In the U.S. equity markets, 2018 really hasn’t been as bad as it seems. The S&P 500 is down less than 1% so far this year. Volatility has increased, and the index is down almost 10% from its highs. But performance isn’t close to as bad as recent media coverage and commentary might suggest — there are still plenty of stocks to buy heading into 2019.
That said, 2018 has been close to disastrous for certain stocks, and certain sectors. Semiconductor stocks have pulled back sharply. Chinese stocks have been plunging since the spring. Housing and construction-related stocks are down 50% or more in many cases.
It remains to be seen whether those declines, and the recent pullback in broad indices, are the result of investors overreacting to real concerns (tariffs, inflation, higher interest rates), or a buying opportunity. For these 15 stocks to buy, it looks like the latter. In some cases, good companies have been sold off too far.
In others, all but the worst-case scenario seems already priced in. All 15 stocks to buy have struggled in 2018, but have a good chance of much brighter performance in 2019.
Electronic Arts (EA)
Video game stocks, including Electronic Arts (NASDAQ:EA), have taken a shellacking over the past few months. EA stock is down 23% for the year and 46% off its highs. Activision Blizzard (NASDAQ:ATVI) has declined over 40% in less than three months. Take-Two Interactive (NASDAQ:TTWO) has fallen 24% from its October peak — a drop that seems downright benign in the context of the group.
I’ve long argued that TTWO is the best pick in the space, all else equal. And the pullback looks enticing. But EA’s sharper fall and more reasonable valuation — 15x forward earnings — make it worth a long look. In April, I thought the stock wasn’t cheap enough at $120+. Back at $80, the case seems very different.
EA looks close to cheap, but the long-term tailwinds benefiting the stock, and the industry, still seem intact. The shift to digital downloads will help margins. Recurring revenue from in-game purchases should drive growth for years to come. EA certainly has made its share of missteps — notably with Battlefront II — but those can be fixed. If they are, EA’s decline will be a buying opportunity.
Southwest Airlines (LUV)
Historically, airlines have been notably poor investments. Warren Buffett famously said that, “If a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”
But Southwest Airlines (NYSE:LUV) has been the exception to the rule. Not only has Southwest never declared bankruptcy (unlike its peers), LUV stock has been a wonderful investment. Its 1971 IPO raised $6.5 million; the company now has a market capitalization of nearly $30 billion.
Yet investors have taken the short-term view in 2018: LUV stock is down 24% so far this year. But even the short-term focus seems misguided. LUV plunged to $50 after Q3 earnings, where the company guided for higher costs, particularly for fuel. But oil prices are actually plunging.
The selloff leaves — as Buffett might say — a wonderful business available at not just a fair price, but a cheap one. With millennials clearly spending more on experiences like travel than on objects, there’s a secular tailwind (pardon the pun) behind the airline industry. And Southwest remains best in breed. Even Buffett’s Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) now owns it. At 10x earnings, most investors should too.
Beaten-Down Stocks to Buy: A.O. Smith (AOS)
In this market, there’s no shortage of quality cyclical stocks on sale and A.O. Smith (NYSE:AOS) certainly qualifies. Shares of the water heater manufacturer have dropped 31% so far this year, and are challenging the two-plus-year low reached in late December.
There is some logic to the pullback, admittedly. AOS obviously has a great deal of exposure to U.S. housing, and those stocks have been dumped for most of 2018. Higher input costs are pressuring margins. Expansion into China was supposed to be a growth driver, but there, too, investors are fearful.
Near-term worries, however, have obscured a solid long-term case — and an attractive valuation. AOS now trades at just 15x 2019 earnings-per-share estimates and offers a 2%+ dividend yield. Demand should continue to rise, particularly for the company’s water treatment offerings (which are being pushed by Lowe’s (NYSE:LOW)). Here, like at LUV, investors are focusing on short-term risks to the exclusion of long-term rewards. Here, too, that likely will reverse.
Beaten-Down Stocks to Buy: Scientific Games (SGMS)
Within ten months, SGMS would soar from $35 to over $60, backed by optimism toward the gaming industry. From those highs, however, SGMS has dropped a stunning 75%.
From a performance standpoint, it might be difficult to see what has caused the decline. Earnings the last two quarters haven’t been great — SciGames missed revenue estimates twice — but they haven’t been horrible, either. SGMS actually soared 25% after Q3 earnings last month, though it gave those gains back rather quickly.
There are two key, clear issues, here. The first is Scientific Games’ enormous debt load. The company closed Q3 with nearly $9 billion in debt. Yet the market cap is just $1.5 billion, which means small moves in the valuation of the overall business lead to huge swings in the SGMS stock price.
The second issue is investor sentiment toward the gaming space. Casino stocks have fallen across the board since early October, and perhaps for good reason. Valuations in the sector were at levels not seen since before the financial crisis, which turned out to be an awful time to own anything in the sector. SciGames’ two big rivals have seen their stocks fall as well: Everi Holdings (NASDAQ:EVRI) is down 20% this year, and International Game Technology (NYSE:IGT) off 39%.
That said, there’s an interesting contrarian play to make here, even if some option traders were a bit early in trying to do so. A 1 turn expansion in the EBITDA multiple, driven by increasing sentiment, would lead SGMS to nearly double. The debt load is a concern – but Scientific Games bonds actually have held up reasonably well. And a recent legal settlement could be an upside catalyst.
If an investor believes the market is too fearful right now, SGMS is one of the best bets to take.
Arlo Technologies (ARLO)
The spin-off of Arlo Technologies (NYSE:ARLO) by NETGEAR (NASDAQ:NTGR) has not gone according to plan. NETGEAR wanted to separate its fast-growing IP camera unit to allow its sizzling revenue growth to shine through.
But investors have steadily dumped ARLO stock since the month after the company’s August IPO. Arlo’s revenue growth has been solid. But margin concerns, a Q4 revenue warning, and fears about competition from Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) unit Google and others have pressured the stock. The remaining shares of Arlo are set to be distributed to NTGR shareholders at year-end, but those shares now are nearly 40% below the $16 IPO price.
The news isn’t all bad, and it’s possible that fund-driven selling is adding to the pressure on ARLO. Revenue is still growing. There’s no sign, yet, that Arlo is losing its dominant market share. With ARLO now trading at a little over 1x revenue, investors are acting as if growth is coming to an end. If that’s too pessimistic, ARLO has plenty of room to rally in 2019.
Beaten-Down Stocks to Buy: eBay (EBAY)
The problem for eBay (NASDAQ:EBAY) in 2018 has been pretty simple. Investors simply don’t see the online retailing giant as driving much in the way of growth. Whether its competition from Amazon (NASDAQ:AMZN) or just buyer fatigue, investors seems to think eBay’s best days are behind it.
But as EBAY stock has dropped over 30% from March highs, and 23% so far this year, the market might have missed a key fact. EBAY stock isn’t priced for growth anymore. The stock trades at less than 13x 2018 EPS estimates — a multiple that prices in basically zero profit growth.
Yet eBay still is driving some growth, and a lot of free cash flow that can be used for buybacks, dividends or even M&A. I thought EBAY was worth sticking with at $34; below $30, it looks even better.
The merger that created DowDuPont (NYSE:DWDP) hasn’t fully played out yet, but investors are bailing anyway. DWDP shares have lost almost a quarter of their value this year.
Cyclical fears are an issue here, too. But DWDP has plenty of catalysts heading into 2019. It’s splitting into three companies: an agricultural chemicals play, a specialty materials company (which will get the Dow name) and a “new” DuPont.
There’s a lot of upside to be unlocked and a lot of smart money behind the play. The smaller businesses should be more nimble and easier for investors to value. Trading next year could be volatile as the spin-offs take place, but investors willing to stomach that volatility should be rewarded.
The carnage in Chinese stocks this year has left a number of “buy the dip” opportunities. And Weibo (NASDAQ:WB) is one of the more intriguing plays.
On this site, Luke Lango highlighted seven China plays ready to rebound. Josh Enomoto detailed 10 stocks to buy in the market for 2019. Both authors chose WB stock as a worthy choice, and with good reason.
The company often referred to as the Twitter (NYSE:TWTR) of China actually had a strong 2018. All three earnings reports have beaten Street estimates, continuing a streak that goes back to 2015. Revenue rose 44% in Q3, and non-GAAP net income climbed 49%.
And yet WB shares have lost 38% of their value this year. The stock now trades at less than 20x forward earnings — a discount not only to TWTR but most U.S. tech plays. Obviously, political and macro risks in China are a factor. But for investors who see the China selloff as having gone too far, WB stock is worth a long look.
In one sense, it makes sense that Gap (NYSE:GPS) shares have fallen 22% so far this year. Apparel retail stocks have struggled of late, as a rally that began late last year has fizzled out. Shares of mall owners are declining amid falling traffic and Gap and Banana Republic are two well-known, mall-heavy brands. Add to that underlying economic worries in the U.S. and the pressure on GPS stock doesn’t seem particularly surprising.
But that analysis misses a key point: Gap Inc is not Gap brand. At this point, Gap Inc relies heavily on Old Navy: management commentary suggests that concept drives at least two-thirds of total profit. And that business is doing well, with impressive same-store sales. By my math, Old Navy alone supports the entire valuation of Gap Inc and possibly then some.
Admittedly, management hasn’t done a good job of telling that story, as I wrote last month. I expect, however, that will change at some point soon. And when it does, GPS will get back its 2018 losses, and then some.
J.M. Smucker (SJM)
J M Smucker (NYSE:SJM) at the moment has an intriguing story, as well as some questions about execution. Back in April, I highlighted the company’s pivot away from the tough consumer food space toward pet products and coffee. It was a pivot that made sense given the intense pressure facing consumer packaged goods manufacturers. And it was a pivot that made SJM look attractive at $120.
The problem has been the results. Smucker whiffed on Q2 results late last month, and cut full-year profit guidance. And so investors are worried about whether Smucker can execute that pivot and perhaps rightly so. SJM just missed touching a three-year low before rebounding modestly over the past few sessions.
That said, the selloff looks like it has gone a bit too far. Even with reduced guidance, SJM trades at less than 13x FY19 EPS. Some bumps in the road should be expected as the company overhauls its business. A 3.3% dividend yield allows investors to “get paid to wait,” as the old saying goes. There are few consumer stocks to buy out there, but SJM looks like one of them heading into 2019.
Cognex Corporation (NASDAQ:CGNX) shares are down 35% so far this year, but hardly look cheap. CGNX still trades over 20x FY19 EBITDA and near 30x EPS. And there are risks here looking to 2019.
Apple (NASDAQ:AAPL) has accounted for roughly 20% of revenue the last three years and investors are worried about growth at that key customer. China drives 14% of sales, and is the “fastest-growing market”, per the CGNX 10-K. Investors aren’t particularly bullish on that market, either. Q3 earnings disappointed. The chart doesn’t look great: CGNX made a brief rally late last month, but it faded quickly, and the stock is again testing support around $40.
This is a case where patience might be advised, or a hedged entry might be preferable. But this is also a very attractive long-term story available at a much cheaper price. Cognex supplies “machine vision” products that capture information — and help industrial automation. That’s a trend with years, if not decades, of expansion ahead. In that context, a ~30x forward price-to-earnings ratio isn’t nearly as expensive as it sounds. Cognex should grow for years to come, but it’s not priced as such, even it doesn’t look “cheap.”
Foundation Building Materials (FBM)
As noted, housing and construction stocks have been shredded in 2018. I listed six potential buys in the sector last month, but an intriguing, if high-risk, small-cap play is distributor Foundation Building Materials (NYSE:FBM).
Like most of its peers, FBM has had a rough year, dropping by 46%. There’s a clear concern of a “double whammy”, with slowing residential construction hitting demand and inflation and tariffs driving up costs. FBM has a heavily leveraged balance sheet, which has added to the selling pressure and increases risk going forward.
That said, there’s a case for big rewards here as well. The company is selling its mechanical insulation business for $116 million, which should cut debt by over 20%. 2019 guidance for Adjusted EBITDA of $160-$180 million suggests a sub-5x forward multiple and solid year-over-year growth. FBM stock actually rallied on both pieces of news on Nov. 1, only for market fears to overwhelm the rally.
It’s possible management could be wrong. But at these prices, the market is pricing in essentially zero probability that management is right. If that’s the case — and/or if the pressure on construction in 2019 isn’t as intense as investors seem to fear — FBM should have substantial upside.
Beaten-Down Stocks to Buy: Goldman Sachs (GS)
Financials are another group that has had a rough year, and few have had it worse than Goldman Sachs (NYSE:GS). GS stock has dropped 31% and given back basically all of the gains seen after the U.S. presidential election.
There are concerns about the 1MDB scandal, admittedly. But that mistake by Goldman suggests a fine of a few billion dollars at most; GS stock has lost some $30 billion in market value so far this year.
The decline leaves GS stock exceedingly cheap. A price-to-book multiple of 0.87x is the lowest since early 2016 and not far from the absolute lows reached during the financial crisis. GS trades at 7x forward earnings. Both multiples are far too low for a premier investment bank, even if a recession is on the way. At some point, Goldman Sachs stock should rebound.
Beaten-Down Stocks to Buy: Whirlpool (WHR)
Appliance manufacturer Whirpool (NYSE:WHR) has been a clear victim of tariff concerns. The company said after Q3 results that it expected some $300 million in tariff-related costs in 2019. That would seem a good reason to avoid WHR stock – and many investors have, as WHR has dropped over 30% in 2018.
But with WHR bouncing off a five-year low, much of the pressure looks priced in. Stronger Q3 earnings offset some of the worries raised by a disappointing Q2 release. The company is raising prices to offset tariff costs – and there’s still the hope of a truce in the trade war that likely would send WHR shares climbing.
Risks are real, but this is a strong American manufacturer trading at barely 7x next year’s earnings and yielding nearly 4%. WHR looks like it’s worth taking those risks.
The selloff in industrial component manufacturer Rogers Corporation (NYSE:ROG) has simply gone too far. ROG is down 35% for the year at this point, with a good chunk of the losses coming just since late September.
Like with so many other stocks, tariffs and macro concerns are part of the story. But the vehemence of ROG’s decline seems like an overreaction. Rogers still has long-term growth drivers in automotive components and wireless infrastructure. Growth has been impressive for several years now, and Q3 earnings beat expectations.
Analysts, at least, haven’t budged: the average price target suggests nearly 50% upside. If the Street is even half right, ROG should be a big winner in 2019.
As of this writing, Vince Martin was long shares of NETGEAR and Gap Inc.