In spite of what seemed like insurmountable odds back in March and April, stocks have come roaring back this year. As measured by the S&P 500, the market is up about 7.5% to-date in 2020 -- even after a pullback headed into Election Day.
But that doesn't mean the run is over. Despite the earlier loss, 2020 looks like the start of a new bull market that could last for a few years, driven by accelerating technology trends. Five stocks I think are worth a serious look right now because of their potential to take advantage of these accelerating trends are Skechers (SKX -0.79%), Magnite (MGNI -2.08%), Teladoc Health (TDOC -1.52%), PayPal (PYPL 0.34%), and Arista Networks (ANET -4.32%).
Let's take a closer look at these five stocks and why you should consider investing in them before another market rally begins.
Image source: Getty Images.
1. Skechers: Not just cheap sneakers, but a fashionable and growing digital brand
First up is one of my favorite consumer goods stocks, Skechers. Shares have been on a wild ride for years as the company has spent heavily to promote growth overseas, but its progress was undone this year when COVID-19 emerged. The stock remains down 30% from all-time highs.
Given Skechers has yet to fully recover, this makes sense. But it is making good progress and is getting ignored by many investors. Third-quarter 2020 revenue was down just 4% from a year ago to $1.3 billion -- driven by a massive 78% rally in sales from the quarter prior, a 6% year-over-year increase in U.S. wholesale, and a 24% year-over-year increase in China. Net income of $64.3 million was down 38% from 2019 due to a one-time legal expense and higher warehousing and distribution costs, but the bottom line was nonetheless positive and will make a comeback as effects of the coronavirus lockdowns ease.
Skechers has transformed itself into a global everyday fashion essential, and its investment in digital channels around the world in recent years is only starting to pay off. E-commerce grew 172% in Q3 even as brick-and-mortar retail stores started to reopen. In a new digital era, this department will serve Skechers well and will eventually lead to higher profits as it reaches a more efficient scale. Shares trade for 45 times trailing 12-month free cash flow (revenue less cash operating and capital expenses) -- a metric inflated by the losses racked up back in the spring -- but this stock could be a real value looking a few years down the road.
2. Magnite: Connected TV and digital ads are the future
An acceleration in streaming TV and increased time in front of screens in general has been a boon for digital advertising platforms this year. In spite of a brief pause in activity in the spring, ads have come roaring back -- many of them in an online format. This has worked in sell-side ad platform Magnite's favor. Management said its connected TV revenues were up 50% year over year in July. A full Q3 update is coming on Nov. 9.
I'm optimistic. Magnite stock -- the product of a merger between former peers Telaria and The Rubicon Project -- is still down over 20% from all-time highs back in February. But if the company reports an acceleration in sales as is expected, there is room for further upside as 2020 grinds to a close. And in the course of the next decade, digital ads will continue to gobble up share of an industry worth hundreds of billions a year. With revenue of only $165 million over the last 12-month stretch, suffice to say there is ample room for this company to expand.
Granted, not all investors will be comfortable with this small stock. Over the last year, it's generated negative free cash flow of $16.7 million, much of that driven by the merger and effects from the pandemic. Nevertheless, Magnite is well-funded with $107 million in cash and equivalents on the books and no debt. And at just 4.1 times trailing 12-month sales, this tiny growth stock looks like a very reasonable long-term value.
3. Teladoc Health: An emerging leader for the future of healthcare
I'll admit healthcare investing is not my specialty. But a few years ago, I made an exception with Teladoc, then a little-known outfit trying to disrupt the status quo with virtually delivered care. Fast-forward to today, and Teladoc is in the driver's seat of the white-hot telemedicine industry.
Turns out shelter-in-place and social-distancing orders were all that was needed to get many consumers to give a virtual visit with a healthcare provider a try. Q3 2020 was a banner period for Teladoc, generating 109% year-over-year revenue growth to $289 million on the back of a 209% increase in patient visits to 2.8 million. Net loss was $35.9 million, but free cash flow is well into positive territory and at $58.8 million over the last 12 months.
Subsequent to the Q3 report, Teladoc completed its merger with fellow high-growth healthcare technologist Livongo Health. Together, the two companies form a health tech powerhouse currently valued at a $29 billion market cap. And for the final quarter of 2020, Teladoc-plus-Livongo expects to generate revenue of about $1.01 billion -- no less than an 82% increase from a year ago based on stand-alone Teladoc and Livongo results in 2019. Down 20% from all-time highs and trading for 18 times sales, I'm still buying this stock for the long haul.
4. PayPal: The intersection of digital payments, e-commerce, and fintech
PayPal has slowly been inserting itself into the role traditionally held by banks, but 2020 has accelerated uptake of the company's tools for consumers and merchants alike. Whether it's point-of-sale services or checking account-like digital wallets, PayPal has enjoyed a sharp increase in activity on its platform in the last few quarters.
In Q3 specifically, total transaction volume increased 38% from a year ago to $247 billion, leading to a 25% revenue increase to $5.46 billion. Mobile money movement and digital wallet subsidiary Venmo put in another strong showing, accounting for $44 billion worth of transaction volume all on its own -- a 61% increase from the same period in 2019.
Some investors were disappointed by the results, though, as previously surging free cash flow reversed course in Q3 to $479 million, down 48% from last year. The culprit? Investments in new growth initiatives at PayPal were weighted toward the second half of this year. But it's easy to forget that this large company is still prioritizing expansion; profits will rebound later. Nevertheless, free cash flow through the first nine months of the year was up 43% from 2019 and was good for a free cash flow margin of 26%. Not bad for a large fast-growing company that's finding plenty of new projects to spend money on, like touchless payments for physical stores and e-commerce rewards. Down 10% from all-time highs, and trading for 11 times sales and 45 times trailing 12-month free cash flow, there are still plenty of reasons to be bullish on PayPal stock.
5. Arista Networks: Renewed demand for data center construction on the way
To be fair, Arista Networks has already begun to rally after its Q3 report. The stock is up 17% since the last quarterly update, even though sales and free cash flow continue to tumble from last year's levels as many data center and networking hardware projects have been put on hold this year. However, shares are still down some 20% from all-time highs notched in early 2019.
But that is about to change. Arista said it expects a return to growth in Q4 (a 13% rise in revenue is anticipated), as well as a double-digit percentage increase in 2021 as capital investments among its customers pick up pace once again. Cloud titans could make up much of this surge in activity. In its last update, Facebook said it would be spending $21 billion to $23 billion in capital expenditures next year -- up from an anticipated $16 billion this year -- on data centers, servers, and other network infrastructure. If Facebook and other tech giants are gearing up for some upgrades, that bodes well for Arista and its portfolio of cloud computing and networking hardware and software.
But there's much more going in Arista's favor long term. Smaller organizations are also in need of some IT updates in the new digital era emerging from the COVID-19 crisis, and the company has built a compelling solution that encompasses networking gear as well as subscription software to help manage and secure it. It's also highly profitable, generating a nearly 40% free cash flow margin over the last year -- even in a cyclical downturn. At 23 times trailing 12-month free cash flow, Arista Networks looks like a real growth-at-a-value play right now.
