When it comes to snagging the best returns, retail investors like us want high returns from our stocks. But that’s not how companies function. Instead, they aim to maximize the return on invested capital (ROIC).
Wouldn’t stocks that can satisfy both groups be some of the best?
Morningstar identified 5 ultracheap stocks to buy with the best return on investment:
| Ultracheap Stock | Ticker | Price/Fair Value | 10-year annualized return | Average 3-year ROIC | Morningstar Economic Moat Rating | Morningstar Capital Allocation Rating | Industry |
|---|---|---|---|---|---|---|---|
| Teradyne | NASDAQ: TER | 0.62 | 18.7% | 33.1% | Wide | Standard | Equipment & Materials |
| Taiwan Semiconductor Manufacturing Co. | NYSE: TSM | 0.70 | 20.2% | 26.1% | Wide | Exemplary | Semiconductors |
| Skyworks Solutions | NASDAQ: SWKS | 0.71 | 15.3% | 20.3% | Narrow | Exemplary | Semiconductors |
| MarketAxess | NASDAQ: MKTX | 0.76 | 13.8% | 25.5% | Wide | Exemplary | Capital Markets |
| Edwards Lifesciences | NYSE: EW | 0.78 | 19.9% | 21.6% | Narrow | Exemplary | Medical Devices |
How did they find these stocks?
Morningstar screened for:
- Stocks that outperformed the Morningstar US Market Index on an annualized basis during the trailing 10-year period.
- Companies with average three-year ROICs of more than 20%.
- Companies with wide or narrow Morningstar Economic Moat Ratings.
- Stocks that are trading at least 20% below Morningstar’s fair value estimates.
5 ultracheap stocks to buy with the best return on investment
1) Teradyne (NASDAQ: TER)
Teradyne is the cheapest on this list, trading at a 38% discount from Morningstar’s fair value of $147.
Right now, the market’s a bit lukewarm on Teradyne thanks to some soft demand in smartphones and a bit of a slump in the memory chip scene. But Morningstar believes Teradyne is perfectly poised to bounce back big time with the market cycle. This could be a good opportunity to catch the rebound.
What do they do?
Teradyne stands out in the semiconductor industry as a leading supplier of automated test equipment, specializing in cutting-edge chip testers, with only one other global competitor.
Its success stems from strong engineering capabilities and strategic organic investment, fostering key relationships with industry giants like Apple and Taiwan Semiconductor.
Teradyne’s market dominance is reflected in its top margins, solid capital returns, and significant market share, earning it a wide economic moat rating. The company expertly balances development investment with profitability, generating substantial free cash flow. Its focus on shareholder returns and strategic acquisitions, particularly in the burgeoning industrial automation sector, complements its robust financials.
Teradyne’s future growth is expected to be driven by investments in robotics and semiconductor testing, benefiting from technological advancements and increased demand in chipmaking. As a central player in the global chip market, Teradyne enjoys minimal cyclicality due to its essential role in the supply chain.
2) Taiwan Semiconductor Manufacturing Co. (NYSE: TSM)
Taiwan Semiconductor aces it with the best trailing 10-year annualized return on this list. And that’s not all, TSMC delivered an average of >20% in both ROIC and return on equity for the past decade.
Morningstar points out that TSMC’s earnings are way steadier than their rivals. This wide moat stock is currently trading 30% below Morningstar’s fair value estimates, suggesting a good deal.
TSMC’s management is deemed to be excellent at allocating their capital, earning the “Exemplary Morningstar Capital Allocation Rating”.
What do they do?
Taiwan Semiconductor Manufacturing Co is the world’s largest dedicated contract chipmaker.
The company excels in creating integrated circuits from customer designs. Its growth is fueled by the shift from integrated device manufacturers to fabless designers. However, the foundry industry faces cyclicality, often adding excessive capacity during demand peaks, leading to underutilization in downturns, impacting profitability.
Despite rising competition, mostly in low-end manufacturing, TSMC maintains its edge with leading-edge technology, focusing first on logic products for CPUs and mobile chips, then cost-effective applications. Two key growth drivers for TSMC are the consolidation in the semiconductor sector, boosting demand for advanced node-integrated systems, and the sustained organic growth in AI, IoT, and high-performance computing. These technologies demand efficient chips for complex tasks like autonomous driving and language processing, while cheaper semiconductors are integrating sensors and controllers for enhanced efficiency in homes, offices, and factories.
3) Skyworks Solutions (NASDAQ: SWKS)
Another semiconductor stock on this list, SWKS holds a narrow economic moat rating and has efficient capital allocation. Although the stock is in a slump now, Morningstar believes that Skyworks’ radio frequency chip business and its earning potential remains resilient.
SWKS is trading at 29% below Morningstar’s fair value estimate of $133.
What do they do?
Skyworks Solutions is a key player in radio frequency components for smartphones and electronics. The company is set to prosper with the shift to 5G technology, demanding higher RF content per phone.
Predominantly earning from mobile products, Skyworks is capitalizing on the complex RF needs of 5G smartphones.
Despite intense competition and heavy reliance on a few major customers like Apple, Skyworks’ scale gives it an advantage. The company’s diversification into emerging markets like automotive shows promise, but its success remains closely linked to the wireless industry.
4) MarketAxess (NASDAQ: MKTX)
MarketAxess, the third wide-moat stock that made the list is considered a bargain, trading 24% below Morningstar’s $305 fair value estimate.
Plus, the company has a hefty cash reserve for future investments or maybe even an acquisition. However, since the Fed started hiking up interest rates, there’s been a bit of a squeeze on pricing, which has put a dent in their results this year.
MarketAxess also made our list of Best Stocks with Moats, you can download the full report here:
What do they do?
MarketAxess, the top dog in electronic corporate bond trading, has a strong global footprint with a significant chunk of its trading volume in emerging-market debts and Eurobonds. While it is expanding into U.S. Treasuries and municipal bonds, thanks to acquisitions like LiquidityEdge and MuniBrokers, corporate bonds remain its mainstay. The shift towards electronic trading platforms is boosting MarketAxess, especially with features like automated trade execution.
In 2023, despite challenges like competition and mixed market conditions, MarketAxess is expected to grow, fueled by increased trading volumes due to rising interest rates. However, the company faces stiff competition, particularly in the U.S. corporate bond market, and must navigate a somewhat stagnant market share in investment-grade bonds and underwhelming performance in high-yield bonds.
Despite these hurdles, MarketAxess still has substantial potential for growth, though competition remains a significant factor.
Alvin listed MarketAxess as one of the 10 monopolies that make good investments previously.
5) Edwards Lifesciences (NYSE: EW)
Wrapping up the list of ultracheap stocks is Edwards Lifesciences, a big player in the surgical heart valve market.
As a market leader, Edwards Lifesciences usually trades above Morningstar’s fair value estimate. It is rare to see EW going 22% below their $86 fair value estimate, you might want to explore this medical device company further.
What do they do?
For two decades, Edwards Lifesciences has led in tissue heart valves innovation, dominating in surgical heart valves and minimally invasive valve therapy.
Investing heavily in R&D, the company boasts a significant 27-percentage-point gross margin boost from its shift to higher-margin transcatheter heart valve products. Despite being smaller than competitors like Medtronic and Abbott, Edwards leads globally in heart valves. The company’s strategic acquisitions in transcatheter mitral valve technologies keep it at the forefront, including its Sapien transcatheter aortic valve.
Edwards is well-placed for growth as valve replacements increasingly shift to transcatheter methods, despite potential market challenges and competition.
What is Return on Invested Capital (ROIC)?
If you got here without understanding what ROIC is, fret not, here’s a simple explanation.
Return on Invested Capital aka ROIC tells you how profitable a company is in relation to the capital it invested. The higher to ROIC, the more efficiently the company is using its capital.
For this list, Morningstar used a 3-year 20% average ROIC screen to look for companies that generated at least $20 for every $100 spent, over the past 3 years on average.
For more ways to value a stock, read our Value Investing Guide!
There’re opportunities if you are looking
Morningstar shared 5 ultracheap stocks, each present a unique investment opportunity by combining undervaluation with strong market positions and innovative business strategies. As leaders in their respective fields, these companies are well-positioned for future growth, making them compelling picks for investors seeking value and solid returns.
Remember to do your own due diligence before jumping into any stocks!