3 Stocks to Buy the Dip Now


3 Stocks to Buy the Dip Now

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This article is excerpted from Tom Yeung’s Moonshot Investor newsletter. To make sure you don’t miss any of Tom’s picks, subscribe to his mailing list here.

A Sunset… And a Sunrise

Well… it’s been an excellent ride for The Moonshot Investor.

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Falling consumer confidence…

Plus, we know that things can worsen over the next six to 12 months. Fed Chair Jerome Powell has barely raised rates by 1% and stocks are already convulsing.

But experienced investors know one thing for sure:

Markets will eventually recover.

American stocks have survived wars and pandemics before. Today’s rate hikes to combat inflation will eventually be nothing more than a footnote in stock market history.

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In the meantime, here’s another sample of Tom Yeung’s Profit & Protection.

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3 Stocks to Buy the Dip Now

Worried about “buying the dip?”

You’d be right.

An investor who bought the 50 worst relative strength stocks from 1951 to 2003 would have turned $10,000 into only $79,266, according to data collected by fund manager Jim O’Shaughnessy. The same $10,000 in index funds would have grown to $5,743,706.

Today, the story remains the same. “Buying the dip” remains a losing game.

Of the 3,000 stocks in the broad-based Russell 3000 index, the lowest-performing quintile of stocks during H2 2021 has continued to lag this year.

A chart showing the year-to-date performance of stocks in the Russell 3000 index. Stocks are grouped into 5 quintiles based on performance in the second half of 2021, and the lowest quintile has the worst performance year-to-date.

Lowest-momentum stocks have performed the worst in 2022 so far.

Of course, there are always exceptions to the rule.

Companies like NexTier Oilfield Solutions (NYSE:NEX) turned a -30% loss in H2 2021 into a 191% gain.

And history is filled with downturns that gave investors a second chance to buy high-quality stocks.

Apple (NASDAQ:AAPL) in 1997… Amazon (NASDAQ:AMZN) in 2002… Netflix (NASDAQ:NFLX) in 2008… Tesla (NASDAQ:TSLA) in 2018…

The list goes on and on.

How to Buy the Dip?

So how should investors find today’s Amazon and NexTier comeback stories while avoiding flops like Pets.com?

The answer is surprisingly straightforward. Successful buy-the-dip firms generally have at least one of these features:

  1. Outside Saviors. Some firms like GameStop (NYSE:GME) find white knights like Chewy founder Ryan Cohen. These activist investors scoop up shares with the intention of saving businesses from certain death.
  2. Internal Assets. Others, such as Occidental Petroleum (NYSE:OXY), recover thanks to asset values. These companies tend to have tangible assets that can be traded or converted to cash as needed.
  3. Strong Cash Flows. Finally, some firms can generate cash regardless of market conditions. Companies like Walmart (NYSE:WMT) and McDonald’s (NYSE:MCD) saw shares rise during the 2008 financial crisis as consumers shifted to cheaper options.

Occasionally, some companies will check multiple boxes. My top penny stock pick of 2021 Hertz (NASDAQ:HTZ) emerged from bankruptcy when 1) white knight investors believed the firm’s 2) billion-dollar automobile fleet and 3) anticipated post-Covid-19 cash flows were worth more than bankruptcy courts gave the company credit for.

Once you find companies with these features, it’s often worthwhile to back up the truck.

For Profit…

Of the three categories, “Outside Saviors” is perhaps the most rewarding — if paired with another catalyst. Relying on a single person like Elon Musk or Softbank’s Masayoshi Son for a bailout is otherwise too risky.

Fortunately, I have good news:

“Internal Assets” companies are now everywhere.

Today, no fewer than 373 billion-dollar companies trade at negative enterprise value. An enterprising (and deep-pocketed) investor could theoretically take any of these firms private and end up with more assets than they started with. High-growth firms like Rhythm Pharmaceuticals (NASDAQ:RYTM) and Singular Genomics (NASDAQ:OMIC) make attractive takeover targets.

And that brings me to Desktop Metal (NYSE:DM) — a firm I’ve already written about at length.

In prior notes, I’ve commented that this 3D printing firm is on the leading edge of an American manufacturing revolution. Its ability to print metal products at high speeds makes it competitive with casting — a labor-intensive process that has stymied many American manufacturers.

Today, I’m adding DM to the top of my list of “buy-the-dip” plays. The 3D printing firm now trades close to its tangible book value, making it a potential buyout target. And though the firm still has a 25% to 35% chance of going bankrupt over its weak cash flow, its valuable intellectual property (IP) and strong sales team give it a reasonable chance of surviving any potential crisis to become a 10x stock.

A chart showing share price vs. tangible book value for DM stock over time.

Meanwhile, “Strong Cash Flows” companies are also on blue-light special.

This week, I’m introducing Etsy (NASDAQ:ETSY) as a “buy-the-dip” play thanks to its wide-moat business and strong cash flows.

Since 2017, the ecommerce site has generated a steady stream of profits thanks to its focus on unique, non-commoditized goods. The company generated $620 million in free cash flow in 2021, which it used on value-added acquisitions.

Etsy is also shrugging off the end of the Covid-19 pandemic. Analysts expect the ecommerce firm to grow revenues another 60% by 2024, compared to a -5% decline for fellow work-from-home darling ContextLogic (NASDAQ:WISH).

The recent tech selloff has also moved prices to reasonable levels. Etsy now trades at a 16x forward price-to-cashflow multiple (P/CF), a figure comparable to Amazon’s 18x ratio and far lower than Shopify’s (NYSE:SHOP) >500x.

A chart showing share price vs. cash flow per share of ETSY stock over time.

Investors, however, should still exercise restraint with position sizing.  If the U.S. economy swings into an unexpectedly deep recession, share prices could theoretically drop below $50 — a 12x P/CF ratio. And Etsy’s current $10 billion market capitalization means it needs to drop 20% to 30% for any would-be acquirer to swallow.

Still, Etsy remains my top “buy-the-dip” ecommerce firm for its ability to generate strong cash flows and the potential for a buyout offer should prices continue to fall.

…And for Protection

Investors seeking stronger protection than Desktop Metal or Etsy should turn to history. As mentioned on Tuesday, Consumer Staples tend to outperform during recessions.

A chart showing the annualized relative performance of sectors during recession cycles.

And that brings me to HanesBrands (NYSE:HBI), an innerwear firm that has averaged double-digit return on invested capital (ROIC) for the past two decades.

In many ways, HBI looks like a Perpetual Money Machine — abnormally high ROIC and a wide-moat business that does well regardless of recessions or fashion trends.

Even when the economy is falling apart, people still need underwear.

HanesBrands also has a hard-to-beat cost advantage. The firm owns Hanes, Champion and Bonds, giving the parent firm a 32% market share of the North American market and 21% of the Australian one.

The firm also produces 70% of its products in-house, giving it slightly better control over costs in its supply chain.

Today, investors can scoop up HanesBrands for under 8x forward price-to-earnings. Competitors Gap (NYSE:GPS) and Gildan Activewear (NYSE:GIL) trade for 41% and 30% premiums, respectively.

A chart showing share price vs. forward EPS for HBI stock.

That said, HBI will face some issues along the way. Shipping delays, rising commodity prices and retail store closures will eat into profits; Wall Street analysts have already cut earnings estimates by 9.3%.

HanesBrands also fails one of the Perpetual Money Machine requirements — the ability to reinvest its high ROIC back into the business. The innerwear business is a mature, zero-growth industry, while activewear is cutthroat and competitive. HBI will have trouble doing much with its expected 20% ROIC besides issuing a steady dividend.

Yet, the longer-term matters far less for those looking to ride out the next 6 to 12 months. When worldwide stock markets are falling apart, HBI offers a combination of strong cash flows and low prices that are hard to beat.

Bottom line: HBI offers the lowest-risk “buy-the-dip” investment, followed by ETSY. DM is the highest risk of the three for its shaky financials, but offers the best potential returns.

The Value of Quant Investing

When I first started trading in my early 20s, I followed the same advice virtually every novice Wall Streeter heeds:

“Buy the dip.”

The old quip has been touted by everyone from Nathan Rothschild to Warren Buffett as a responsible way to invest in stocks.

Yet the data tells a different story.

As a group, lagging stocks tend to keep crashing. Low share prices can make it harder to raise capital, creating a “death spiral” of worsening growth and even lower stock prices. Social messaging boards are filled with stories of people jumping into loss makers like GameStop and getting served another helping of declines.

But a quant-based approach can help us avoid these duds.

By removing the worst cash-flow companies from the lowest momentum quintile of H2 2021 stocks (i.e., all companies earning less than 10% cash-flow-to-sales), returns improve from -38% to -17.6%. Cutting firms with high valuations of >10x EV/CFO from that group further increases returns to a positive 1.1%.

A chart showing how removing low CF and expensive stocks raises the YTD return of 2021's underperforming stocks.

These insights can help investors gain handsomely. Once markets finally bottom out, these top “buy-the-dip” stocks quickly become the gas that powers portfolios to recovery.

To keep up with these market insights, make sure you subscribe to Tom Yeung’s Profit & Protection by clicking here.

And if you’ve already signed up, thanks! Stay tuned for the first issue coming on May 24.

On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.

Article printed from InvestorPlace Media, https://investorplace.com/2022/05/3-stocks-to-buy-the-dip-now/.

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