Editor’s note: This column is part of our Best Stocks for 2016 contest. John Divine’s pick for the contest is Snap-On Incorporated (NYSE:SNA).
Snap-On Incorporated (NYSE:SNA), my pick for the 2016 Best Stocks Competition, isn’t faring so well this year. It’s off about 13% in 2016, or a more modest 12% when dividends are accounted for.
It’s no wonder that, heading into the fourth quarter, Snap-On stock finds itself in the lowly eighth spot in InvestorPlace’s annual competition.
Despite the poor showing, I believe Snap-On remains a solid stock to buy, and if I were to land a coveted spot in the contest again next year, it’s a distinct possibility that SNA might just repeat as my 2017 pick.
Here’s why:
SNA Stock: A Steady Eddie
SNA, which sells high-tech tools to mechanics and other service industry professionals, earns a reliable income each year from its franchisees, who pay the parent company a percentage of their revenue for the right to use Snap-On’s brand.
They also buy Snap-On’s namesake tools and diagnostics equipment from the company, making franchisees a low-risk, reliable source of cash flow.
In today’s market, where low yields and zero-interest-rate policies by countries across the world abound, well-established companies with predictable, regular cash flows are the risk-conscious investor’s best friend.
Not only is SNA stock’s 1.7% dividend roughly in line with the 10-year treasury, the stock is also unnaturally cheap.
That, perhaps, is the only true thing to celebrate about SNA’s lousy return this year: Mr. Market is giving you, the individual investor, a pretty sweet deal.
Underloved and Undervalued
Perhaps because Snap-On is more or less an under-the-radar stock, it trades at a meaningfully cheaper valuation than the S&P 500. The price-to-earnings ratio on SNA stock is just 16.8, a 30% discount to the S&P’s rather lofty 24.5 multiple. Even Snap-On’s forward P/E ratio — 14.7 — is 18% lower than the S&P’s 18.4 forward multiple.
Now, the following may seem unfathomable to those who believe in the efficient markets hypothesis, but it appears Wall Street punished Snap-On, along with the rest of the stock market, back in the first few months of the year when markets were in freefall. SNA stock, at its lows in mid-February, was down over 20% from its 2015 close.
That’s not particularly surprising. What is a little surprising though is that Wall Street seemed to mostly forget about SNA stock in the months-long recovery that followed — even as Snap-On beat analyst earnings per share expectations in Q1 and Q2.
Snap-On Is an Earnings Monster
In fact, SNA has now beaten consensus EPS estimates in 14 straight quarters.
A major earnings catalyst for Snap-On is its prospering financing arm, where it extends loans to customers like auto mechanics, who use financing for about 95% of their tool purchases. While net sales rose just 2.4% in the second quarter, financial services operating earnings soared 19.6%, and EPS soared 16.3%.
The company’s strength in financial services, and its focus on rapid continuous improvement, which focuses on efficiency and cost savings, are two reasons I initially recommended the stock; both have also been instrumental in Snap-On’s ability to expand its net margins year after year, resulting in a multiyear string of EPS beats.
So, while there’s virtually zero chance SNA will stage a rally enormous enough to crack the top three of this year’s Best Stocks competition, I still think Snap-On is a solid buy at these depressed levels.
As of this writing, John Divine did not hold a position in any of the aforementioned securities.
