Value stocks have fallen out of fashion during the coronavirus pandemic.
Year to date, the Vanguard Value ETF, whose biggest holdings are Berkshire Hathaway, Johnson & Johnson, and Procter & Gamble, is down 5% through Nov. 20 compared to a 10% gain for the broad-based S&P 500 and a 32% gain in the tech-heavy Nasdaq. The stocks that have done best this year are those best equipped for the crisis, which tend to be tech stocks, especially those on the growth side in areas like e-commerce, cloud computing, and digital payments. Meanwhile, accommodative monetary policy from the Federal Reserve has also favored growth stocks as non-dividend payers are outperforming dividend payers.
However, mean reversion is one of the most powerful forces in the stock market, and the outperformance of the growth sector won't last forever. In fact, it's likely to end when the pandemic comes to a close. That explains why value stocks surged after Pfizer and BioNTech reported that its vaccine had an efficacy rate of more than 90% in Phase 3 trials earlier this month, and that trend is likely to continue as the march toward a fully accessible vaccine proceeds.
A ride through a winter wonderland
The recent spike in coronavirus cases across the U.S. means that this winter is going to be a socially distanced one. The summer saw a run on recreational vehicles as Americans sought socially distanced ways of going on summer vacation, lifting stocks like Camping World, Thor Industries, and Winnebago, and this winter could mean the same thing for recreational vehicles like snowmobiles, and ATVs (all-terrain vehicles) in warmer parts of the country. Americans who have money to spend and are looking for entertainment will have limited ways to spend it, and outdoor recreational vehicles look like an appealing choice. The company that looks most poised to capitalize on such a trend is Polaris, the market share leader in off-road vehicles in North America, and the #2 company in snowmobiles.
Polaris is already capitalizing on the demand shifts caused by the pandemic as the company saw adjusted profits nearly double in the third quarter on a 15% increase in North American retail sales. Management noted strong demand in the third quarter carrying over to the start of the fourth, and raised its adjusted earnings per share guidance for the year to $7.15 to $7.30. That gives the stock a price-to-earnings ratio of 13 based on that forecast, which looks like a bargain for a stock seeing rapid profit growth. Polaris shares are also down 10% year to date, showing upside potential. Even if the pandemic-driven gains are only temporary, management can plow those windfall profits into share buybacks that will further lift the stock's value.
A recession-proof rock star
Like recreational vehicles, another sector that has seen a pandemic-driven boom is auto parts. The industry is benefiting from a pair of tailwinds. First, used car sales have spiked during the crisis, as an aversion to public transportation and a shift away from cities and into suburbs has prompted a number of Americans to get their own set of wheels. Meanwhile, economic stress also tends to be a tailwind for retailers like Auto Zone as consumers choose to spend money repairing their current vehicles rather than purchasing new ones.
Auto Zone was a clear beneficiary of these trends as its comparable sales jumped 21.8% in its most recent quarter, driving a 37% jump in earnings per share. Auto parts retailers also seem to have benefited from government stimulus, but Auto Zone's sales remained strong even when the $600 weekly unemployment payments ended. Management said the recessionary climate favors the company going forward, as its sales have historically been strongest coming out of recessions like in 2009 to 2011 and 2001 to 2002. A car is a necessity, after all, for most Americans so making repairs isn't a choice, and vehicle miles will rebound as the economy reopens, prompting more repairs.
Auto Zone currently trades at a P/E of 15, less than half of the valuation of the S&P 500, and should have a few strong quarters ahead of it as the pandemic rages on and the economic slump continues. Despite that bright forecast, the stock is down 6% year to date.
A travel recovery play
Trivago may not look like a conventional value stock, but in this environment the definition needs to be flexible. Trivago is an online travel agency that specializes in hotels and accommodations, and has historically generated minimal profits. The stock is down 44% year to date, but Trivago isn't like other travel stocks that have high fixed costs, like airlines, hotels, and cruise lines, and therefore face structural challenges in the recovery. Most of its spending goes to marketing, and that can be easily dialed up and down, according to demand.
Trivago also made some changes during the crisis that should improve its performance when the economy normalizes, including a restructuring that cut costs in part by laying off staff and closing regional offices. Additionally, it made its ad-bidding model more friendly to advertisers, aligning its incentives with theirs, and added local search and discovery features, helping users who come to the site without a destination in mind. It's also vastly expanded its alternative accommodations listings in recent years for properties on sites like Airbnb and VRBO.
When the pandemic ends, there will likely be significant pent-up demand for travel, and business leaders like Uber CEO Dara Khosrowshahi, who previously led Expedia, has said as much. With its beaten-down price tag, flexible business model, and recent restructuring initiatives, Trivago looks like a promising way to take advantage of the recovery.