The stock market had a really bad Friday. It followed that up with a historically bad Monday. Then on Tuesday, stocks couldn’t decide if they wanted to rebound or keep selling off.
As many astute investors have pointed out, this is typical late-cycle behavior. Rates are coming up, and that is forcing investors to reprice equities since they have long been priced as if rates were going to remain low forever. But signs of inflation are starting to show up — near decade-high wage growth in the January Jobs Report. That has caused rates to go up, valuations to go down, and stocks to fall.
And although the Dow Jones just posted its biggest single-day point drop in history, no one is really freaking out for the long term. Everyone I’ve talked to is using this “repricing” dip as a buying opportunity. Big investment banks, financial media personalities, and average Joe investors all think the same thing.
I don’t think they are all wrong. I’m taking advantage of this weakness. But I’m also not treating every stock like it has big rebound potential. I’m looking to buy winners who have been unfairly treated like losers. One such winner I’m picking up on this dip is iRobot Corporation (NASDAQ:IRBT).
Why IRBT Stock Is a Buy Here
iRobot stock is a secular growth stock that trades at a reasonable valuation and has a huge forthcoming catalyst on the horizon. Despite all that, IRBT stock has been hammered during this recent sell-off. It’s fallen from the mid-$90s to the low-$80s.
The steep drop is a buying opportunity.
IRBT is the leader in the secular growth consumer robotics market, mainly vacuums. That market is expected to grow at a 20%-plus clip over the next five to six years. Earlier this year, Spruce Capital Management called out iRobot stock as being overvalued. They said that despite the big market growth potential, competitors would chip away at IRBT’s leadership position, causing growth rates to naturally erode.
That call made sense to a lot of people. You can’t run in open fields forever. Consequently, iRobot stock dropped from a $110 high in July to the mid-$60s by October.
Fast forward a few months. Competition has arrived, mainly from the Shark ION Robot. But growth hasn’t eroded. Instead, IRBT continues to report revenue growth north of 20%. More than that, gross margins continue to trend up year-over-year despite the Shark ION vacuum being markedly cheaper.
In other words, although the consumer vacuum robotics landscape has grown increasingly competitive, IRBT has maintained 20%-plus revenue growth and gross margin expansion. This resiliency speaks to just how dominant IRBT is in this space.
IRBT Maintains Strong Position
When looking to buy stocks on big market dips, market leaders are a good place to start. Market leaders in secular growth markets are a great place to start.
Beyond that, iRobot stock is also reasonably valued. This is easily a 20%-plus revenue growth narrative over the next several years, with gross margin expansion and expense leverage potential. All together, this is easily a 25%-plus earnings growth narrative. Applying the S&P 500‘s price-to-earnings/growth (PEG) ratio of 1.3 to IRBT, you get a fair forward multiple of 32.5.
Earnings estimates for fiscal 2018 sit at $2.70, but IRBT has a tendency to blow estimates out of the water. Consequently, when it’s all said and done, I think 2018 earnings will look like $3. A 32.5 forward multiple on $3 earnings gets you to a price target in the upper-$90s.
Bottom Line on IRBT Stock
IRBT is a strong market leader in a secular growth market with a stock that has been dropped into undervalued territory after this recent market-wide sell-off.
There is also a big catalyst on the horizon with holiday earnings due Thursday before the bell. Those numbers will likely be pretty good. Consumers opened up their wallets more than usual this holiday season, and it looks IRBT was a beneficiary of that — see favorable interest and pricing trends.
I expect a beat-and-raise quarter out of IRBT stock on Thursday morning. By then, I also think the majority of this big stock market sell-off will be in the rear-view mirror, and the markets will be in rebound mode. A market in rebound mode coupled with a strong ER could send IRBT stock flying on Thursday.
As of this writing, Luke Lango was long IRBT.
