This article is excerpted from Tom Yeung’s Profit & Protection newsletter. To make sure you don’t miss any of Tom’s picks, subscribe to his mailing list here.
Over the past month, we’ve covered the essential aspects of the Profit & Protection investment system.
But here’s the twist:
The system doesn’t necessarily pick obvious companies.
As we saw in previous letters, some commonly held standards like “high operating margins,” “low P/E ratios,” and “fast past growth” are actually negative indicators for future stock growth.
Instead, data from the past decade suggests investors are statistically more likely to outperform by buying turnarounds, ultra-low price-to-sales companies, high-growth stocks and those with extreme momentum in any direction.
Put another way, struggling Bed Bath & Beyond (NASDAQ:BBBY) is more likely to come out ahead of blue-chip energy firm Kinder Morgan (NYSE:KMI) once the dust settles from Jerome Powell’s rate increases.
Today, we’ll consider five companies set to do even better.
The Five Top Stocks to Buy for 2022
To simplify the Profit & Protection playbook, the selection system grades companies on an “A/B/C/D” scale based off growth, quality, value and momentum. The final scores are then averaged and tallied.
Shoals Technologies Group (SHLS)
Growth: A+ | Value: A | Quality: A+ | Momentum: A+
Overall Grade: A+
From a quant-only standpoint, it’s easy to see why this solar play makes it to the top of the Profit & Protection stock-picking system. Profits and growth are both stunningly high for this supplier of electrical balance of system (EBOS) products and its share price has wind in its sails.
Shoals (NASDAQ:SHLS) is a key player in the solar value chain. Its EBOS products carry electrical currents from panels to inverters — a component with a high cost of failure. And its BLA (Big Lead Assembly) harness introduced in 2017 has been a game-changer for the firm — its “plug and play” system now makes solar panel almost as easy as installing a toaster (i.e., no electrician required).
The firm also enjoys significant political tailwinds. Earlier this month, the White House signed a bill that would declare a 24-month tariff exemption for imported solar panels. SHLS has already risen 20% on the news.
The quant-only Profit & Protection system does, however, miss some details. Shoals has historically focused on the EPC (engineering, procurement and construction) segment — a faster-growing but far more price-sensitive group than developers. Shoals only recently started targeting more developers as customers, but there’s no guarantee that its current EPC customers will continue paying for higher-end EBOS systems.
Cheaper imports could also spoil the market. The U.S. photovoltaic (PV) industry has long accused the Chinese government of subsidizing Chinese firms; the tariff exemption could open the door for EBOS companies to compete.
Though Shoals is a game-changing company, make sure you join me tomorrow to see if its high quant-based scores are enough to put it on the core Profit & Protection buy list.
BJ’s Wholesale Club (BJ)
Growth: A- | Value: A+ | Quality: A+ | Momentum: A+
Overall Grade: A+
BJ’s Wholesale Club (NYSE:BJ) has quietly become one of the cheapest high-quality retailers on the market. The firm eclipses both Walmart (NYSE:WMT) and Target’s (NYSE:TGT) ROIC with a 23.7% ratio and is cheaper than both by price-to-sales ratios.
Unfortunately, BJ’s suffers from the “middle-child” syndrome. Its ROIC isn’t as high as Costco’s 39%, nor is it a turnaround case like GameStop (NYSE:GME) or other struggling brick-and-mortar retailers. Analysts expect BJ’s to grow sales by 10% this year and for net income to expand another 25% by 2025 — a score only good enough to warrant an “A-” grade for growth.
Yet the company’s other scores are more than enough to push it into the top 5 of the Profit & Protection screener. Analysts expect return on equity to remain above 30% through 2025 and for the firm to keep adding another 10 to 12 stores per year.
Momentum is also working in the company’s favor. The stock’s 30% price rise over the past 12-months reflects a return to coupon-clipping by cash-strapped consumers. And the company’s willingness to drop membership fees in exchange for growth shows a willingness to ride out the market cycle with longer-term thinking.
RealReal Inc (REAL)
Growth: A+ | Value: A+ | Quality: A- | Momentum: A+
Overall Grade: A
If you’ve ever wondered how to buy a used Gucci handbag without risking thousands of dollars on Craigslist, the RealReal (NASDAQ:REAL) is your answer.
The e-commerce firm has quietly become the world’s largest online marketplace for authenticated luxury goods. The company manages a network of consignors who collect used luxury items for the RealReal to authenticate, photograph, price and sell to consumers.
The formula has worked wonders. Gross merchandise value rose 50% in 2021 and analysts expect another 26% growth in 2022.
RealReal also scores high in “quality” for its turnaround potential. The firm has lost money over the past-3 years, making its slow march to profitability look like a turnaround in the eyes of the quant-based system.
Finally, its negative momentum makes for an attractive “buy-the-dip” play. REAL has lost 75% of its value this year, pricing the firm at a stunningly low 0.44x forward price-to-sales (P/S) ratio for an online business. Wall Street analysts have a $9.67 price target on the firm, or a 3.2x upside.
For investors seeking a little more risk, the RealReal offers the potential for significant gains.
Growth: A+ | Value: A+ | Quality: A- | Momentum: B
Overall Grade: A+
High-growth Wayfair (NYSE:W) should land squarely on any tech investor’s list. Its 18% revenue growth rate and 43% EPS rise puts it in the top 5% of all companies by those metrics.
Those who follow the traditional ecommerce space will already know why. The online home goods market is highly fragmented; even Amazon (NASDAQ:AMZN) has struggled to gain a dominant market share.
That’s given Wayfair the opportunity to expand. Between 2013 through 2020, the Boston-based firm grew an average of 49% per year — a third faster than Amazon between 2000 and 2007.
Wayfair also operates an inventory-light model — a tactic that reduces the amount of capital required upfront and raises ROIC to unnaturally high levels (If Wayfair were a goose that laid a golden egg, an asset-light model means its suppliers are the ones paying for the next goose!)
Though its 71% year-to-date slide is too negative for a positive momentum score, Wayfair makes it into the top 5 thanks to its other outstanding elements.
2Seventy Bio (TSVT)
Growth: A+ | Value: A+ | Quality: B- | Momentum: A+
Overall Grade: A+
Finally, biotech firm 2Seventy Bio (NASDAQ:TSVT) offers investors a chance to buy into a “turnaround” stock.
From a traditionalist standpoint, TSVT looks risky at best. Operating losses widened by 126% to $314 million in 2021, tearing a hole through the company’s balance sheet; only its well-timed IPO saved 2Seventy Bio from a worse fate.
Shares have also performed miserably. Since its November split from parent Bluebird Bio (NASDAQ:BLUE), TSVT has fallen almost 70% as investors reconsidered their bets on risky, money-losing ventures.
But these figures also point to the potential for a massive turnaround.
2Seventy is growing, fast. The company owns the rights to Abecma, a gene therapy approved last year for cancer treatment that’s gaining traction among oncology doctors. In clinical trials, almost three-quarters of patients responded to the treatment for multiple myeloma, and a quarter shed all signs of the disease.
Demand for the treatment has since boomed. Analysts believe revenues will rise 55% in 2023 and 52% in 2024; 2Seventy has since ended the development of a competing CAR-T therapy.
The company’s partnership with Bristol Myers Squibb (NYSE:BMY) helps keeps overhead costs under control. Marketing and development costs fall to its more significant partner, while developing new gene therapy drugs — a more controllable aspect — is kept with 2Seventy.
Few biotech R&D companies have the fortune of having a revenue-producing drug to fund more research. And that’s what gives 2Seventy Bio such a substantial Profit & Protection score.
Quantitative Plus Qualitative
The quant-based Profit & Protection system gives us a phenomenal head start. If we bought all five picks from today, there’s a good chance we’ll outperform the market by 15% to 20% per year.
But what if we want to do better?
That’s where a qualitative system comes in — the process of choosing the top 1-2 of the list based on our insights.
Sometimes, these hidden trends are easy to unearth. Climate change has sent solar stocks into overdrive, while a shift to ecommerce has made companies like Wayfair winners.
Other times, some phone calls go a long way.
I regularly confer with researchers to understand the latest findings in cancer research (this is publicly available information, and I never ask about a specific company’s drugs).
These insights are what hedge funds have long called “having an edge.” And that’s why high-scoring Profit & Protection stocks will always have a second round of consideration before getting added to the core list.
P.S. Do you want to hear more about cryptocurrencies? Penny stocks? Options? Leave me a note at email@example.com or connect with me on LinkedIn and let me know what you’d like to see.
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.