"Cheap" is a relative term on the stock market, particularly given that indexes are up over 200% in the past decade. But even a broad rally like that can leave many stocks undervalued relative to their peers and to their long-term growth potential.
Below, we'll look at three such investments. Read on to find out why Motley Fool contributors see room for big gains ahead for AutoNation (AN 1.49%), Carnival Cruise Lines (CCL -3.45%), and Skechers (SKX 0.36%).
A misunderstood retailer
Daniel Miller (AutoNation): As is often the case, a stock trading at an absurdly cheap valuation has plenty of pessimism surrounding its business: AutoNation. To be fair, investors are shying away from owning shares of the largest automotive dealership group in America at a time when new-vehicle sales are plateauing after years of growth, and that makes sense. However, if you have a long-term mindset and buy into Buffett's mantra of buying when others are fearful, AutoNation could be a long-term winner and is currently trading at a paltry 9x price-to-earnings ratio.
If you're still nervous about owning shares of AutoNation amid peak sales cycle, let's dive into what makes AutoNation more than just a vehicle retailer. Let's use the first-quarter data for this example: Roughly 50% of first-quarter revenue was generated by sales of new vehicles, with another 26% generated by sales of used vehicles. Seventeen percent of first-quarter revenue was generated by parts and service, with the remaining revenue coming from finance and insurance, and other. With roughly 76% of revenue surely to feel the pressure from slowing sales, the good news is that its parts and service business actually keeps the lights on. Consider that parts and service, with only 17% of first-quarter revenue, accounted for 47% of the company's gross profit. Finance and insurance generated nearly 28% of gross profit, while sales of new and used vehicles generated 14% and almost 11%, respectively.
AutoNation's parts and service gross profit machine is what enabled first-quarter earnings per share to hit a record at a time when same-store sales declined 5% and total revenue dropped 5.3%. Long-term investors can bank on the company's bottom line being more resilient thanks to its parts and service business, but the company will have to adapt in the coming years. One sign of it adapting is the company's agreement with Alphabet's self-driving company, Waymo, to service its autonomous vehicles. Sure, servicing driverless vehicles is nowhere near being a financial driving force for AutoNation, but it's important that management figures out its future revenue streams now.
Many are fearful of owning an auto retailer currently, and that's fair, but its bottom line is safer than many understand, and at a price-to-earnings ratio of 9x, savvy long-term investors could scoop up a winner for cheap.
Set sail for profits
Demitri Kalogeropoulos (Carnival): Their stocks normally move in concert with each other, but recently Carnival shares have dramatically underperformed Royal Caribbean's, setting up a potential buy opportunity for investors interested in the cruise vacation industry.
Just like its smaller peer, Carnival in 2018 closed out another fiscal year of record ticket sales, record profits, and improving returns on invested capital. But investors instead chose to focus on the fact that revenue growth is moderating right now, with core sales on pace to rise by about 1% compared to 4% last year and 3% in 2017. Royal Caribbean sees faster growth ahead, and investors have responded to that outlook gap by valuing Carnival shares at less than 12 times earnings compared to Royal Caribbean's P/E of 14. Both companies' valuations are at multiyear lows.
Years of healthy demand and rising efficiency have boosted cash flow so that Carnival has plenty of capital it can put toward adding new ships to its fleet, and 17 vessels are currently in the pipeline, equating to capacity growth of around 5% between now and 2020. Royal Caribbean's latest results also point to other attractive areas of investment, like proprietary shore outings and experiences. With a few avenues available to boost sales, then, there's every reason to like Carnival stock today even more, since shares are 20% below the 2018 highs.
Shoes, China, and tariffs
Nicholas Rossolillo (Skechers): Investors in the chunky sneaker maker haven't had a particularly good time the last few years. Though Skechers continues to grow at a double-digit clip internationally, domestic sales have been volatile. Plus, overseas expansion costs money, which has kept earnings in check. The stock has been a wild up-and-down ride resulting in a negative 5% return over the last trailing three-year stretch.
The latest round of volatility has to do with the trade spat between the U.S. and China. The Asian economic juggernaut has been a strong growth catalyst for Skechers the last few years, not to mention a primary manufacturing location. Thus, the threat of higher tariffs (which equates to higher prices on shoes) and an escalating dispute between the two countries spells uncertainty for the company's global enterprise.
Nevertheless, Skechers is still growing, and a new international sales driver could be emerging in India. Sales are also expected to rebound in the U.S. throughout this year after a disappointing first quarter of 2019; and even though total revenues were up a paltry 2.1%, earnings from operations were up 11.5% during the period.
As of this writing, Skechers stock is priced at just 12.5 times trailing 12-month free cash flow, and expected one-year forward price to earnings is 12.2. For a company that still has plenty left in the tank -- especially outside the U.S. in fast-growing emerging markets -- that looks like a pretty cheap price to pay.