Carefully selecting stocks that are backed by strong fundamentals and trade at low multiples is a strategy that has produced market-beating returns for many investors. But sometimes, looks are deceiving, and what could be perceived as a lofty valuation takes into account their growth potential.
We assembled a team of three Motley Fool investors and asked each member to profile a stock that they believe will deliver bang for your buck -- despite potentially looking expensive at first glance. Read on to learn why they think Shutterfly (NASDAQ:SFLY), AutoZone (NYSE:AZO), and Activision Blizzard (NASDAQ:ATVI) fit the bill and deserve your attention.
A picture-perfect opportunity
Rich Duprey (Shutterfly): Digital photo specialist Shutterfly is in the midst of a restructuring that it announced in the first quarter. In a bid to simplify its business, the company is shedding brands that haven't performed well like TripPix and FavePix in order to focus more on the profitable and cost-effective ones, like its eponymous brand. Additionally, other services such as Wedding Paper Divas are being consolidated under a new Shutterfly branded service, Shutterfly Wedding, and all of its consumer brands will be brought together on a single platform.
It's also engaged in some major cost-cutting initiatives, like getting rid of 13% of its workforce. While it's best known for consumer-facing services, Shutterfly has a small but growing business division called Shutterfly Business Solutions that enjoyed near-20% growth in the first quarter, to $31 million. It also has an effective though much smaller business-facing division that saw revenue jump 19% in the first quarter, outpacing the 3% gains in the consumer business.
Because Shutterfly's business is heavily weighted around the fourth quarter, it often posts losses at other times of the year, which gives it a seemingly ridiculous market multiple of more than 700%. Yet analysts anticipate Shutterfly will be able to grow its earnings 32% annually for the next five years, well ahead of the meager 2.3% growth it's averaged over the last five. Moreover, Shutterfly trades at just seven times its free cash flow, making it a picture-perfect candidate for a stock that looks expensive on the surface, but is really cheap once you begin to dig down into the business.
A high-priced bet on car care
Dan Caplinger (AutoZone): It's easy to get confused about the value of a stock, and many people focus far too much on the value of a single share. AutoZone has a high share price of more than $500, and that makes many investors shy away. Yet with fewer than 30 million shares outstanding, AutoZone's total market capitalization is only about $14 billion, giving the auto-parts retailer plenty of room for future growth.
More importantly, AutoZone has the earnings power to back up its high share price. Over the past 12 months, AutoZone has earned more than $43 per share. That gives the stock a trailing earnings multiple of less than 12, far below the overall market average.
Investors are nervous that AutoZone could be a value trap, and that has sent the stock down from as much as $800 per share since late last year. Yet the company said that late-issued tax refunds were responsible for some of the shortfall in its most recent earnings report. If that's the case, then those lost sales should show up when it next reports financial results. AutoZone faces some headwinds, such as the rise of internet-based competition and technological changes to vehicle production. At its current valuation, however, AutoZone offers a margin of safety even if earnings slide going forward.
Far from "game over"
Keith Noonan (Activision Blizzard): With a forward price-to-earnings ratio of roughly 30, Activision Blizzard might not look cheap. But the stock still has room to run, and I think that investors who buy at current prices will see great returns over the long term.
Activision's potential to benefit as video game enthusiasts increasingly spend money on virtual content and buy titles digitally, rather through brick-and-mortar middlemen like GameStop (NYSE:GME), has been pretty well-documented. But the company's recently launched consumer-products division is a growth avenue that doesn't seem to be getting as much attention as it deserves.
With hit franchises including Overwatch, World of Warcraft, Destiny, and Call of Duty, Activision has a stable of potent entertainment properties that are ripe for merchandise sales. This is a high-margin business opportunity that has limited risks and more predictable production cycles compared to video game development, and delivering high-quality merchandise even has the potential to strengthen the appeal of the underlying properties.
The company is also making the push into original television and film production, a move that carries bigger risks than its merchandising initiatives -- but one that also ties in with its consumer-products business and could open up big growth down the line.
Analysts expect Activision Blizzard to increase earnings roughly 18% annually over the next five years, which already recasts what might be seen as an expensive price-to-earnings multiple, and its emerging growth avenues suggest the stock still has big potential.
Dan Caplinger has no position in any of the stocks mentioned. Keith Noonan owns shares of Activision Blizzard. Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Activision Blizzard. The Motley Fool owns shares of GameStop and has the following options: short July 2017 $24 calls on GameStop. The Motley Fool recommends AutoZone. The Motley Fool has a disclosure policy.