The S&P 500 index grew 16.3% in 2020, despite the coronavirus pandemic and economic uncertainty in the first half of the year. Now, the index trades near the top of its historical valuation range, with an average price-to-earnings (P/E) multiple of 38.
It is impossible to predict how the market will perform in 2021. But repeated strong performances are not necessarily the norm. Investors looking toward 2021 might want to consider betting on value stocks with fewer expectations built into their prices (good and bad) to mitigate risk in what is currently a pricey market.
Let's explore the reasons why value stocks like Johnson & Johnson (JNJ -0.15%) and Target (TGT 2.46%) could make great picks for the new year.
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1. Johnson & Johnson
With a P/E ratio of 19.5, Johnson & Johnson trades at the high end of its historic range. But the healthcare and consumer goods giant is still a compelling value stock because of its steady growth and consistent earnings. Johnson & Johnson's COVID-19 vaccine candidate, JNJ-78436735, could help set the company up for success in 2021 because of its logistics advantages over coronavirus vaccines developed by Pfizer and Moderna.
Analysts at Morgan Stanley and Credit Suisse expect the COVID-19 vaccine market to be worth over $10 billion a year -- that's assuming the disease becomes endemic, and people will need to get the injection every year, as with the flu. And while Johnson & Johnson has agreed to distribute its vaccine candidate on a "not-for-profit" basis during the pandemic, the vaccine could capture a large market share once the crisis is under control because it is easier to store and administer.
Unlike other approved vaccines, which require two doses and an elaborate cold storage chain, JNJ-78436735 only requires one dose and is stable for up to three months at temperatures of 36°F–46°F. The Trump administration believes Johnson & Johnson could have enough data to submit an emergency-use application to the FDA by late January, and distribution could follow soon after.
The vaccine could be a welcome boost to Johnson & Johnson's relatively slow-growing top line. Third-quarter sales grew 1.7% to $21.1 billion (driven by strong pharmaceutical sales), while adjusted earnings per share increased 3.8% to $2.20 billion. The stock boasts a dividend yield of 2.57%, and the company has grown its payout yearly for a jaw-dropping 58 consecutive years, making it a Dividend King.
2. Target
Discount retailers are ideal for value investors. These companies often boast modest valuations and hold up well during economic downturns because of their focus on consumer staple products. Target enjoyed a surge in demand in 2020 as shoppers stockpiled essentials during the coronavirus pandemic. And the company's fast-growing e-commerce business could help power growth in 2021.
The coronavirus pandemic has changed the way people shop, with more people turning to e-commerce solutions for household essentials like groceries. Target can help meet this growing demand because of its network of 1,897 stores in the U.S., which gives it a competitive advantage in same-day fulfillment compared to e-commerce rivals like Amazon, which have a smaller physical footprint.
Sales increased by 21% year over year to $22.3 billion in the third quarter, with digital sales surging 155% to represent roughly 16% of sales in the period. According to CEO Brian Cornell, Target's fastest growth is coming from its same-day services, including store pickup and contact-free drive-up.
Target's stock price soared roughly 43% in 2020 to end the year at $177 per share. Despite the massive rally, shares boast a P/E ratio of 23, which is significantly below the market average of 38 and represents a good value considering the company's new digital growth driver. The retailer also has a rock-solid dividend that has been raised consistently for 48 straight years, making Target a Dividend Aristocrat.
More for your buck
With average equity valuations soaring to eye-watering levels, investors can sleep easier by betting on stocks that offer more bang for the buck. Johnson & Johnson and Target currently trade at the higher end of their historical P/E ratios, but they are still a good value for investors because of their new growth drivers (coronavirus vaccines and e-commerce).
