Fixed-income yields are creeping higher, and the stock market doesn’t like that.
Put simply, bonds and stocks are competing investment vehicles. Therefore, the higher fixed-income yields go, the more attractive bonds look as an investment relative to stocks. That is especially true now considering the earnings yield on stocks is near record lows, so big moves higher in bond yields are really felt by the stock market.
Where should investors seek refuge as rates creep higher? Value stocks, specifically cheap stocks.
Traditionally, value stocks tend to outperform growth stocks when rates head higher. The logic here is also pretty simple. As fixed income yields head higher, that adds a ton of pressure to low earnings yield (high multiple) stocks. But the pressure is much less intense on high earnings yield (low multiple) stocks. Therefore, as rates rise, investors tend to rotate away from big growth names and into deep value names.
Which deep value names should you be buying in this market? Here’s a list of my three favorite cheap stocks for the next 12-24 months.
3 Dirt Cheap Stocks That Will Make Value Investors Fall in Love: Foot Locker (FL)
Investors once considered premium athletic footwear retailer Foot Locker, Inc. (NYSE:FL) a survivor of the retail apocalypse. But once Nike Inc (NYSE:NKE) partnered with Amazon.com, Inc. (NASDAQ:AMZN) and other athletic brands started emphasizing direct over wholesale, investors started to re-assess their long-term outlook for Foot Locker. The prevailing thesis became that FL is getting squeezed out of the athletic retail game, and FL stock subsequently dropped.
All the way from $80 to $30 in a matter of months.
But the market has it wrong on this name. Athletic retail is shifting en masse away from wholesale and towards direct. That will kill undifferentiated wholesalers like Finish Line Inc (NASDAQ:FINL) and Big 5 Sporting Goods Corporation (NASDAQ:BGFV). But this shift won’t affect top-end and differentiated wholesalers like FL. Unlike the majority of wholesale athletic retailers, Foot Locker actually has a brand name and offers a differentiated retail experience.
Consider that Foot Locker has endorsements with superstar athletes like the Houston Rockets’ James Harden, or that the company runs ads with NBA players all the time. Also consider that Foot Locker is famous for their jersey-wearing employees and has a whole section of Foot Locker exclusive products. These features make Foot Locker a premium-end wholesale athletic retailer that will remain an integral part of the way athletic brands connect with consumers.
But as these other wholesale athletic retailers like Finish Line and Big 5 get squeezed out, FL will have room to grow market share. That means going forward, FL should actually be able to post positive comparable sales growth (management is guiding for positive comps this year) alongside margin improvements (gross margins are also expected to bounce back this year).
FL stock, meanwhile, is trading at just 9-times forward earnings. With comps expected to turn positive, margins starting to inflect upward, a sky-high tax rate set to come down meaningfully, and buybacks in the pipeline, this is easily a 10% earnings growth narrative over the next 5 years. Plus, the balance sheet is strong and the dividend yield is right around 3.5%.
Put that all together (9-times forward earnings, 10% earnings growth prospects, healthy balance sheet, and 3.5% dividend yield), and it’s easy to see why FL stock is a value picker’s dream.
3 Dirt Cheap Stocks That Will Make Value Investors Fall in Love: Skechers (SKX)
Sticking in the athletic retail industry, I also think that the often forgotten Skechers USA Inc (NYSE:SKX) is a deep value stock that offers plenty of upside potential with mitigated downside risk.
In the athletic retail world, it seems everyone is focused on the triumvirate of Nike Inc (NYSE:NKE), Under Armour Inc (NYSE:UAA) and adidas AG (ADR) (OTCMKTS:ADDYY). These are the players with the big athlete endorsements, the ultra-expensive performance shoes, and the “cool” factor. You could even throw Lululemon Athletica inc. (NASDAQ:LULU) in there.
Skechers isn’t part of that conversation. But here’s a fun fact: of all five big athletic retail brands, Skechers is posting the biggest revenue and earnings growth in the group.
Nike posted revenue growth of 5% last quarter. Same with Under Armour. Adidas reported revenue growth of 12% last quarter. Lululemon saw revenues jump 14% higher last quarter.
Over at Skechers, revenues soared 27% higher last quarter. And that wasn’t just a one-time thing. For the full-year, revenues jumped 17% higher. Meanwhile, gross margins are racing higher, the operating expense rate is falling, operating margins are booming, and profits are soaring.
What’s going on under the hood? SKX is completely avoiding competition with the likes of Nike, Under Armour, Adidas and Lululemon by focusing on the mid-price-point athletic shoe market, and targeting value-oriented shoppers who don’t care about all the frills that Nike and company offer. Skechers makes a high-quality, good-looking shoe and sells it for somewhere between $50 and $100.
This “good product, better price” mantra is working out well for SKX, especially on the international front, where sales rose 40% last quarter. This growth story, especially on the international front, is just getting started. But SKX stock trades at a mere 18-times forward earnings for what analysts see as 15% earnings growth per year over the next 5 years.
That is remarkably cheap in the Nike/Under Armour/Adidas/Lululemon group. Plus, the company has enough cash on its balance sheet to cover more than 10% of its current market cap. All together, this is a dirt-cheap name with very strong forward looking growth prospects.
3 Dirt Cheap Stocks That Will Make Value Investors Fall in Love: L Brands (LB)
Much like Foot Locker, L Brands Inc (NYSE:LB) was once considered one of the few survivors of the retail apocalypse. Investors viewed LB’s flagship Victoria’s Secret and Bath & Body Works stores as having secular appeal and strong enough brands to fend off competition.
For a while, this was true. But then LB decided that Victoria’s Secret would exit the swim and apparel categories. This happened at the same time that there was this secular shift away from “bombshell beauty” and towards “natural beauty”, a trend which ran counter to Victoria’s Secret line-up of push-up bras. All together, comparable sales at Victoria’s Secret tumbled and dragged LB stock down.
Now, with the swim and apparel exit in the rear-view mirror, those comps are starting to rebound. Victoria’s Secret reported comparable sales growth of 4% in January, the biggest comparable sales gain since November 2016. Comps are still negative on a 2-year basis, which speaks to the trend away from bombshell beauty, but currently positive comps speak to the fact that regardless of secular trends, women will still always shop at Victoria’s Secret for intimates.
Meanwhile, Bath & Body Works has been resoundingly strong during the whole Victoria’s Secret transition. Comps at Bath & Body Works rose 13% in January, on top of a 12% increase a year ago.
So L Brands is still the company behind two brands with secular appeal. Bath & Body Works has been strong for the past several years, while Victoria’s Secret is just now getting its groove back after an ugly transition period. Positive comps at Victoria’s Secret and Bath & Body Works, coupled with improving margins and tax cuts, should drive at least 10% earnings growth over the next several years.
LB stock is trading at just 13-times forward earnings for that 10% growth. That is pretty cheap, especially considering the dividend yield is right around 5.5%.
As of this writing, Luke Lango was long FL, SKX, LB, NKE, and AMZN.