The goal today is to find large-cap stocks that are lagging but won’t be for long. The underlying assumption is that the bulls will remain in control on Wall Street. So far, buyers have been relentless. Investors are refusing to sell much for any sustainable period of time. And when they sell one thing it’s only to roll into another. “Rotation” has been the theme for months. As a result, there are many large-cap stocks to buy before they catch a wave of interest.
The markets set new highs yet again last week. None of this was because the macroeconomic conditions got better. In fact things are getting worse because of the novel coronavirus. Many major states are rolling back business restrictions. California is pretty much shut down again. There are pockets within it that are revolting like riverside county for example. There, Sheriff Chad Bianco announced he would defy Governor Newsom’s order. They are not going to enforce the order. The end result are worsening conditions, yet here we are with higher stocks.
What we don’t want to do today is scrape the bottom of the barrel. There are opportunities where investors have ignored equities that were worthy. This year, Wall Street is trading like a child. If it is not in the news, it acts like the opportunity is not there. The three large-cap stocks to consider today have not made news in a while. Consequently, their stock prices have retreated.
But, with a bit of homework, we can get ahead of the next wave of buying:
Large-Cap Stocks to Buy: McDonald’s (MCD)
Almost every kid on the planet recognizes the golden arches over the McDonald’s restaurant buildings. It’s a global brand that has executed well for decades. MCD rarely runs into controversies that cause harm to investors. Recently, MCD stock fell out of favor on Wall Street, so it’s about 10% off its highs. Therein lies some immediate upside for new buyers. More importantly, the stock is now retesting the February quarantine crash site. Usually approaching major pivot points like this translates into support in the price.
In recent years, management has succeeded in divesting from the “fast food is bad for you” stigma. They have even earned recognition for their coffee to the point of competing with Starbucks (NASDAQ:SBUX). Consequently, the fundamental thesis in MCD is as solid as it has ever been. They have also stepped out of the happy meal box and invested in technology.
In 2019, they acquired innovative tech to help boost sales. These are moves I would expect from Chipotle (NYSE:CMG), so kudos to the MCD team. Since it has been lagging the benchmarks by about half, the timing favors the bulls. Buying MCD stock here has more upside potential than more pain.
Fundamentally, McDonald’s sells at a trailing 12-month price-to-earnings ratio of 30x. That is not cheap, especially for a stock that lacks pizzazz. The price-to-sales is also high at 9x, but not from an absolute value. Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) or Facebook (NASDAQ:FB) have higher levels, but they also grow faster. A relatively stagnant growth company like MCD should be cheaper. This leaves some risk that too much hope is still baked in the stock price today.
The sales line lacks excitement and has been stagnant for 3 years. But between 2016 and 2019, MCD grew net income 28%. What’s important for a mature company like this is the bottom line and there they are winners.
Home Depot (HD)
The quarantine has disrupted every person on the planet. We have never spent this much time at home before and for this long. It is only natural that we spend more time tinkering with our situation there. This translates into more potential business for Home Depot. Moreover, interest rates have never been lower. Thanks to the U.S. Federal Reserve, aggressive inflationary policies made variable mortgage rate fell over 2% this year. Millions others are taking advantage to refinance.
According to Freddie-Mac (OTCMKTS:FMCC), 42% of those who do also cash out and increase their loan amounts at least 5%. This money most often finds its way back into the home as improvements. That’s the upside in HD stock because demand on its products and services is solid. That explains how they grew sales 25% year-over-year.
Fundamentally, the value of HD stock is moderate. It’s not outrageously cheap, so that’s not a reason alone to buy it. But technically, it is stuck in a bearish pattern and it’s almost done. There is a lack of interest in it, but that’s why we are considering it today. This is a stock to own for a long-term investment, especially given that it pays a 2.25% dividend. This is more than twice what the 10-year U.S. bond pays. As a bonus, Wall Street also loves it from time to time, so they will again soon.
The recent downturn priced out a lot of the froth it built during its past three rallies. The good news is that it has spent months consolidating a wide range above $260 per share. Prices are closer to the lower end and it should be support. This was the breakout point in June and just above the pandemic start in February. Swing spots like these often make for solid footing. Consequently, HD stock makes for a good bet for short swings and long-term starter positions here.
Like Home Depot, LOW stock has no major issue from a valuation perspective. Yet, like HD it too is going the wrong way, while markets are setting records. They are both stuck in almost identical technical bearish patterns. They have more to go to fill them, but it’s a good time to setup entry points for a bounce.
As the saying goes, “they don’t ring bells for perfect entry points.” Furthermore, in most cases, the bottom is a process– not a snap moment in time. In this case, LOW stock should start getting investor attention as it nears $140. That was the July battle between the bulls and the bears. They are likely to fight it out hard once more, which means upcoming support is inevitable. Congestion from the action usually translates into an interim bottom for a stock.
While there will be buyers, the zone is squishy. So for those who want to build even more, they can do so using options. Buying LOW stock at face value risks money without protection. Instead, investors can sell the Jan $140 put and collect $2.25 per contract. LOW stock can then fall 7% and this trade would deliver maximum gains. The break even point would be $137.75 per share.
In summary, there are no magic bullets when it comes to investing. Doing homework can increase the chances that we find hidden gems before the others. These three large-cap stocks all fit the bill, but I still wouldn’t take all three at the same time. Furthermore, stocks are at record highs so there is risk from that alone.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Nicolas Chahine is the managing director of SellSpreads.com.