The stock market is the most effective wealth-creation tool the world has ever known. But finding the best stocks is easier said than done.
To that end, one way to generate market-beating returns is to look where others aren't. So we asked three top Motley Fool investors to each pick a stock that they believe Wall Street is overlooking today. Read on to learn why they chose iRobot (IRBT +0.00%), Healthcare Services Group (HCSG +3.99%), and Scotts Miracle-Gro (SMG +4.54%).
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Shunning near-term profits for long-term growth
Steve Symington (iRobot): Increased competition in the robotic vacuum space has Wall Street giving iRobot the cold shoulder. Shares of iRobot are trading 40% below their 52-week high as of this writing, including a more than 30% single-day plunge last month after the company offered mixed financial guidance for the coming year relative to expectations.
More specifically, iRobot told investors to expect revenue in fiscal 2018 in the range of $1.05 billion to $1.08 billion, good for growth of 19% to 22% and above estimates for $1.02 billion. But it also predicted its earnings would arrive in the range of $2.10 to $2.35 per share, below Wall Street's estimates for $2.70 per share.
At the time, iRobot chairman and CEO Colin Angle explained that, "with the market accelerating in its growth and competitive pressure coming into the markets, we made a choice to double down on ensuring we had adequate dry powder to drive that top-line growth."
Angle also believes that the consumer robotics industry is in the early stages of growth and the next three years will determine the "true winners" in the industry over the next decade. The vast majority of that near-term growth will come from iRobot's core Roomba robotic vacuum line, supplemented by its floor-mopping Braava bots. Later on, it should benefit from new market verticals, such as robotic lawn mowing.
That's not to say iRobot has fared badly in the face of intensifying competition so far. During an investor presentation earlier this month, iRobot revealed that Roomba still commanded a whopping 62% of the global robotic vacuum cleaner (RVC) market in terms of dollars sold last year, down modestly from 64% in 2016 despite the entry of dozens of new competitors.
Make no mistake: iRobot's market share will almost certainly continue to drift lower in the coming years. But it still should command the lion's share, given its first-mover advantage, and the overall growth of RVCs and new bots down the road should mean exceptional growth for years to come.
In short, I don't think investors should fear iRobot's decision to consciously forsake near-term profits in favor of longer-term growth. And I think its recent pullback offers a perfect opportunity to buy the stock.
This company proves that boring is beautiful
Brian Feroldi (Healthcare Services Group): While large consumer-facing companies tend to grab all the headlines, there are scores of great businesses out there that quietly deliver exceptional results for their shareholders. Take Healthcare Services Group as a prime example. This company provides housekeeping and nutritional services to healthcare facilities across the U.S. While its business is as boring as it comes, investors who have held onto this company for the long term have walloped the S&P 500.
SPY Total Return Price data by YCharts.
How has the company pulled this off? The answer is that Healthcare Services Group has a knack for consistently bringing new customers into the fold while simultaneously selling more services to existing ones. That's a simple, but powerful, combination.
In recent years, the company's growth has been driven by the company's dining and nutrition services business. This division grew by 60% last quarter and helped the company post overall revenue growth of 26%.
Looking ahead, I think that the company's profits are poised for double-digit growth from here on the back of margin improvements, a lowered tax rate, and continued growth in the nutritional services business. That's an attractive proposition for a company that's trading at 23 times forward earnings and comes with a 1.8% dividend yield that consumes less than two-thirds of profits.
A gross overreaction
Maxx Chatsko (Scotts Miracle-Gro): Consumer gardening leader Scotts Miracle-Gro just can't seem to catch a break from Mr. Market this year. After the company announced a slower-than-expected start to its fiscal 2018 and revised growth estimates downward, Wall Street didn't waste any time sending the stock sharply lower. Shares have dropped even further since then and have lost over 20% of their value since the beginning of the year.
On one hand, lowered guidance should be a red flag to investors. On the other hand, a healthy dose of nuance is needed.
Scotts Miracle-Gro revised its full-year fiscal 2018 revenue-growth expectations to a range of 2% to 4%, down from the previous range of 4% to 6% after its high-growth hydroponics subsidiary encountered headwinds that lingered a few months longer than anticipated. But management didn't touch its earnings per share (EPS) guidance. Furthermore, the headwinds appear to be short-term concerns (see "months").
None of that matters much to Wall Street, which has continued to overlook Scotts Miracle-Gro stock. Part of that is the fault of analysts, who focused a bit too much on labeling the company as a "marijuana stock." Since slower growth from the hydroponics subsidiary disrupts that narrative, it's easier to blame the company for its own broken spreadsheet models. Makes sense.
Long-term investors don't have to be straddled with the same insecurities. Scotts Miracle-Gro shares now trade at just 16 times forward earnings -- below the 10-year average price-to-earnings ratio -- and boast a 2.5% dividend yield. Plus, with so much focus on the hydroponics unit, I wouldn't be surprised if the core consumer-products segment reminds investors that the business is far from a one-trick pony. After all, the segment has grown operating income nearly 20% from fiscal 2015 to fiscal 2017, with relatively stable revenue, thanks to doubling down on the strongest brands and strategic investments.
Long story short, Wall Street may be overlooking Scotts Miracle-Gro stock, but you don't have to.
The bottom line
We can't absolutely guarantee that these three stocks will achieve outsized returns for investors going forward. But when we consider the steady, under-the-radar business employed by Healthcare Services Group, as well as the underlying reasons for the negative reactions to recent guidance from both iRobot and Scotts Miracle-Gro, we think the chances are high that they'll each crush the market going forward. And investors who are willing to buy now stand to be handsomely rewarded if we're right.
