honest, I just got it a few days ago and I haven’t had the time to read through it just yet. I’ve actually been pretty focused on our fourth-quarter outlook, which actually should be published on our morningstar.com today. So take a look for that. But yeah, I’m actually going to put it into my bag this morning on my way to work.

So it’s something that I will be reading myself on my train ride in and out of the city. As I get a few less hairs up top, I, too, also need to start really thinking more about retirement.

Dziubinski: Yeah, well, I’m taking my retirement more serious than you are, Dave, because I’ve read it. I recommend it. A lot of practical guidance from retirement experts in it. and viewers can find it where books are sold. All right. Back to new research from Morningstar on Micron. Now, Micron—its stock shot up last week after earnings. What’s Morningstar think of what Micron had to say?

Sekera: Well we talked about it last week, and at that point in time we noted it was one of the few large-cap tech names that we thought was still undervalued out there. And that, going into earnings, we thought that not only would have benefit from the buildout of data centers for artificial intelligence-those of course need a significant amount of memory, but also from AI-enabled PCs and smartphones. They also require much higher memory content. And generally, our equity research team foresees demand outpacing supply through calendar 2025, which we expect that to support high prices, driving strong revenue growth at Micron. And looking at earnings, all of that essentially has been coming to fruition. As you noted, that stock jumped, I think, is up 15% after earnings.

But I would note we actually held our fair value steady, as the results that came in are really kind of in line with what we had already modeled.

Dziubinski: So does Morningstar think Micron stock is attractive after the rally, or is this one for investors to sort of keep on a watchlist for now?

Sekera: It’s definitely a watchlist kind of stock. So following that rally, that stock is trading pretty close to our $110 per share fair value. Now it is a company we rate with no economic moat. So in my mind I think this is one where investors keep it on that watchlist, but being a no-moat company, of course, I would look for a pretty wide margin of safety before I’d get involved.

Dziubinski: All right, well, it’s time to move on to the picks portion of our program this morning. This week, you’ve brought viewers five alternatives to pricey US stocks, and they’re all ADRs of China-based companies. So before you name names, let’s take a step back and talk about China. China’s central bank introduced a stimulus package last week to help drive economic growth.

So, does Morningstar think it’s going to work?

Sekera: Well, I talked to Lorraine Tan. She’s the head of our Asia equity analyst team. And the short answer here is we only anticipate that these stimulus measures will have a mildly positive impact. In fact, we think all these measures are really are going to end up doing at the end of the day is reducing the risk of a deeper slowdown than what we’ve seen in China. We think it’s unlikely this is really going to cause the market’s expectations to rebound back to the Chinese government’s 5% target. To some degree, the reaction that we’ve seen in the Chinese markets the past couple days is really a relief rally. And that relief rally, just being based on the Chinese government really being willing to intensify their efforts to bolster their economy.

Now, in our opinion, their economy probably still has a lot of excess housing that they need to work off. We think that probably won’t be until the middle of next year. Now, having said that, there are a lot of Chinese stocks we cover that are trading at just what we consider to be especially depressed levels.

So, for investment opportunities, I know our equity team in Asia has really been focused on those Chinese stocks that have minimal exposure to exports, giving that we do expect that the global economy is slowing, slowing growth everywhere. And, of course, heightened geopolitical risks. So we’re really looking for those Chinese stocks that are more reliant on Chinese consumer spending.

As the new stimulus measures that are being put in place should really help accelerate consumer spending, specifically domestic Chinese consumer spending, as those measures flow through their real economy.

Dziubinski: So did this new package have any impact on how Morningstar values the companies that are domiciled in China?

Sekera: Again the short answer is not all that much. We maintained our base-case forecast, and that is for GDP growth to be closer to 4% as opposed to the 5% that’s targeted by the Chinese government.

Dziubinski: So then what’s Morningstar’s take overall on Chinese stocks today?

Sekera: Well, actually, I don’t have a view on all Chinese stocks or the Chinese stock market as a whole. But we do see a significant number of individual Chinese-listed ADRs that trade in the US that we think are significantly undervalued. In fact, kind of my own opinion here is this might be an unusual case where I think buying individual undervalued stocks might be less risky than buying the overall index exposure.

And of course, it always comes down to valuation. We think that as poorly as the Chinese stock markets have performed over, call it, the past three years, a lot of very valuable, high-quality Chinese companies have been dragged down with the overall market.

Dziubinski: All right then, Dave, let’s name some names. Your first pick this week is Tencent. Run through the key stats on this one.

Sekera: So Tencent is rated 4 stars. Trades at a very healthy discount to our fair value of 37%. Although this isn’t one for dividend investors. I believe the dividend yield is under 1%. Now we rate Tencent with a wide economic moat. Reading through our write-up here, the wide moat is primarily based on the network effects around its just massive user base.

But it also has some secondary moat sources as well that were highlighted like intangibles, cost advantages, and switching costs. And just to give you an idea of the scale of the size of this company, and again, some of these numbers, we are talking about Chinese companies, are a little old here, but as of Sept. 21, our equity analyst team just noted that the number of monthly active users on WeChat reached 1.26 billion.

That essentially covers 90% of the Chinese population.

Dziubinski: Now, here’s an example of a stock. Tencent’s down substantially from its highs, but it’s performing quite well in 2024. The ADRs, last I checked, were up more than 50%. So what’s Morningstar’s thesis on the company going forward?

Sekera: Well, first of all, for those of you that don’t know, the company, Tencent owns what we consider to be the most dominant messaging apps in China, including one called WeChat. And unlike other messaging apps, we think WeChat is a platform that’s actually used both for daily life as well as for work. And we noted that through in-app features, users can just do a wide range of things, anywhere from playing games, reading news, doing searches, watching videos, listening to music, as well as shopping.

So in a way, our equity analyst team noted that WeChat, they consider that to essentially be the Chinese equivalent of Facebook, WhatsApp, Netflix, Spotify, and PayPal all rolled into one. And the thing that really I think investors should take a look at is Tencent has really just demonstrated the ability to profitably monetize its network through all of those different in-app activities.

And when I look at our model here: We’re forecasting earnings growth of about 15% on average from 2025 through 2028. But the stock only trades at about 20 times earnings.

Dziubinski: All right. Your second pick this week is Yum China, which is the largest restaurant chain in China. Now unlike Tencent, Yum China’s ADRs are up only about 8% this year. So, what’s the market missing here, Dave?

Sekera: Well, we shall see. I mean, this has been one of those stocks that we’ve thought has been undervalued for quite a long time. So hopefully this is the catalyst for this stock to start moving up to our intrinsic valuation. As you noted it is the largest restaurant chain in China. I believe it has over 13,000 units.

Now those units are mostly KFC and Pizza Hut, but they do have a number of other brands, including Taco Bell. So I think the results here have been pretty choppy for the past couple of years. And a lot of that is really been more macro-driven. Of course, the top line declined in 2020 during the pandemic. We had a pretty strong rebound in 2021, but then it slid again in 2022 as the Chinese economy stagnated.

We had growth back in 2023, and then stagnation again here in 2024. But over the long term, when I look at our five-year forecast period, we’re forecasting a 10% average growth rate over the five-year period.

Dziubinski: So give us those key stats on Yum China then.

Sekera: Rated 5 stars. 40% discount to fair value. Only a 1.4% dividend yield. But again another company we rate with a wide economic moat. And I’d also note here, too, this is the only Chinese ADR we cover that has a Medium Uncertainty Rating. Taking a look at the moat, it’s based on intangibles like the brand names.

But we also see just very consistent menu-innovation, digital capabilities that we don’t see in other brands in China. And of course just based on its size and scale, it does have a number of different cost advantages based on their purchasing power and their sourcing through their supply chain. Stock trades I think a little under 20 times our earnings estimates, yet we forecast a 17% annual compound annual growth rate over that next five-year period.

Dziubinski: Now, your next pick this week is PDD, which owns Temu, among other holdings. So share some of the key metrics on this one.

Sekera: Yeah, Temu is just amazing. And I don’t think I’d even heard of Temu before, maybe a year ago, at this point, before it came on-scene here in the US. But stock is rated 4 stars, trades at a 21% discount. It’s a company we rate with a narrow economic moat. But it will highlight we do have a Very High Uncertainty Rating on this one.

Taking a look at our moat write-up, we’d note that the primary moat source here is going to be the network effect. It has probably the largest active base of buyers, I think, 882 million as of the March quarter in 2022. So again, very large network effect here. And when I look at the size of their base, I think that there’s really only about 1.2 billion online in China over that same period, so that 882 million in March of 2022—just a huge percentage of the total population online in China.

Dziubinski: Now, Morningstar recently slashed its fair value estimate on PDD by about 20%. Why?

Sekera: Well, management came out, and they reduced guidance. They took down their future revenue growth, just due to intensifying computation in the space. So we ended up cutting our 10-year operating profit compound annual growth rate all the way down to 10% from 18%, based on the expectation that they’re going to have to reinvest and put a lot more money into the business in order to be able to maintain that growth.

Even so, our top line five-year compound annual growth rate is 28%. And we’re looking for earnings growth over that five-year period on a compound annual growth rate of 25%.

Dziubinski: So even after that fair value cut, there’s still upside potential here, right?

Sekera: Yeah, exactly. So even after the reduction in that intrinsic valuation, the stock is trading at a 21% discount to our fair value. And as an indication of valuation here, I would just note the stock is only trading at 11 times this year’s earnings estimate.

Dziubinski: All right. Next up is internet giant Baidu. That’s your next pick. The stock’s down about 70% from its highs a couple of years ago. So what’s Morningstar’s take?

Sekera: As you mentioned, Baidu is the largest internet search engine in China. I believe it has over 50% share. Taking a look at the revenue, 72% of the revenue comes from online marketing services from that search engine. But another 18% of revenue last year did come from artificial intelligence and cloud business. And then the remaining 10% comes from a couple of different things like video streaming, voice recognition technology, as well as other work in autonomous driving.

So we lowered our fair value, but only by 5% after earnings. We were just forecasting that the sluggish economy in China would lead to lower advertising revenue this next quarter, and we did reduce our operating margin assumptions in 2024 and 2025 due to the lack of monetization in its ads. But really, that’s because of that weak economic sentiment that we see here, that we’re now starting to see rebound with all of those Chinese stimulus measures that are being put in place.

Dziubinski: So then what are the key data points for Baidu?

Sekera: So it’s a 4-star-rated stock at a 33% discount to fair value. Again another Chinese company we rate with a wide economic moat, in this case based on its network effect. And again, just a dominant share in its user base, from that search engine as well as intangible assets from the AI development that they’ve been working on.

So again as one of the earliest internet companies in China, Baidu, we see as really having an ecosystem built around that search business. And I’d also note, too, that we think that they’ve pretty successfully shifted to the mobile internet. Now, in my mind, this one is actually a bit of a value play.

Now we’re not expecting much growth. Taking a look at our model here, we’re only looking for 4% average top line growth over the next five years and only 2% earnings growth. But with the stock trading at 11 times projected earnings, to me, that puts it in kind of that value category. However, I will caution, it is a stock that we write with a High Uncertainty Level.

Dziubinski: And then your last pick this week is JD.com, which is another major e-commerce player in China. Now the ADR is having a decent year, but like all the others, we’ve talked about today, it’s still off its markets highs. So rattle off the key metrics for JD.com.

Sekera: So, JD we actually estimate the its size is probably pretty similar to PDD, although it is lower in size than something like an Alibaba. They offer a really wide selection of products, but they use their own nationwide fulfillment infrastructure as well as their own last mile delivery network. It’s a 4-star-rated stock at a 20% discount.

We rate it with a wide economic moat, although a High Uncertainty Level. And taking a look at the wide moat—it is really based on their intangible assets of high reliability, their own inventory, high quality, fast proprietary logistics and delivery, as well as the cost advantage from having just really large and growing economies of scale.

Dziubinski: So then what’s Morningstar’s take looking ahead for the stock?

Sekera: I again think this is another value play. We’re not expecting all that much growth. Looking at our forecasts, only a 4% average top line growth for the next five years. Only 5% earnings growth. But the stock trades at only 8 times our projected earnings. So really just to wrap things up here, Susan, I would caution investors, when you are looking at Chinese stocks and Chinese ADRs, I think you really need to do some extra research and investing in these companies.

You are undertaking a lot of other risks and complexities as opposed to investing in just typical US stocks. For example, we’ve seen over time, the Chinese government can institute rules, regulations, things that can significantly impair businesses going forward. I think that makes it especially important to be able to buy these stocks at these large margins of safety.

So again, I’d highly recommend before investing in any of these stocks, doing your own analysis, including but certainly not limited to, reading our research on morningstar.com. The end of the day, I think you need to have a very high level of confidence in the underlying fundamentals and valuations before putting your money to work in individual Chinese stocks.

Dziubinski: Well, thanks for your time this morning, Dave. Viewers, we hope you’ll join us for The Morning Filter next Monday at 9 a.m. Eastern, 8 a.m. Central. In the meantime, please like this video and subscribe to Morningstar’s channel. Have a great week!