However, fairly valued investments are tough to come by right now, according to Morningstar.
Top minds at the leading equity research firm found that US equities were 3% overvalued heading into the fourth quarter. Although that doesn't sound like an unhealthy extension, the market has only been that expensive 15% of the time since late 2010, wrote Dave Sekera, Morningstar's chief US market strategist, in a recent report.
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Stocks earned that premium after economic growth exceeded expectations as inflation fell. The most aggressive rate hikes in 40 years were no match for US GDP growth, which has held up admirably in the last two years due to factors like consumers' excess savings and government spending, the note read. Inflation falling from multi-decade highs was also a crucial tailwind.
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"The combination of an economy that has held up better than expected, moderating inflation, declining interest rates, and easing monetary policy has led to stronger equity market returns than we had expected at the beginning of the year," Sekera and his colleagues wrote.
Morningstar
Additionally, US stocks were aided by a surge in spending on artificial intelligence. Enthusiasm about that burgeoning technology drove growth-oriented companies to record highs.
Therefore, it's no shock that those growth stocks are responsible for the market's lofty valuation. The group is trading 13% above Morningstar's fair-value estimate, compared to a 2% premium for core stocks and a 3% discount for value names.
Similarly, large caps are 4% more expensive than they should be, in Morningstar's view, while mid caps are close to fair value while small caps are unusually cheap at a 15% discount.
Morningstar had revised its fair-value estimates upward as the AI-powered rally raged on and consumer spending remained solid, but stocks still exceeded those targets.
Attractively priced equities are scarce, but Sekera is sure that deals are still out there.
"While the overall market appears to be priced to perfection, we continue to see undervalued opportunities, albeit much fewer and further between than earlier this year," Sekera wrote.
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33 top stocks to own
In Morningstar's fourth-quarter note, the firm designated 33 stocks as its top picks across sectors and groups like cyclicals, defensives, and economically sensitive companies.
Naturally, some parts of the market are much cheaper than others. Only the communication services and energy sectors are cheap, according to Morningstar's methodology, while consumer defensives — better known as staples — and utilities are too expensive.
Morningstar
Still, investors can succeed by shifting toward the stocks that Morningstar put the spotlight on.
"To outperform, we think investors will need to look for contrarian investments and story stocks," Sekera wrote.
Below are Morningstar's 33 top picks heading into the fourth quarter in alphabetical order by sector within their broader groups, which are also in alphabetical order. Along with each company is its ticker, market capitalization, group, sector, rating, price target, upside to that target, and selected commentary from Morningstar.
Commentary: "We believe the company has a solid competitive edge in the sizable addressable markets in which it operates. Its strong brand-intangible asset is supported by its leadership position across the bath and shower and the candle and air freshener industries in recent years, which has been bolstered by Bath & Body Works' quick response to consumer trends. We expect product innovation and productivity gains of new store formats will support top- and bottom-line growth at the enterprise over time."
Commentary: "Although Kohl's and other department stores have been struggling, CEO Tom Kingsbury is focused on improving the customer experience, managing inventory, and rationalizing pricing. Kohl's strengths include its large e-commerce operation that benefits from direct shipments from stores and a buy online/pick up in store offering."
Commentary: "We rate Nike, the global sportswear leader, as a wide-moat company based on a brand intangible asset. Its sales growth has stalled, but it achieves premium prices for its products through its innovation, marketing, and direct selling. Nike is also cutting costs through restructuring efforts, planning to reduce annual expenses by $2 billion by 2026."
Commentary: "Last year the company faced dual headwinds from both low corporate bond issuance levels and unfavorable mix shift creating downward pressure on its average fees. While these headwinds are still a factor, the company is benefiting from higher trading volume industrywide and, if interest rates fall, the company will see some relief for its average pricing."
Commentary: "With market confidence in the stock at a low ebb, we see a potentially good long-term opportunity. While we recognize the headwinds PayPal faces in the near term, in the long term the company's fate remains tied to the high-growth e-commerce space, with Venmo providing some additional upside option value. Historically, PayPal has demonstrated it can take share in this area, and we think it continues to do so on an overall basis."
Commentary: "US Bancorp has sold off like some of the regionals, but we see relatively lower risk for the company, given that it is the largest regional. The bank does have slightly higher-than-average unrealized losses on securities, but we view this more as an earnings problem (lower-yielding assets stuck on the balance sheet) and not a capital problem."
Commentary: "Albemarle's main business is lithium, which generated roughly 90% of profits in 2023. The company produces lithium from two of the lowest-cost resources globally, which create the cost advantage that underpins our narrow moat rating. Albemarle's low-cost position and solid balance sheet should allow the company to withstand the lithium price downturn. We point to rising lithium prices as a catalyst for shares."
Commentary: "For Dow, we forecast recovery in volumes in fourth-quarter 2024 and into 2025 and favorable unit economics to drive a recovery in profits, and we expect FMC will also rebound in second-half 2024 and into 2025."
Commentary: "FMC is a crop protection pure-play company. While this led to a great profit fall versus more diversified crop input peers, we expect FMC will see a stronger rebound in the second half of 2024 and into 2025. The market is also concerned with the industry recovery and FMC's patent expiration risk of its diamide products, which currently generate around 50% of profits. However, as the company develops new premium products from its strong research and development pipeline, we forecast FMC will see solid long-term profit growth."
Commentary: "Healthpeak's portfolio of medical offices and life science portfolios should provide steady, recession-resistant revenue growth. … The company's development pipeline should also produce yields above the company's cost of capital even in a higher interest rate environment, producing additional cash flow growth for shareholders."
Commentary: "We recognize the uncertainty surrounding the future of office real estate and believe that the environment will remain challenging in the near to medium term. Having said this, we also believe that the selloff has been overdone and the market is not recognizing the value of the company's non-office-related assets and its land bank. … Further, the company has a strong balance sheet with the lowest leverage within our office REIT coverage."
Commentary: "We believe that Sun Communities will produce same-store NOI above the residential REIT average and investors will recognize the strong internal growth story when interest rates stabilize."
Commentary: "Dollar General is under pressure in short term as its core customer base pulls back on discretionary spending, yet long term we expect spending habits and margins will normalize as wage growth catches up to inflation."
Commentary: "We believe Estee's brand investments and solid execution will help bring margins back to historical levels while ensuring the firm's standing (underpinned by category-leading brands and preferred vendor status) remains in place. Further, we believe Estee is poised to benefit from secular premiumization trends across developed and emerging markets."
Commentary: "We suspect investors are skeptical it will shun a material volume contraction in a tough economy (higher inflation and lackluster consumer spending) and amid intense competition (increased promotions by other brands and private label) after recent price hikes. However, we hold a favorable view on the firm's efforts to unearth cost savings to support brand spending (research, development, and marketing), which should help drive top-line growth in the longer term."
Commentary: "Baxter looks attractive, with shares trading at a significant discount to what we think they are worth. Demand is improving in most of its medical supply businesses because of rising medical utilization, and new product introductions like the Novum IQ pump platform could boost sales growth further. Baxter also represents a margin improvement story, as most inflationary challenges in its supply chain are easing and key new group purchasing organization contracts should take effect in 2025, which should help boost Baxter's own product pricing."
Commentary: "Humana reflects a significant discount to our fair value estimate and holds a strong competitive position in Medicare Advantage, which has strong mid- and long-term prospects due to demographics, increasing popularity of the program, and future rate increases. We do expect deflated profits in 2024 at Humana due to mispriced Medicare Advantage plans that may not fully cover surging medical utilization. Over a multi-year period, though, we expect Humana to push that higher medical utilization onto clients and end users by increasing prices and/or reducing benefits somewhat. So, while near-term uncertainty surrounds the company's typically very strong outlook, we think Humana's longer-term prospects remain bright."
Commentary: "While we have modest expectations for sales of the firm's covid vaccine following massive pandemic-fueled demand in 2021 and 2022, we think Moderna's pipeline of mRNA-based vaccines and treatments is advancing rapidly across multiple therapeutic areas. We're confident in the long-term sales trajectory of the firm's diversified pipeline, despite a competitive RSV vaccine market clouding near-term prospects."
Commentary: "Evergy trades at one of the lowest valuations and highest dividend yields of any US utility. We expect management will raise its capital investment plan later this year. … Although the market seems concerned about Evergy's growth prospects, we forecast 6% annual earnings growth, in line with most other utilities."
Commentary: "NiSource has a long and transparent runway of growth as it moves gradually from fossil fuels to renewable energy, supporting at least a decade of faster growth than most US utilities. … We expect NiSource to invest $17 billion over the next five years and as much as $30 billion during the next 10 years, leading to 7% earnings growth and similar dividend growth."
Commentary: "WEC Energy combines best-in-class management and above-average growth opportunities supported by constructive regulation across most of its jurisdictions. The company's new five-year capital investment plan totals $23.7 billion, a nearly 20% increase from its prior plan. WEC will increase investments in renewable generation, natural gas generation, and transmission due to significant economic development in southeastern Wisconsin."
Commentary: "We believe investors are overly pessimistic when it comes to antitrust concerns around Alphabet as well as its competitive positioning in AI. On antitrust issues, we think the worst-case scenario, a breakup of the firm, is highly unlikely and that the company will be able to navigate remedies without materially damaging its core business. We also see Alphabet as one of three credible leaders in public cloud, and that it is well positioned to benefit from surging interest in generative AI."
Commentary: "We expect Comcast's network will enable it to maintain the size of its broadband customer base over time while a rational competitive environment allows broadband prices to rise. The cable companies, including Comcast, will need to increase network spending in the coming years to keep pace with the phone companies' fiber network capabilities but we expect cable cash flow to grow modestly over the coming years. In our view, the NBCUniversal business isn't as strong, but it remains an important media asset."
Commentary: "The streaming business has turned to profitability, and ESPN has been stronger than we expected as it fights against the decline in traditional television. With sports remaining in demand, ESPN a clear sports leader, and streaming beginning to contribute to profits, we believe Disney's media business looks healthier than it has recently. We expect experiences to remain strong in the long term due to Disney's unique intellectual property and forthcoming capacity expansion."
Commentary: "APA is hoping for a game changer with its exploration assets in Suriname. The firm has announced a string of promising discoveries and may have a final investment decision in 2024. We think the project will move forward, and the market isn't giving enough credit. … We like the upside as a catalyst-driven name that might outperform in a challenging oil and gas price environment."
Commentary: "Exxon plans to double earnings and cash flow from 2019 levels by 2027 on a combination of structural operating cost reductions, portfolio improvement, and growth across its upstream, downstream, and chemical segments. Exxon estimates that under the current plan, it will generate about $100 billion in surplus cash, after funding investment and paying the dividend, during the next five years."
Commentary: "SLB's leading-edge technological advancements continue to distinguish the firm from peers: its myriad innovations consistently add value for customers, preserving SLB's ability to command premium pricing over and above the currently favorable operating environment. The impending ChampionX acquisition — expected to close by year-end — will add sizable exposure to the chemicals market, further diversifying SLB's already-impressive product catalog."
Commentary: "Chart Industries has pivoted toward expanding its specialty portfolio of products into high-growth areas such as hydrogen and liquefied natural gas. It made several attractive investments and joint ventures with key partners that enabled it to increase the amount of in-house content it uses for larger projects, lowering costs, and providing more control over delivery times."
Commentary: "Demand for CNH has been weak in the short term as crop prices remain depressed, yet long term, the replacement cycle and incremental opportunity in precision agriculture remains favorable."
Commentary: "Wesco International is an industrial distributor that has three reportable segments, electrical and electronic solutions, communications and security solutions, and utility and broadband solutions. Shares sold off after second-quarter earnings fell short of market expectations amid inventory destocking and project delays, and they have not fully recovered since. We are still confident in Wesco's long-term prospects and think growth will return in the near future, driven by increased US infrastructure spending."
Commentary: "The company's investment in OpenAI has catapulted Microsoft into a leadership position in generative AI, which has driven an acceleration of Azure growth in recent quarters. Our growth assumptions are centered around Azure, Microsoft 365 E5 migration, traction with the Power Platform for long-term value creation, and proliferation of AI."
Commentary: "NXP's auto business is well tied to the secular tailwinds around rising chip content per vehicle and we think the market is too focused on a near-term slowdown in demand. We expect NXP will return to revenue growth in 2025."
Commentary: "We continue to like the long-term secular tailwinds in the automotive end market, as ST should profit from increased chip content per car, especially in electric vehicles. The company has also achieved nice gross margin expansion in recent years, and we foresee the company maintaining these margins in the long run."
