4 Top Stocks to Buy on Sale

Susan Dziubinski: Hi, I am Susan Dziubinski with Morningstar. Every Monday morning I sit down with Morningstar Research Services’ chief U.S. market strategist Dave Sekera to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead. So on your radar this week, Dave, it is the tail end of earnings season. One company reporting this week is a name you recommended on last week’s show, and that’s Salesforce CRM. Now the stock looks just slightly undervalued heading into earnings. What will you be listening for?

Sekera: Good morning, Susan. Salesforce, and by the way, its ticker is actually CRM. It doesn’t necessarily make a lot of sense compared to the name, but again, that’s what it is. That stock is up 68% year to date, and it recently moved into 3-star territory. As you noted, it’s really only trading at about a 12% discount to our fair value estimate at this point. It is a company we rate with a wide economic moat, and as you mentioned, this is a stock that we’ve highlighted a number of times in the past.

So, talking to some of our equity analysts, in this case, it’s Dan Romanoff, he covers this company, and he’s noted in his view the company just has the best combination of revenue growth, the potential for operating margin expansion, and a strong balance sheet across the entire technology sector. What we’re going to be listening for this week is really just to hear if the company remains on track to be able to meet those growth and margin targets that we’re expecting. For long-term investors, we are looking for this company to increase its revenue at a 12% compound annual growth rate over the next five years. And we expect that over that same time period that the margin should expand from 23% last year, all the way up to 30% at five years from now.

Dziubinski: What about economic reports? Anything coming out this week that you’re going to be watching?

Sekera: Looking at the calendar here, the only one that I really think has the chance to move markets is going to be personal consumption expenditures. That’s on Thursday, for PCE, that’s the inflation measure that the Fed really watches very closely, and specifically the core reading. As long as that comes in either in line or lower than expected, I think it’s going to be a nonevent. Looking at consensus right now, that core reading is expected to be up 3.5% this month. It looks like it was up 3.7% last month.

Now on the other side, if it does come in hotter than expected, I’d say “Look out below.” The market rally here in November, and I think we’re up 9% just in November alone, that’s really predicated on the assumption that the Fed is done hiking the federal-funds rate. So if a high inflation reading puts that assumption into doubt, if we start seeing the fed-fund futures start to rise, I’d expect to see a pretty sharp downward selloff across the stock market.

And then lastly, it does look like Federal Reserve Chair Powell does have a fireside chat at Spelman College here on Friday. Now having said that, he’s always been very thoughtful and very careful with his public remarks. As long as he sticks with the current narrative, I think that’s going to be a nonevent.

Dziubinski: Let’s move on to some new research from Morningstar, starting out with Morningstar’s take on Nvidia’s earnings. Now, heading into earnings last week, Nvidia’s NVDA stock looked about fairly valued, trading near our $480 fair value estimate. What did Nvidia have to say, and what was of most interest to you, and what do we think of the stock today?

Sekera: Well, last week I said I’d be surprised if there wasn’t a large swing in that stock price after earnings. And I have to admit, I think I was wrong. Now the stock did fall about 4% at the open, and then throughout the rest of the day regained some of that loss, so I think for the day is only down about 2.5%.

Last week we also talked about how Target TGT ad its earnings come out and is what we consider to be a low-quality beat. In this case, I think it’s the exact opposite. Nvidia earnings are what I consider to be a very high-quality beat. They beat both on revenue and earnings, both were better than expected. And then, the company also gave guidance for next quarter, also higher than what the market expected.

Now, we did leave our fair value estimate unchanged at $480 a share, but I think what this report really did was bolster our confidence in our longer-term projections. So again, getting into some of these projections, we’re looking at revenue growing out from $27 billion in fiscal ‘23 all the way up to $120 billion in 2028. We’re looking for that operating margin to expand from 21% last year to 50% this year and all the way up to 58% in 2028.

I do have to caution investors here, the valuation for this company is based on this very rapid growth rate, and anything that could potentially derail that growth rate certainly would have a very negative impact on its valuation. But that’s also why we assign this company a Very High Uncertainty Rating. And I think what we’ve noted here, the timing and the magnitude of future artificial intelligence processor growth does still remain a bit unclear.

As far as why did the stock sell off when we did have that high-quality beat? I don’t really have a great explanation here, other than we do think that the stock is fully valued. And I think it’s also probably likely a lot of investors are just looking to lock in some of this year’s just extraordinarily high gains in the stock. I think that stock is up 233% year to date.

And then one thing I do have to mention, not earnings-related, but on Friday, Reuters had a report out there that the company may have to delay the semiconductors that it’s currently designing for making to export directly to China. And of course, there are a lot of U.S. export restrictions on what’s allowable. So, the stock did take a little bit of a dive on Friday on that report as well.

Dziubinski: Let’s turn on to some new research you’ve been working on, Dave, about retail sales this holiday season. Now viewers can find this research in a link below the video. You noted on last week’s show that sales from Black Friday weekend matter less to retailers than they did, say, 15 years ago. Remind viewers why that is.

Sekera: There’s just a lot of reasons for that. We’re seeing a lot more sales coming even before Black Friday, just a lot of companies trying to get that share of wallet before consumers start seeing some of those types of sales. Consumers, they’ve just been trained over the past decade really to watch for sales, not just on Black Friday but throughout the entire holiday season. And a lot of the best deals are coming just those couple of days right before Christmas as well.

Now the other thing that we’ve seen, too, is that a lot of people have been using gift cards. And so, when people receive those gift cards, that’s also going to shift a lot of those sales until after Christmas as well.

And then, lastly, over the past decade, the internet has just made it so easy to price-compare that consumers really have a much better idea of what sale prices are really good sale prices versus which ones are marginal. And I think that’s also evidenced by taking a look at Google Trends. I looked at that last week, and if you pull that up, going all the way back to 2004, the number of searches for Black Friday increase every single year, pretty much all the way up until the pandemic. But over the last couple of years here, we’ve seen the number of searches on the term Black Friday actually start to decrease each year.

Dziubinski: What’s Morningstar’s forecast then for fourth-quarter retail sales and how does that compare to last year?

Sekera: This year we’re projecting a 3.2% increase in what we call modified retail sales for the fourth quarter. So what modified retail sales are is we take the overall retail sales number and then we adjust that to come up with that part of retail sales that we think is subject to holiday purchases. For example, we’ll strip out a number of different categories, things like automobiles, fuel, homebuilding materials, and groceries. This year we are projecting a decrease in the rate of growth to 3.2%, whereas last year it was up 6.0%. So really this year I think we’re really just in line with inflation, so that would mean that the volume of purchases should be substantially similar as last year.

Dziubinski: Dave, break the numbers down a little bit by in-store sales versus online sales.

Sekera: Each has been significantly impacted throughout the pandemic just by the change in consumer behavior and what people were spending on and where they were spending. As far as in-store sales, we did see a big rebound in foot traffic in 2022, people coming back to the stores, shopping in person. That did drive in-store sales last year 5.4% higher. We are seeing much more normalized foot traffic patterns this year, so this year we’re actually only looking for a little bit under a 1.0% increase.

Now, as far as online sales go, there were huge increases in online shopping, especially in the early years of the pandemic. Looking at our numbers here, in 2020, online sales increased an astounding 45%. So, that did slow down to a 7.5% increase in 2022, and it was a combination, just one of much more normalized behavior, plus at that point, we just had two years of very high comps that we were lapping. So, we are looking for a slightly higher growth rate in online sales, getting back to more of a historically normal pattern. This year for online, we’re projecting a 9.3% increase.

Dziubinski: Dave, what has sort of that longer-term impact of the pandemic been on retail?

Sekera: Early during the pandemic, especially in 2020 and 2021, there was just a huge shift in spending into goods categories and away from services categories. And a lot of that was just due to consumers either being unable to go out because of lockdown or just unwilling to go out in public. Now we have been seeing spending patterns revert back toward prepandemic levels. And we’re not totally fully normalized at this point, but we’re certainly getting very close.

Now that shift in spending patterns as well as a number of other factors over the past few years also then led to a lot of supply chain disruptions, shipping bottlenecks, and that all then disrupted a lot of inventory levels. That also is still playing out to some degree, but I think this is going to be the last year that we see these pandemic-related disruptions. Going into 2024, I think we’re going to have much more normalized historical patterns reemerge. And I think when we look at a lot of the retail stocks, I think that’s why we still see such huge divergences in some of our long-term valuations as opposed to where the market is trading. Because in many cases, I think investors are still too overly focused on those short-term disruptions.

Dziubinski: Let’s talk about some of the different pockets in retail, maybe starting with the toy companies. What are you expecting in terms of toy sales this holiday season? And how do the toy companies Morningstar covers look from an investment perspective today?

Sekera: Well, unfortunately for the kids out there, I think the Grinch, I think he’s going to have his way in the toy category this year. I did speak with Jaime Katz, she’s our equity analyst that covers the toy sector, and she’s forecasting this will probably be the second down year in a row for the toy category. I know some of the things that she’s hearing is that the retailers aren’t taking as much inventory this year. The reason being is that they had too much inventory last year. They had to discount a lot of that at very low prices at the end of the holiday season.

I think what the good news is, is that going forward after suffering a lot of these supply chain and inventory disruptions over the past few years, there won’t be as much inventory buildup, so that won’t require as much of a discount to clear up the shelf space this year. And I think what that’s going to do for that sector is really set up a much more normalized restocking pattern for next year.

Dziubinski: What about electronic gaming? What’s the outlook there?

Sekera: I think for e-gaming, it’s just really the ordinary course of business this year. I think spending on video games this year is going to be very similar to what we saw last year. I spoke to our analyst there, and he just noted the Xbox and the PlayStation consoles, those cycles are very well established. And I don’t think he saw a lot of really new major titles to be released this year that he thinks is going to drive anything other than just kind of the normal sales we’ve seen.

Dziubinski: What about luxury retailers? What are your expectations there, and what does Morningstar think of some of the key players?

Sekera: Luxury, of course, has done very well for the past few years. And I think a lot of that is because spending that otherwise would have gone into travel ended up going into luxury instead. Now this year, we’re hearing from a number of different global luxury brands that spending on luxury items is falling, and not just in the U.S. but across the world, and that a lot of it really has started coming down just here last October. In my opinion, I think there’s probably more risk to the downside among the luxury items just generally.

Taking a look at our coverage, Ralph Lauren RL stock is fairly valued at this point, although I do have to point out Tapestry TPR. So that stock is very undervalued. It’s a five-star rated stock and it trades at half of fair value. Now it is a bit of a story stock at this point. That stock was under pressure earlier this year, but then it really got hit hard in August and that’s when it announced that it was acquiring Capri CPRI. And the market certainly did not like that deal.

So what the deal does here is in the handbag sector brings together several different high-profile brands here in the U.S. We’ve got Coach, Kate Spade, and Michael Kors. We do think that over time they will get some additional operating leverage from that. And we also think that Tapestry management might be able to better grow the Versace and the Jimmy Choo brands better than Capri Management has. However, I just don’t think this is going to be an overnight story. I think it’s going to take at least several quarters after the acquisition closes before we might start really seeing some meaningful results from that deal.

Dziubinski: Lastly, Dave, let’s talk about the specialty retailers. What are your expectations there?

Sekera: Well, as the name implies, in specialty retail, performance I think is highly idiosyncratic to the individual companies. You really can’t make the same kind of broad assumptions like you can in the general merchandise categories. But I also think that’s why it’s a much more interesting area for investors to find new opportunities than the general broad categories. And so I think a lot of the other stories in the retail sector like the department stores, I think a lot of those are going to take a lot of time to play out before they start getting better. But we see a lot of very undervalued stocks in that specialty space.

Dziubinski: It’s time to move on to the stock picks portion of our program. And this week you’re focusing on undervalued stocks that fit into that specialty retail theme. Your first stock pick this week is eBay EBAY. Why?

Sekera: Well, to be honest, I really hadn’t paid much attention to eBay in quite a while. Everyone kind of looks at eBay as being an old story at this point, and I don’t think I’m really the only one that really hadn’t paid much attention. I think there’s just been so much focus elsewhere in the market with the “Magnificent Seven” and a lot of other high-tech and growth stocks that I think this one has just kind of got left behind. So I spoke to Sean Dunlop last week, he’s our analyst that covers this one, in order to get an update on the story. The stock’s a 4-star rated stock. It does have a narrow moat. It trades at a 15% discount and actually has a 2.3% dividend yield—not bad for something more in the tech sector.

The story here is that we do expect total sales across its platform to be flat to down 2% here in the fourth quarter. There’s going to be some negative operating leverage here. So, fourth-quarter earnings should be down 2% to 6%. Although I would note I do think eBay is a little bit more of a first-quarter story. The reason for that is a lot of people will use eBay in the first quarter in order to sell some of those holiday gifts that they got that they didn’t want.

And then really, I think what is most interesting to me here is that Sean talked about a new app that eBay had recently rolled out. This will allow users to more easily post new listings, plus I think those new listings will have an improved appearance. We do expect that app will help boost sales both by increasing the number of listings as well as making those listings more attractive for buyers.

And then the last thing I would note is I do think that over time eBay can benefit from this higher inflation that we’ve had for the past couple of years. To some degree, users may have to look to eBay to monetize some of their personal goods in order to raise money. And then, also I do think a lot of shoppers will look to eBay in order to purchase used goods to help them save money for their households.

Dziubinski: Your second pick this week is a personal favorite of mine. I’ve already purchased holiday gifts on this platform. It’s Etsy ETSY.

Sekera: Exactly. Etsy has definitely got a loyal following. Now for those of you that don’t know Etsy, it’s an online retailer, and they specialize in things like home furnishings and crafts and specifically gifting for special events. And I think this is another good example of how the pandemic has impacted sales patterns over time. Of course, Etsy did very well during the pandemic. A lot of shoppers were going online in order to make their purchases. But of course, now that growth rate has slowed.

I think this also exemplifies just the high degree of uncertainty surrounding the amount of consumer spending this holiday season. I think that’s going to increase some of the volatility in the stock. Now, Etsy did provide a relatively wide range of guidance for its sales on its platform. They’re looking for it to be anywhere down kind of that mid-single-digit percentage to up slightly.

But I think the long story short here is that we think the market is overlooking its long-term potential. This is a company we do rate with a wide economic moat. The stock currently trades in 5-star territory as it trades about half of our fair value estimate.

Dziubinski: Now your third stock pick this week is Chewy CHWY.

Sekera: Well, similar to you being a customer of Etsy, we’re a customer of Chewy here. And for those that don’t know Chewy, it is the largest e-commerce petcare retailer in the U.S., and again, another really good example of how the pandemic skewed its revenue growth trajectories over the past couple of years.

So following the emergence of the pandemic and as lockdowns and social distancing were becoming the norm, we saw the number of households with a new pet surge. So, of course, growth at Chewy also initially surged as those pet earners turn to the company to feed their pets but also just to be able to buy a lot of those other things that you need when you have a new pet in your household, whether that’s crates, pet toys, and other accessories.

And what we found here is that pet owners do tend to be a very loyal bunch. Seventy-five percent of Chewy’s revenue is generated on a subscription basis. So, sales growth has slowed this past year. We have seen fewer new households bringing pets into their lives. But we do think we’re starting to get to the point where the growth rate for households with pets should begin to start normalizing and start returning back to historically normalized levels. In our view, Chewy just remains a growth business that’s not necessarily being recognized that way by the market. And we do think the company will continue to benefit over time as we see sales in that pet category move increasingly online, another 5-star rated stock, trades at half of our fair value, and a company that we do rate with a narrow economic moat.

Dziubinski: And your last pick this week, Dave, is Bath & Body Works BBWI. Why?

Sekera: To some degree, I really don’t know why this stock still remains this undervalued. And maybe it sounds kind of dumb, but I think too many investors still confuse Bath & Body Works with Bed Bath & Beyond, which, of course, was a company that went bankrupt earlier this year, I think in April. And also, just one anecdote here, I think even consumers to some degree still kind of confuse these two companies. Actually, my daughter had worked there, and she just noted it just was not that uncommon for shoppers to come in and they would bring coupons with them for Bed Bath & Beyond.

If you really take a look at this company, I think even in what we consider to be a more challenging retail sales environment this year, Bath & Body Works should be able to hold its own. When we take a look at its product portfolio, they specialize in items that we do think consumers will consider to be affordable and gift-worthy. And they have a lot of different price points for all different types of income levels.

So, again, this may also be another example of a stock where it might take some time for it to work, but for long-term investors, this is a stock that’s rated 5 stars, a company that we do rate with a narrow economic moat, trades at about a 60% discount to our fair value estimate, and in fact, I do think it’s actually one of the most undervalued stocks across our entire US coverage.

Dziubinski: Well, Dave, thanks for your time this morning. Viewers interested in researching any of the stocks that Dave talked about today can visit Morningstar.com for more analysis. Dave and I will be back live 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.