4 Undervalued Stocks to Buy for Income
Plus, what August’s market moves mean for investors.
Key Takeaways
- The factors driving stock market performance in August.
- What to watch for in retail earnings this week.
- Whether Cisco CSCO or Applied Materials AMAT are buys after earnings—and whether Nebius Group NBIS is still a sell.
- Why it’s time to double down on On Holding ONON.
- The ins and outs of stop-loss orders.
- Dividend stocks versus MLPs versus REITs: where to invest for income today.
- Overlooked stocks to invest in for income.
In this new episode of The Morning Filter podcast, co-hosts Dave Sekera and Susan Dziubinski discuss August’s market activity and weigh what last week’s encouraging inflation numbers may mean for the Federal Reserve’s next move. They cover what to watch for in the earnings reports from Walmart WMT, Target TGT, Home Depot HD, Lowe’s LOW and other retailers this week. Tune in to find out whether Cisco or Applied Materials looks attractive after earnings, if Nebius Group is overvalued after a fair value increase, and why we continue to like On Holding.
They welcome special guest Dan Lefkovitz from Morningstar Indexes, who covers the pros and cons of various income investments today, including core bonds, dividend stocks, master limited partnerships, high-yield bonds, REITs, and others. They wrap the episode with four income investments to buy that look undervalued today.
Got a question for Dave? Send it to themorningfilter@morningstar.com.
Transcript
Susan Dziubinski: Hello, welcome to The Morning Filter Podcast. I’m Susan Dziubinski with Morningstar. Every Monday before market open, I sit down with Morningstar Chief US Market Strategist Dave Sekera to talk about what’s going on in the market, what investors should have on their radars for the week, some new Morningstar research, and a few stock ideas.
Why Are Stocks Up?
Well, good morning, Dave. Let’s start out this morning by talking about reconnectivity in the US stock market. After a tough July, stocks seem to be having a pretty good August. What do you make of that, and what should investors make of it?
David Sekera: Hey, good morning, Susan. There’s an old adage in the stock market, which essentially states the stock market takes the stairs on the way up, but the elevator on the way down. Essentially what you typically see in the market is that stocks will take a leg up, they’ll grind higher for a little bit, hit a plateau, maybe even retrench a little bit before taking their next step up. But we’ve really seen the opposite of that over really the past six weeks. It’s really been some interesting market action in that we saw over the course of July, the stock market, where it’s taken the stairs down, here at the beginning of August, really just taking the elevator up. If you look beneath the surface, I think what we’ve seen is really just a continuation of the concerns regarding all of the capital-expenditure spending that’s going on for artificial intelligence and whether or not these companies will end up being able to really generate economic returns on that spending over the long term.
What we saw is really a rotation out of a lot of those stocks that are most closely tied to AI capex spending and into other areas of the market. Specifically, some of the AI commodity tech hardware stocks that we’ve talked about—why we think they’re so overvalued really for quite a while now—took some big hits, like Sandisk SNDK; I think that was down almost 50% from its highs. Micron MU down 28%, Ciena CIEN down 23%, even Western Digital WDC down 15%. What we saw at the beginning of early August was really just the market shooting up higher. In fact, in four trading days, not only did we recapture all of those losses in July, but we’re now hitting new highs in the stock market. In fact, right now the S&P 500, I mean, 8,000 is pretty close in sight. I think that’s only about 3% away. I wouldn’t be surprised to see us hit that somewhere over the next couple of weeks.
But what we did see is this big rotation now into those stocks that, for really the last year and a half, even past two years, a lot of those companies that people thought were going to be very disrupted by AI, those stocks have been just really down and to the right for quite a while. If you think about the software sector, it’s been under a huge amount of pressure; people think software is going to be hugely disrupted or really just force a lot of these companies out of business over time because of AI.
But companies like Salesforce CRM, ServiceNow NOW, two stocks that we’ve been recommending for a while, were up 25%. Workday WDAY, that’s been a recommendation in the past. That was up 62%. In fact, that stock had fallen enough now. There are now buyout rumors. Again, that’s part of the big reason we saw that one spike so much. And then finally, Microsoft MSFT, that’s been one of our best picks for quite a while. That’s nice to see that finally start to work. I think that’s up about 27% since they’ve reported earnings. It’s really interesting seeing what’s going on underneath the surface as opposed to just looking at the headline index level.
September Rate Hike Odds
Dziubinski: Now, last week’s inflation numbers were pretty encouraging, actually. What do you think that might mean for the Fed’s September meeting?
Sekera: Encouraging, but in my opinion, I probably wouldn’t read too much into them just yet. Headline inflation was still up 3.4%, only a tick better than the 3.5% posted last month. Similarly, core inflation at 2.5%, so only one tick better than 2.6% last month. Both are going in the right direction; both are in line with consensus, but at the end of the day, still both are too high. In my mind, certainly not an all-clear signal just yet. Taking a look at the oil markets, oil is back up above $82 this morning. Just to put that in perspective, about 52 weeks ago it was at $62 a barrel, so that’s still going to keep inflation moving higher. If you look at the 10-year US Treasury, that’s about 4.7% this morning. Again, last year that was only 4.3%. We’ll have another inflation reading before the Fed meeting in September, so we’ll see where that one comes out.
Now, we did see the probability of a rate hike in September drop a little bit. At this point, it’s only 33%. Prior to the inflation numbers, it was 44%, but the market’s still looking for at least one rate hike by the end of the year, at least a 70% probability of at least one hike, potentially even more, at that December meeting.
On Radar: Retail Earnings
Dziubinski: All right. Well, let’s talk earnings. We have a number of retailers reporting this week, including Walmart WMT, Target TGT, Home Depot HD, and Lowe’s LOW, among others. Anything in particular you’re going to be listening for?
Sekera: I mean, there’s really nothing too specific that I’m going to be listening for. I think more than anything else, maybe some color on how the back-to-school sales season has been going. Back-to-school sales always have had a pretty high correlation with holiday sales over time. Anytime you’ve seen a pretty good back-to-school season, that’s usually indicated a good holiday season coming as well. We’ll see if we get any color there. Overall, I mean, really, I’m just still trying to understand just how strong consumer spending can remain, how long it can remain here, just with oil prices being as high as they are and taking a bite out of people’s wallets, along with food prices also being pretty high. Again, any change in consumer buying habits that get reported, I think, is really what I’m going to be listening for.
I do have to mention that the retail sales report that came out last week came in pretty weak. The question there: Is this just like a one-off report? People were talking about a shift in Amazon Prime sales from June to July led to a big decrease in nonstore sales, but it wasn’t just that. I mean, there are other categories like weak auto sales, weak auto parts, weak electronics that led to that decline in retail sales as well. Again, really going to keep a close eye, really just more on the broader trends in retail sales than anything else.
CSCO: Attractive After Earnings?
Dziubinski: All right. Well, let’s move on to some new research from Morningstar. Starting with Cisco CSCO, its stock was down almost 10% even after the company beat on earnings and revenue. Morningstar held its fair value estimate on the stock at $115. What does Morningstar think of the results?
Sekera: I think it just got caught up with a lot of what we’ve seen as far as people selling off a lot of these commodity tech hardware stocks. If you look at the earnings in and of themselves, it’s just a continuation of what the company’s been doing, posting strong results, continuation of them raising guidance. They beat their guidance. Revenue came out up 18% year over year. Guidance for fiscal 2027, looking for double-digit earnings and both revenue and earnings growth. Taking a look at the numbers here. The growth, of course, is still just being driven by the AI buildout boom. In fact, they’re looking for revenue attributable to that AI hyperscaler buildout, the AI buildout boom, to really double over fiscal 2027. I know a lot of our readers have kind of mentioned that they’re getting tired of us always talking about AI, but at the same point, if you don’t know what’s going on with the AI buildout boom, I don’t think you really understand what’s going on with the market in general and a lot of these stocks in particular.
Dziubinski: Cisco stock did pull back last week. Is it attractive on that pullback or not?
Sekera: Not really. It’s a 3-star-rated stock. I mean, it trades almost right on top of our fair value. In fact, our analyst noted that our valuation essentially puts the company trading at 20 times 2028 earnings. That’s at pretty much the high end of the historical range where that company has traded in the past. In our mind, probably not much room for further expansion at this point.
AMAT Earnings Review
Dziubinski: All right. Well, Applied Materials AMAT was down about 5% after reporting. Morningstar held its $520 fair value estimate on the stock. Dave, unpack the results here. Tell us how the stock looks from a valuation perspective after earnings.
Sekera: Taking a look at our stock analyst note, our analyst characterized the results as solid. Revenue beat consensus, came in up 25% year over year. They’ve had a pretty solid increase to guidance. In fact, that was slightly ahead of our estimates as well. Again, you just got to note the majority of the growth in the wafer fab equipment sales for 2026 and 2027 is all about the AI buildout boom. Specifically, they called out rising demand for leading-edge logic, DRAM, and advanced packaging solutions. In this case, I think the selloff is just a matter of that solid just isn’t enough for today’s market. The stock retreated a bit after its earnings, putting it in 3-star territory. In fact, I think it’s really close to our fair value estimate.
NBIS: Still a Sell?
Dziubinski: Now, Nebius Group NBIS was one of your stocks to sell on last week’s episode of the podcast. The company reported earnings last week, and the stock shot up 27%. Morningstar raised its fair value estimate by $30 to $150. First, Dave, what drove that fair value increase? Second, do you still consider the stock to be a sell at this updated valuation?
Sekera: Yeah. This is just one of these stories that’s really hard to kind of wrap your arms around. Honestly, I have a very tough time really understanding what the valuation of this company is when you think about it from that long-term intrinsic value point of view. In this case, GPU spot rental prices are just continuing to soar higher. Our analysts noted the average contract value per megawatt has tripled year to date. At the beginning of the year, it was selling for about 12 million per megawatt. By the second quarter, it was selling for 20 million per megawatt. Third quarter contracts already being signed at $40 million per megawatt. And the management of this company is avoiding any long-term capacity commitments. They’re really just sticking with selling three to six months forward because they still think that those spot rates will continue to climb even from here.
Revenue: phenomenal results, up over 450%. But yet, even with that kind of revenue growth, because they’re spending so much money on capex, they still have a negative operating margin at a negative 30% level. Now, as far as our fair value goes, really the increase was driven by a couple of things. We did increase our GPU rental prices over the course of the next three years a bit. We did increase our operating margins, so we have a little bit of operating margin expansion. Of course, then that led to a reduced free cash flow burn. Even with our updated results, we’re still looking for the company to burn $30 billion in free cash flow over the next three years, which means they still have to be able to have access to both the equity and the debt markets to be able to fund that. If there’s any issue with the IPO market or being able to raise equity in the stock market, or if the debt market is under any pressure, that really puts the business at risk here.
I know we talked about it last week, but just an update as far as our expectations for revenue. Again, the company did $530 million in revenue last year. We’re projecting them now to do $4.4 billion this year. We’re modeling out a five-year compound annual growth rate of 135%. That means revenue by 2030 would be coming in at $32 billion. Again, short-term growth rates here are just astounding. Yet at the end of the day, I just don’t know what this company does that competitors won’t be able to replicate over time. I mean, when you think about competitors like Amazon.com’s AMZN AWS and Google GOOGL Cloud, overall, I mean, they are larger and better funded. You have other competitors like CoreWeave CRWV, which have a pretty similar strategy here. Customers just don’t have any real switching costs at the end of the day. Overall, when you think about that, and you think about our own valuations, it’s still at an 85% premium to fair value. It’s a 1-star-rated stock. Certainly a situation that if you want to trade this thing around, go right ahead, but just know what you’re getting yourself into.
ONON: Buy on Pullback
Dziubinski: All right, let’s hop off the tech train and talk about gym shoes.
Sekera: That was a really smooth transition.
Dziubinski: Wasn’t that great? I worked real hard on that, Dan. Now, On Holding ONON was a pick of yours back in April. The stock was down 20% after reporting earnings last week. Morningstar maintained its $48 fair value estimate on the stock. What from the report rattled the market, and what did Morningstar think of the results?
Sekera: I mean, the stock reaction here was actually kind of unsettling to me. It makes me wonder if there’s something going on here that we’re missing. After reading through our analyst note, it just seems to me like this is probably an overreaction from the market. When you look at the results in and of themselves, revenue was up 13.5%. But if you strip out the effects of foreign exchange and currency moves, it was up 21.6% in constant currency. EBITDA margin expanded 160 basis points. 2026 guidance was still in line with their prior outlook, in line with our forecasts. I think this is another situation where growth was good, but it just wasn’t good enough for the market. A couple of catalysts here, I would say, to look forward to. I believe in September, the company’s going to host its first investor day since 2023. I think this is going to be a good opportunity for the co-founders of the company to discuss growth.
Some of the categories that they’re expanding into beyond just that core running shoe category. For example, apparel: That division had over 50% constant currency sales growth, but it’s only 6% of total sales. I think that’s one area where apparel, of course, is just a huge total addressable market, but it’s still a very small percentage of their overall sales. They continue to get traction like that. I think that really could drive the next leg higher in this stock.
Dziubinski: All right. Given that, Dave, is it safe to say you still like On Holding today?
Sekera: Well, I liked it before. If it’s down that much, I’ve got to like it even more. So, yeah, 33% discount, 4-star-rated stock. I still think it’s attractive here today, given that maybe it missed some of the expectations in the marketplace, but still performing in line with our analyst expectations.
Stop-Loss Orders
Dziubinski: Alrighty. Well, it’s time for our question of the week. As a reminder to our audience, if you have a question for Dave, you can send it to us at themorningfilter@morningstar.com.
Now this week’s question comes to us from Max. Max wants to know about stop-loss orders. Now, as a reminder, a stop-loss order is an instruction to sell a security once it reaches a particular price, which is the stop price. Dave, the first question is: Do you provide stop price recommendations?
Sekera: No, we don’t really provide those stop-loss recommendations. There are a number of different reasons why. First of all, in my opinion, when I think about when you use stop losses, it’s really much more used in trading strategies than being a long-term investor. For example, there are a lot of different momentum strategies. You might be looking at technical indicators. In that case, you want to use a stop-loss just because if that stock is running out of momentum or maybe it breaks a short-term downward trend, you want to get out of that stock as fast as possible. But again, that’s really much more thinking about it from a trading perspective as opposed to really that long-term fundamental point of view where you’re really trying to find dislocations between price and valuation in the marketplace.
As I’ve talked about before, I think when you enter a new buy position, you need to set yourself a target price both to the upside and the downside. That way, if it hits one of those targets, it really gives you that impetus to reevaluate what’s going on and see if there’s anything different going on than what your original investment thesis was when you bought the stock.
For example, to the upside, maybe business prospects are better than when you first bought the stock. Maybe the value of the company now is higher than what it was before. In that case, you don’t want to sell the stock. There’s really no change in the outlook and valuation. Again, thinking about, to the downside, if there’s anything different now, if that stock is selling off, and really reevaluate that investment thesis as opposed to when you bought the stock. Of course, if the fundamental outlook is deteriorating, valuation is dropping, then yes, in that case, you should probably sell and move on. If not, if your investment thesis still holds, the market’s overreacting to the downside, that’s not when you want to get stopped out of it. That’s actually an opportunity to dollar-cost average into the downside.
Dziubinski: Now again, as you pointed out, this is much more of a trading strategy. Do you have any practical suggestions or best practices for investors interested in pursuing this approach?
Sekera: I mean, a number of things to consider would be, first of all, for really volatile stocks, you don’t want to set that stop price too close to what the market price is. In that case, you might just have some short-term movement in the marketplace. You get stopped out, and then you’re going to miss the recovery when the market turns back up. I’d also note, too, that a stop-loss order, if it’s a true stop-loss, turns into a market order. I’ve seen in the past, sometimes if a stock is just gapping down, those stop-losses turn into that market order. There might be a big gap in between what your stop-loss price was and where that stock is trading. It might be a long way down from where that stop was. In that case, I’d consider using maybe what’s called a stop-limit order. In that case, you put in that stop price, but then you can also put in a limit such that you have to have a minimum price that you’re willing to sell at if that stop gets triggered.
Overall, I think from Morningstar’s point of view, one of the biggest mistakes that investors can make is using that stop-loss order as a substitute for correct position sizing within your portfolio or just kind of broader portfolio construction. A stop-loss can be a good tool, but it really should be a tool that’s used as really much more a part of the broader investment portfolio process rather than really just a sole defense against losses.
Dziubinski: All right. Well, we have a special segment for viewers this week. Last Thursday, I sat down with Morningstar Indexes strategist, Dan Lefkovitz, to discuss a recent column he wrote about various types of income investments, specifically their attractiveness from a yield perspective, as well as their pros and cons. Take a listen.
Dan, thank you so much for being here today.
Dan Lefkovitz: Always great to be with you, Susan.
Finding Income in Today’s Market
Dziubinski: Now, talk a little bit about what made you decide to write this column about income investing at this point in time?
Lefkovitz: Yeah, well, there’s a lot of investor demand for income out there. If you look at the asset flows data, if you think about the demographic trends, so many baby boomers are moving into that retirement phase of life, shifting from accumulation mode to living off their investment portfolios.
Income Play: Core Bonds
Dziubinski: So, good time for that. You talked about several income investments in this column and the pros and cons of each. Let’s pick them off one by one. We’ll start, of course, with a very common income investment, and that’s bonds. Specifically, core bonds, you talk about in your column. Let’s start there. Define what core bonds are.
Lefkovitz: Yeah, core bond traditionally refers to a basket of high-quality investment-grade debt securities. For some investors, it is municipal bonds; they have tax advantages. If you think about the taxable side of the equation, we have a Morningstar US Core Bond Index that’s about half Treasuries, so US government bonds, and then the rest is split between corporate and securitized bonds. As of the end of July, the yield on that is 4.9%. It’s something that can form the foundation of a fixed-income portfolio.
Dziubinski: OK. Given the market climate today, what are the pros and cons of a core bond investment as your income instrument of choice?
Lefkovitz: Yeah, so 4.9% is a pretty decent yield in absolute terms. It’s higher than the inflation rate. Now, inflation is running high. It’s much higher than the yield was on core bonds for that whole period after the financial crisis through 2022 when we had the inflation shock and the big interest rate hikes. In terms of pros and cons, bonds are a lot less volatile than stocks. They almost act like shock absorbers to a portfolio. They do have diversification benefits, not always, but in many market situations, historically when equities have sold off sharply, bonds have appreciated. If you look at this year, it’s not been a great year for bonds. Inflation is running hot, yields have risen, interest rates are remaining higher for longer, but yet our core bond index is about flat for the year to date. Longer term, a lot of investors have concerns around the US government debt and inflation. So, those are considerations.
Income Play: Dividend Stocks
Dziubinski: OK. Dividend stocks, let’s talk about that next because that again is another go-to investment for income seekers. How do yields look today on dividend stocks in general and sort of compare that to that core bond index?
Lefkovitz: Yeah. Well, if you look at the broad asset class level, dividend yield is really, really low—historically low. The yield on the Morningstar US Total Market Index is below 1.1%. At the broad asset class level, bond yield is much, much higher than stock yield. But if you do get selective and target dividend-paying stocks, you can find some decent yields out there.
Dziubinski: OK. Same question here, Dan: What would you say are the pros and cons of dividend stock investing in today’s market?
Lefkovitz: Just for an example, we have a Morningstar US Dividend Leaders Index, 100 high-yielding stocks screened for dividend durability. The yield on that index currently is 4.4%, so a little more competitive with bond yields. Obviously, with stocks, they’re a lot more volatile than bonds. On the plus side, there’s a lot more capital appreciation potential. Just a very different animal than a core bond allocation.
Dziubinski: Talk a little bit about international dividend-paying stocks. Now, I know you’ve written about this in the past for Morningstar.com. Back then—I think that was last year that column ran—international dividend stocks were yielding quite a bit more than US dividend stocks. How does that compare today?
Lefkovitz: Yeah, that is still true. If you think about the factors that have depressed dividend yields on the US side, first of all, share prices have risen a lot, so that brings yields down. Also, companies have elected to spend a lot more cash on share buybacks, repurchasing their own shares, and lately on investing in AI infrastructure. Those factors are less at play internationally. If you think about international stocks, prices have not risen as much. Buybacks are not as popular, and there hasn’t been as much capital expenditure from corporations on AI investments. We have an International Dividend Leaders Index, and the yield on that is about 5.25%. Quite a bit higher than on the US side.
Dziubinski: Talk about the pros and cons there. Pro, obviously, is the higher yield. What are the things that investors need to pay special attention to here?
Lefkovitz: Taxes are definitely a consideration. There is a risk that you can be double-taxed, so that’s with international dividend payers. That’s something that investors should be aware of and should look into. There are also currency dynamics, which can work for or against you. It’s a risk if the currencies in which your international dividend payers are denominated—the euro, the pound, the yen—if those depreciate against the dollar, then you’re going to lose value. On the other hand, that can work in your favor. International dividend payers also provide some diversification benefits vis-a-vis US equities; that global exposure, the currency dynamics can be a source of diversification.
Income Play: MLPs
Dziubinski: Yeah. All right. Now, MLPs, of course, can be another tool in an income seeker’s toolkit. Explain what MLPs are in broad strokes, and then talk a little bit about the tax considerations here specifically.
Lefkovitz: Yeah. MLPs, master limited partnerships, are securities that trade on the stock exchange like corporations, but they pass through their income to investors. Most MLPs are in the energy space. They’re in the business of transporting oil and gas. They’re also known as pipeline companies. They’re sometimes referred to as the midstream of the energy value chain. Yeah.
Dziubinski: How do the yields compare on MLPs versus some of the other income sources we’ve talked about here? And again, pros and cons.
Lefkovitz: Yeah, yields are high. We have a Morningstar MLP Composite Index. The yield is currently 7.6%. Very volatile. This is a very narrow segment, very correlated to energy prices, which bounce around a lot and are hard to predict. Much more volatile than bonds, of course, and even a more diversified basket of dividend payers, but more capital appreciation potential as well.
Dziubinski: It sounds like you wouldn’t want to go all in on MLPs as your income source probably from a portfolio.
Lefkovitz: Yeah, but definitely a tool in the toolkit.
Income Play: Bank Loans
Dziubinski: OK. Bank loans, another income option that you talked about in your column. What sort of yields are we talking about here?
Lefkovitz: Yeah, this is a really interesting asset class. Syndicated bank loans have really grown as a market, as a source of funding below-investment-grade companies. You’re taking on some credit risk here. This is very different to a core bond allocation when it comes to volatility, when it comes to diversification benefits vis-a-vis stocks. But what’s interesting about bank loans is they have floating-rate coupons. Unlike bonds, they actually benefit when interest rates rise. In recent years, we’ve seen the yields come up. We have a Morningstar Leveraged Loan Index, and the yield is currently 8.7%.
Dziubinski: Wow. OK. That’s a pro: the yield on these instruments. What would you say are some of the things to be aware of?
Lefkovitz: Yeah, just that volatility and they’re going to behave more like stocks from a diversification perspective. You’re not getting the same kind of benefits as a core bond allocation.
Income Play: High Yield Bonds
Dziubinski: Back to bonds, but somewhat related, high-yield bonds, of course, are below-investment-grade. What do high-yield bond index yields look like today?
Lefkovitz: Yeah, so this is an asset class that used to be called junk bonds back in the 1980s. It’s become a lot more mainstream, gone through some rebranding to high-yield bonds. Not quite what it once was, the asset class, because of the rise of private credit as well as bank loans, the syndicated bank loans, as a source of borrowing for those sub-investment-grade borrowers, companies. Our US High-Yield Bond Index is about 7.5%, 7.6% currently. Below bank loans, but still pretty impressive. Similar to what I said for bank loans, these are going to be more volatile. They’re going to be closer to stocks on the spectrum than a core bond allocation.
Income Play: REITs
Dziubinski: Yeah, think of them a little bit more like your stock allocation, not your bond allocation. OK. All right, Dan, so lastly, let’s talk about one more tool in the income seekers’ toolkit, and that’s REITs. They’ve actually had a pretty good year. How are yields looking these days?
Lefkovitz: Yeah, real estate investment trusts, similar to MLPs. This is a tax structure, and they pass through most of their income to investors. Our US REIT Index is currently at 4.7%. There’s been a runup this year after many down years for real estate-related companies. It’s partly related to the AI data center buildout, but there are some other reasons as well. I think REITs were oversold. They’ve come back a little this year. From that income perspective, about the same really as core bond.
Dziubinski: OK. Again, pros and cons.
Lefkovitz: Yeah. Again, similar to MLP, very volatile. You’re in a narrow sector, real estate, which has faced some headwinds in recent years, if you think about hybrid work arrangements, if you think about elevated interest rates. I think from a valuation perspective, just got a little bit oversold. Our REIT analysts still think that there are some attractive opportunities in the REIT space.
Dziubinski: Well, great. Thank you for being here, and we’ll see you again before the end of the year, Dan.
Lefkovitz: Sounds good. Thanks so much, Susan.
Income Pick: ET
Dziubinski: Now this week, Dave has brought us four undervalued picks for income investors. Now, your first pick, Dave, is an MLP. It’s Energy Transfer ET. Run through some of the key metrics on it.
Sekera: Sure. Energy Transfer is a 4-star-rated stock, trades at about a 12% discount to our fair value estimate, and has a nice, healthy dividend yield at 6.5%. It’s a company we rate with a Medium
Dziubinski: Dave, why do you like Energy Transfer as an income opportunity today?
Sekera: As far as the MLPs go, I mean, Energy Transfer has really been one of our go-to picks for quite a while. I think the most recent that we recommended was November of 2025, but our recommendation on this stock goes back at least several years. Part of it is just because when you think about an MLP in the pipeline business, they make money on volume, not by passing through the higher prices. I like that stability in the business here.
Now, as far as Energy Transfer specifically, our team has, of course, talked about how data centers are being built. They all need more and more electricity. AI just requires multiple times more electricity than traditional computing. We’re having to build a lot of new power plants to supply that electricity. And of course, the power plants that are being built are mostly natural gas because they’re the quickest and easiest to build. In this case, we think Energy Transfer is one of the better-positioned pipelines to benefit from supplying natural gas to those new power plants that are going to end up powering the AI data centers.
Income Pick: EQR
Dziubinski: All right. Your next two income picks are both REITs, the first one being Equity Residential EQR. Give us the highlights.
Sekera: Equity Residential is a 4-star-rated stock, trades at an 18% discount to fair value, pretty healthy dividend yield at 4.25%, Medium Uncertainty, but like a lot of other REITs in real estate deals, no economic moat.
Dziubinski: Now, Equity Residential is merging with AvalonBay Communities, and both have been picks of yours in the past. Given that, talk about why you like Equity Residential today and what investors might expect once the merger has occurred.
Sekera: In this case, I would note that while we picked Equity Residential, I’d say take a look at AvalonBay AVB, as well. The reason I picked Equity Residential right now, with the merger going on, is just because the stock was at a slightly greater discount than AVB and a slightly greater dividend yield. But at the end of the day, following the merger, you’re really going to own that same proportionate amount and get the same dividend after the merger concludes.
Now, in this case, when you look at the two companies, they have a very similar focus. Both of them are focused on that higher-end apartment community, specifically located either in major urban areas or kind of that close suburban ring around those urban areas. There’s a lot of overlap between these two companies. I talked to our analyst at the end of last week. He noted that AvalonBay really is primarily in six markets, whereas Equity Residential’s in eight markets, but those six markets that AvalonBay is in are all within the same eight markets as Equity Residential. I think overall there will be a lot of synergies from this merger over time.
Now, if you look at our 2028 forecast for FFO—that’s funds from operations—our forecasts are really the same as market consensus. What that tells me is that the market right now is essentially assigning a lower multiple than the valuation than what you would get from our discounted cash flow model. I think that’s what’s bringing up the differential as far as how the market is looking at it on that valuation multiple as opposed to that free cash flow analysis.
What’s been going on with these companies is that we have had a short-term contraction in same-store sales or same-store net operating income growth. In fact, it’s really low right now. It’s below the 15-year average. But to some degree, that’s just a lot of normalization that’s going on right now because, of course, we had much higher or very high above-average growth in 2021 and 2023, just as we had a lot of inflation kind of rolling through those rental prices at that point in time.
I’d also note that in the short term, operating expenses are pretty high just because of rising utility costs. That has led to some short-term margin contraction, but we’ve included really both of those in our model. Even within our model, we still think this stock is pretty undervalued. I think right now the story here is just that the market, especially for REITs, is just showing its preference for growth as opposed to stability. Within the REIT sector, we’ve seen a lot of rotation going on into some of the retail REITs, some of the hotel REITs. In this case, we think that the apartment REITs have just kind of gotten left behind.
Income Pick: SUI
Dziubinski: All right. Well, Sun Communities SUI is your next income pick. It’s also a REIT. Tell us about it.
Sekera: Sun Communities is a 4-star-rated stock trading at a 17% discount, 3.5% dividend yield, Medium Uncertainty. But again, like a lot of our real estate REITs, no economic moat.
Dziubinski: Now, REITs as a group are having a decent year performance-wise, but Sun Communities is lagging behind a bit. What’s the story on this one?
Sekera: Well, first of all, Sun Communities is a residential REIT, but even within the residential REIT, they’re much more focused than that. They end up really buying properties that are used as second homes or vacation properties. In fact, if you look at their portfolio, they have 347 manufactured housing communities and 166 residential vehicle communities. And even with that, 50% of that portfolio is either in Florida or Michigan, but they’re all going to be located near major bodies of water. What these properties are essentially for is people who can’t afford to buy a house directly on the beach or directly on the lake, but they still want a vacation property with that water access. The longer-term story here is there was a big pickup in their business during the pandemic years. Now we’re going through slowing growth because so much of that was pulled forward into 2020 through 2023.
Of course, the stock market just hates seeing slowing growth, even though we do still have ongoing growth here. And of course, that then is where the opportunity is here. The other thing, when I was talking to our analyst on this one, that he thought maybe the market might be missing, is there’s a bit of a transition that’s going on with their business. We’ve been seeing a shift in their business to a higher percentage of revenue, higher percentage of sales coming from membership growth versus the transient growth that they had during the early pandemic. With that membership, you can buy a membership that you can end up using all of the different properties that they’re in. You can use an RV park here, an RV park there, so you don’t always have to be at that one individual location. Of course, the other benefit to the company is that it keeps you within their portfolio of properties. You get that higher share of wallet overall, and you have fewer clients going and staying at other competitors. As you have that shift to that membership growth, we think that improves their margins over time as well.
Income Pick: POR
Dziubinski: All right. Your final pick this week is a dividend stock. It’s Portland General Electric POR. Give us some of the key points about it.
Sekera: Portland is a 4-star-rated stock at a 9% discount, with a 4.2% dividend yield. It’s a Low Uncertainty with a narrow economic moat.
Dziubinski: Now, there are plenty of attractive dividend stocks out there. Why is Portland General your pick among them?
Sekera: Well, when you talk dividend stocks, you always have to have at least one utilities stock in there. People always think about utilities as kind of that fixed-income substitute with a stock as opposed to buying bonds outright or a bond fund or ETF. In this case with utilities, over time, you should also get kind of that expansion or growth in dividends as well. Whereas when you buy into fixed income, you’re locked in at that coupon price.
Now, as far as utility stocks go, utility stocks generally, as a sector, we think are pretty overvalued here. It’s hard to find many other undervalued stocks within the sector. This is one where I think it just kind of got left behind the rest of the utility sector. In our mind, it’s not an AI data center play. I think that’s what the market is looking for: those kind of growth dynamics. The company reported earnings relatively recently. I read through our note, and there’s just nothing in that earnings report that changed our long-term investment thesis. I think this is kind of probably one of those relatively boring stocks in a boring sector that people just don’t care about because it doesn’t have that growth story that you’re seeing elsewhere.
Dziubinski: All right. Well, thank you for your time this morning, Dave. Viewers and listeners who’d like more information about any of the stocks that Dave talked about today can visit Morningstar.com for more details. We hope you’ll join us next Monday for The Morning Filter podcast at 9 a.m. Eastern, 8 a.m. Central. In the meantime, please like this episode and subscribe. Have a great week.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
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