3 Watchlist Stocks I May Soon Buy

Out of a handful of watchlist options, this author has chosen three stocks he could be readying to purchase.

May 4, 2014 at 10:05AM

I follow an inordinately large number of stocks -- some might say too many. However, that vast swath of stocks allows me to track a number of different industries, which usually leaves my portfolio nicely hedged during downturns and affords me plenty of chances to "hit a home run."

The market's march higher over the past five years has been pretty unrelenting, but that doesn't mean there aren't companies trading well off their highs that don't have my attention. Let's be clear: I address companies I've been keeping my eye on each and every week, but it's not every day that I consider pulling the trigger in my personal portfolio.

The following three stocks currently have my full and undivided attention. Soon, they may also have my investing money.

American Eagle Outfitters (NYSE:AEO)
American Eagle Outfitters is a teen retailer that's been throwing up caution flags with investors for about a year. In January, the company's CEO, Robert Hanson, stepped down, and American Eagle has issued a bevy of downside guidance since the back-to-school season noting weaker consumer buying habits and even blaming the weather.

American Eagle Outfitters' latest quarterly report delivered an adjusted drop in profits of 51% while comparable-store sales -- an important measure of organic growth that excludes newly opened stores and closed stores -- fell 7% year over year. Furthermore, with the polar vortex putting a chill on retailers throughout much of the first two months of the year American Eagle issued first-quarter guidance that would include a "high single-digit decline in comparable sales." 


As for me, I'm digging the company here and I'm always surprised by the short-term memory of investors when it comes to teen retailers. This is a cyclical business that's prone to its ups and down that you buy when no one wants it (as we're seeing now), and you sell when nothing can go wrong.

American Eagle Outfitters remains my favorite retailer because it perfectly hits two important factors for its target teen audience and their parents. First, many of its products are branded or emblazoned with the AE logo, making them an instant hit with most teens. Branded merchandise presents the image of owning something exclusive and expensive while allowing consumers to emotionally connect with the brand. But here's the key second point, American Eagle is able to do this at a reasonable price. On the flipside, American Eagle's peers either lack the branding power, or they price a number of consumers out of the market.

American Eagle Outfitters has also historically outperformed its peers when it comes to inventory management. Like I said earlier, periods of weakness will occur, as we're witnessing now, but AE is particularly efficient at discounting and ridding itself of unwanted merchandise quickly. The end result is that it's often one of the first teen retailers to break out of a slump.

American Eagle is cash-rich ($428.9 million in cash), without any debt, profitable, and is currently paying a dividend that's yielding greater than 4%. Needless to say, I'm getting ready to sign on the dotted line.

Arcos Dorados (NYSE:ARCO)
Arcos Dorados (English translation: Golden Arches) is the largest Latin and South American franchisee of McDonald's (NYSE:MCD) restaurants.


Source: McDonald's.

If you have a preconceived notion of what McDonald's is like in the U.S., get it out of your head right now, because it's a completely different experience in Latin America, where a trip to McDonald's is a family outing and sometimes considered a luxury. That so-called luxury has delivered some erratic growth over the past year, with costs increasing for Arcos Dorados across the board.

In its 2013 filing, Arcos Dorados delivered a better than 5% increase in net revenue to just over $4 billion, but operating costs spiked 7%, more than cancelling out its sales gains. To add, the negative effect from currency translation more than doubled year over year to $38.8 million. Like American Eagle, the end result was a disappointing $0.26 in full-year EPS compared to $0.55 in the previous year.

But, rather than abandon Arcos Dorados as its employee and food costs rise, I believe investors should instead focus on the long-term and a number of other positive factors inherent in Arcos Dorados' results.

For one, comparable-store sales growth has been impressive each and every year despite the challenges it's experienced with negative currency translation. The 6.2% comparable-store sales growth in 2013 was a sizable jump from the 3.6% growth reported in 2012, and the results showed a return to growth in Brazil, its most important geographic region, where same-store sales rose 3%.

Another factor to consider is that McDonald's is one of the most recognizable brands in the world. According to brand research specialist Interbrand McDonald's ranked as the seventh most valuable global brand in 2013. What this means for investors is that Arcos Dorados needs to do very little advertising and marketing -- the brand sells itself because billions of people around the world recognize the Golden Arches.  

Finally, consider for a moment that with Arcos Dorados you're gaining exposure to the best of both worlds: the power of a recognized brand name, and the growth potential of emerging-market countries. Understand that while growth overseas can be erratic, and investors can sometimes overreact to this erratic growth, that over the long run these emerging markets can vastly outgrow the already saturated U.S. markets.

Add on the fact that Arcos Dorados also paid out $0.24 per share in dividends last year (equaling a current yield of 2.6%) and is valued at a mere 16 times forward earnings, and you have all the reasons I need to be extremely intrigued at this price.

Oplink Communications (NASDAQ:OPLK)
Last, but not least, we have Oplink Communications, a designer and developer of optical networking components and subsystems that was hammered last week after the company issued dismal fourth-quarter guidance.

For the third quarter, Oplink reported an 8% increase in revenue to $48.1 million, but shareholders saw its adjusted profits shrink down to just $0.01 from per share from $0.12 in the year prior period. The wheels really fell off the wagon with its Q4 guidance, which called for revenue of $48 million-$52 million on adjusted EPS of $0.05-$0.11. By comparison, Wall Street was looking for $52.9 million in revenue and a more robust profit of $0.17 per share. Oplink admitted there was softness in its optical orders, but didn't really elaborate much beyond that.

The earnings dip was a clear reason for investors to be unnerved, but selling now simply wouldn't make a lick of sense, at least in my opinion.

Perhaps the biggest reason for my optimism is the next major catalyst for Oplink is right around the corner. According to its third-quarter press release, the company's non-pairing, group parallel platform-in-a-box, covering security, safety, care, video, and home automation, is scheduled to ship in July. Oplink hasn't shared much in the way of distribution channels for this product, but I'd suspect it'll be available in normal retail settings, where it currently has distribution partnerships such as Fry's Electronics and Amazon.com, for example.

There's also an ongoing surge in telecom infrastructure spending, which should benefit Oplink over the long haul. Many of Oplink's peers demonstrated weak results this past quarter, but their long-term future looks bright, as the billions in spending from the nation's telecom companies begins trickling down the pipeline.

Finally, Oplink is financially better positioned than many of its peers. Despite increased investments in R&D tied to its July product launch, it ended the quarter with $151.6 million in cash and zero debt. This works out to just shy of $8 per share in cash, meaning investors are currently only valuing its profitable business at a mere $6.50 per share.

Currently I own Oplink in an account I manage, but I may be ready to take the plunge and purchase shares for my personal portfolio.

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Sean Williams owns shares of Oplink Communications in a portfolio he manages, but has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool owns shares of, and recommends Amazon.com and McDonald's. It also owns shares of Arcos Dorados. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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