One way we Fools get an edge in the market is to buy great companies Wall Street hasn't yet discovered. So, which under-the-radar stocks have captured our attention? We asked a team of investors to weigh in, and they highlighted Subaru Corporation (OTC:FUJHY), Axon Enterprise (NASDAQ:AAXN), and AppFolio (NASDAQ:APPF).
You know the products, but not the stock
John Rosevear (Subaru Corporation): Everyone has heard of Subaru, but until recently it seemed that nobody in the U.S. ever thought of the stock. That's because, for years, Subaru's corporate parent was known by an unfamiliar name: Fuji Heavy Industries.
The name changed earlier this year, but it seems investors (in the U.S., at least) have yet to take notice. That's too bad: Here's a company with great products in white-hot market segments, a much-loved brand, and a management team that takes a careful, just-right approach to spending.
Unless you've been living under a rock, you've probably noticed that car-based "crossover" SUVs are all the rage. That's a market category that Subaru practically invented, and through October its U.S. sales are up 6.4% from last year's record levels.
Subaru is a small automaker compared to just about any other car company you can think of, but it's no slouch on the tech front. Its suite of advanced driver-assistance technologies, called EyeSight, is as good as anything being offered in the mass market. And its longtime alliance with giant Toyota, which owns 16.82% of Subaru), should give it a leg up on more advanced technologies (like self-driving systems) as they become available.
Careful management has kept Subaru's costs down, which has given it great margins. In the first half of Subaru's fiscal 2018 (April through September 2017), Subaru brought in 212.1 billion yen on 1.686 trillion yen in revenue, for an operating margin of 12.6%. That's huge for an automaker: Compare to General Motors at 7.5% last quarter, or 9.8% for BMW.
Subaru pays a solid dividend, yielding around 3.9% at current prices. There's a growth opportunity, too. Subaru's sales stand to grow significantly over time as Subaru ramps up its still-small presence in crossover-mad China, and as it expands its product line: A new large SUV is expected next year.
For whatever reason, Subaru hasn't yet made it onto most U.S. investors' radar. You might do well by taking advantage before that changes.
A booming law-enforcement stock
Travis Hoium (Axon Enterprise): It's surprising to me that Wall Street isn't more excited about Axon Enterprise, the industry leader in Tasers and body cameras for law enforcement. The company is in a high-growth market, generates strong margins, and has multiyear contracts to sell hardware and services to customers. All of those are ideal for growth investors, yet Axon's stock has been stuck in a rut for the past three years:
The revenue growth you see above is what I think is most impressive. Axon has built a dominant position in the booming body-camera industry and has built a model that should pay dividends for years to come. Most customers sign multiyear contracts to buy cameras and Axon's cloud service at Evidence.com, which will drive growth for years. At the end of the third quarter, Axon had $494.2 million in future revenue already contracted, most of which was for products related to body cameras.
What could be dragging on the stock is the lack of profitability, which you can see above. But this is a short-term phenomenon as management invests in sales, research, and development to grow the business. As the business grows, these should become smaller and smaller percentages of revenue, which will drive net income higher.
I think a company like Axon, that is able to help make law enforcement safer, more effective, and more efficient, has a bright future. Wall Street doesn't seem to see that opportunity yet.
A niche software provider
Brian Feroldi (AppFolio): Nearly every business has become reliant on some type of software product to compete effectively in today's market. While plenty of large software companies attempt to meet this demand, their solutions don't always match up with the needs of businesses in niche markets. That's a market opportunity that small software companies try to fill. One of them that I've become quite fond of is AppFolio.
AppFolio is a software-as-a-service business that primarily focuses on the needs of property managers. Customers have been signing on to AppFolio's platform in droves to get help with tasks like tenant screening, billing, payment processing, website hosting, and more. In exchange, customers pay AppFolio a recurring subscription fee and a usage fee each time they use one of the company's more-advanced services.
A look at AppFolio's results shows that its niche-market focus is working. Revenue grew more than 34% in the most recent quarter thanks to double-digit customer growth and higher billings for its usage-based offerings. What's more, AppFolio has grown large enough to reach profitability, so the company is in terrific financial shape.
AppFolio's growth plan is to sign up more customers, roll out more services, and find new niche markets to service. If this strategy continues to deliver strong financial results, it probably won't be long before Wall Street starts to take notice.