Bear markets are the ideal time to go shopping for growth stocks. These are companies that are tapping into huge secular growth opportunities; buying their shares during a bear market allows you to get in at a deeply discounted price that you'll never see when everyone feels good about the economy.
With that said, here's why Adidas (ADDYY -0.28%) (ADDD.F 2.54%) and Five Below (FIVE -1.12%) are two hot retail stocks to buy before better news sends the market higher.
The Pharrell Williams 4D by Adidas. Image source: Adidas.
Adidas: The German sportswear maker is targeting share gains in the U.S.
The sports apparel market has been one of the hottest segments of the retail industry in recent years, which has led to big gains for investors in Nike (NKE -1.26%) and lululemon athletica (LULU 1.43%). But investors should also be aware of the opportunity in Nike's counterpart across the pond, German-based Adidas.
Collaborations with superstars are what drive sales in the footwear industry, and Adidas has one of the most popular styles with the Yeezy line in collaboration with music artist Kanye West.
For the 10-year period ending in 2019, Adidas stock gained 474%, nearly matching Nike's return. Adidas has been investing to gain share in seven key cities around the world -- London, Paris, Los Angeles, New York, Shanghai, and Tokyo -- as the company sees a long-term growth curve taking shape as more people urbanize around the world.
While Nike calls itself a brand "of China, for China," Adidas sees North America as its biggest growth opportunity. China could one day surpass North America as the largest sports market, but Adidas is growing faster on Nike's home turf. Last year, Adidas saw sales in North America climb 7% despite experiencing supply shortages. Nike sales were up 4% in North America for the nine-month period ending in February.
Adidas has also seen steady improvement in gross margin since 2015, as management executed on its "Creating the New" strategy. This called for increasing brand desirability by getting new styles to market faster, investing in key cities, and collaborating with celebrities, such as Pharrell Williams and Kanye West, to create new styles that grow the top line. Last year, the three-striped brand signed mega-popstar Beyonce to a deal to make an exclusive line of sneakers and apparel under the Ivy Park x Adidas label.
The COVID-19 outbreak will cause some disruption in the near term, but Adidas has a strong balance sheet, and it's returning cash to shareholders with dividends and share repurchases. Adidas paid out about 30% of its free cash flow in dividends in 2019, bringing the current dividend yield to 1.67%. That relatively low payout gives the company some wiggle room to maintain its dividend even if profits were to fall.
One thing to watch at Adidas is the strong momentum in e-commerce, where sales surged 34% last year. On Nike's recent earnings call, management credited its digital momentum for getting its China business back on track amid the pandemic. Adidas could follow a similar growth plan.
The market sell-off has brought the stock down to its lowest valuation in the last five years. The shares currently sell for 24.8 times free cash flow. Another popular valuation metric is enterprise value-to-EBIT (earnings before interest and taxes). On that basis, Adidas is much cheaper than Nike, trading at an EV/EBIT ratio of 12.7 compared to 21.5 for the swoosh.
Image source: Five Below.
Five Below: A high-growth brick-and-mortar store chain
Five Below has been proving for over a decade that unique concepts in the retail industry can still thrive in a digital economy. Before the recent market crash, the stock had risen by 382% from its IPO in 2012 through 2019. Sales have more than tripled since 2013, and earnings have grown even faster, as management executes on opening more stores in high-traffic locations and keeping costs down.
The company has temporarily closed its stores to deal with the COVID-19 outbreak, but management is still targeting an increase in store count to at least 2,500 stores over the long term, which is nearly triple its existing store count. That's why this is an ideal time to take advantage of the market's nearsightedness in these turbulent times and start adding some shares of Five Below to your nest egg.
Five Below sells most items, such as candy, toys, sports gear, and tech items, for no more than $5. As the company's scale has improved, management has started selling some items up to $10, which highlights the potential for the business to branch out to higher-value products over time to drive sales growth.
Fears of an economic slowdown has brought the stock's price-to-sales ratio down to the lowest level since Five Below first sold shares to the public in 2012. The balance sheet is clean, with plenty of cash and no debt. That financial fortitude, along with the store's focus on deeply discounted goods and a fun environment in which to shop, should allow Five Below to weather this downturn and keep growing once the economy recovers, just as it did during the financial crisis in 2008.
