It pays for investors to always be skeptical. They should be skeptical when investors back up the truck on the latest growth stock, and be equally skeptical when they dump the market's most hated stocks.
Warren Buffett told investors to always "be fearful when others are greedy, and greedy when others are fearful." One sector that has recently been crushed by fear is retail, where companies are being crushed by e-tailers and sluggish brick-and-mortar traffic.
But amid that rubble, there are three hated stocks that could be great contrarian plays -- American Eagle Outfitters (AEO 1.15%), GameStop (GME -0.55%), and JC Penney (JCPN.Q).
Source: Getty.
American Eagle Outfitters
American Eagle Outfitters is often lumped together with other struggling mall-based retailers like Abercrombie & Fitch and Gap. AEO certainly faces similar headwinds -- e-tailers, fast fashion rivals, and declining mall traffic have all throttled its growth in recent quarters.
However, AEO's growth figures aren't that bad. Its comps rose 2% last quarter, compared to 6% growth a year ago. Comps at American Eagle dipped 1%, but that was offset by 25% comps growth at its Aerie lingerie and activewear brand. Analysts expect AEO's revenue to rise 2% this year, but its earnings are expected to fall 13% on steeper discounts.
That trend is worrisome, but the growth of Aerie, new denim products, and a renewed focus on its struggling menswear business could get its growth back on track. Additional store closings and buybacks should lift its earnings, which are expected to rebound with 3% growth next year. AEO trades at just 11 times earnings (versus the industry average of 21 for apparel retailers), it pays a forward yield of 4.2%, and it has no debt -- making it an undervalued income play for patient investors.
GameStop
GameStop is often called the "next Blockbuster" due to the notion that its sales of physical video games will be rendered obsolete by digital downloads. That thesis has merit, but only 51% of GameStop's revenue came from sales of new and pre-owned software last quarter.
The rest came from sales of video game hardware, collectibles, consumer electronics, and other products that can't be killed by digital distribution platforms. GameStop is investing more heavily in these businesses, with exclusive in-store collectibles, VR demos, and sales of retro consoles. It also offers its own digital downloads and self-published games.
Amazon (AMZN -2.40%) recently partnered with GameStop to allow customers to trade-in games for AmazonCash -- which could bring customers back to its stores. The popularity of the Nintendo Switch, which uses cartridges, could also lift its store traffic again.
Source: GameStop.
As a result, GameStop's future isn't that bleak. Analysts expect its revenue to rise 1% this year, but for its earnings to dip 12% on lower game sales. But as it pivots its business, its decline could bottom out with 1% growth next year. GameStop still hasn't proven that turnaround can work, but it trades at just six times earnings with a sustainable forward yield of 7.2% -- so it could be a good contrarian play.
JC Penney
The bears often compare JC Penney to Sears Holdings (SHLDQ). But I think that comparison is unfair -- JC Penney is implementing numerous turnaround strategies, while Sears is mostly treading water by closing stores.
On the surface, JC Penney's numbers look weak -- its revenue rose 3% in fiscal 2015, but fell 1% in 2016. Comps growth remained flat last year. Wall Street is expecting top line declines for both 2017 and 2018. On the bright side, JC Penney posted its a full-year profit in 2016, thanks to cost-cutting and streamlining strategies, and its earnings should stay in the black for the next two years.
JC Penney plans to boost sales by expanding its home improvement and athletic apparel departments, offering more plus-size apparel, and upgrading its website and analytics capabilities. It also added toy shops, unveiled a B2B program for selling furnishings to hotels, and expanded its Sephora in-store locations. This scattershot strategy might widen its moat against Amazon, but it remains an uphill battle.
Nonetheless, JC Penney looks very cheap at 0.1 times sales and 19 times forward earnings. If the retailer can stop its bleeding, as Wall Street's forecasts suggest, it could be an impressive comeback play.
Should you buy these stocks today?
AEO, GameStop, and JC Penney are all contrarian plays that could fall further if they fail to execute their turnaround plans. I wouldn't recommend buying these stocks as core investments, but they could be good speculative bets that rebound over the next few years.
