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Here's My Top Stock to Buy Now -- and It's Not a Growth Stock

By Daniel Sparks - Dec 16, 2020 at 8:06AM

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This stock can help round out your portfolio with some value and a rapidly growing dividend.

This has been an outstanding year for many individual investors, and particularly those willing to buy and hold high-quality growth stocks. This investment approach has largely been a winning strategy over the past decade and the past year.

Many growth stocks have delivered impressive 2020 business performance to account for their soaring stock prices. Other growth-oriented Wall Street darlings have valuations that are becoming increasingly difficult to justify. With this backdrop in mind, it may make sense for investors to venture beyond the growth stocks for which the market has developed an insatiable appetite recently.

Here's why grocery chain Kroger ( KR -0.02% ) could make sense for your portfolio.

A person looking at charts on a laptop

Image source: Getty Images.

Accelerating momentum

Kroger's revenue growth has unsurprisingly accelerated in 2020, as the pandemic drove many Americans to stock up on essential items. But this isn't the acceleration worth highlighting in this article.

Here's what's even more notable: Kroger's growth was accelerating even before the pandemic hit. The company's stores -- which operate under many names, including King Soopers, Smith's, City Market, Fred Meyer, Fry's, and more -- are winning over customers. In recent years, the company has been steadily improving its same-store sales. This is a measure of year-over-year sales growth at stores that have been open for five full quarters. After posting a same-store sales growth of just 0.7% (excluding fuel sales) in 2017, this metric improved to 1.8% in 2018 and edged higher to 2% in 2019. Management was guiding for yet another acceleration going into 2020. Kroger initially said it expected same-store sales growth of 2.25% or greater this year. 

Of course, Kroger has seen much better performance than the 2.25% same-store sales growth management initially predicted for 2020. During lockdowns, consumers flocked to Kroger for essential items. Year-to-date same-store sales, when excluding fuel sales, are up 15.3% -- an acceleration from 2% in the same period last year. For the full year, management now expects same-store sales growth of 14%. 

Is Buffett's Berkshire onto something?

What's particularly refreshing about Kroger stock is its compelling valuation. The company still trades at a conservative valuation despite its robust fundamentals. Indeed, the company's strong momentum relative to its valuation has even managed to attract substantial investment from famed investor Warren Buffett's Berkshire Hathaway. The Oracle of Omaha's conglomerate bought about 19 million shares of Kroger in the fourth quarter of 2019, accumulating a 2.4% stake. Since then, Berkshire has continued to add to the position. It now amounts to approximately 25 million shares, representing a 3.2% stake in the grocer. 

A young person shopping at a grocery store.

Image source: Getty Images.

Even with $129 billion in trailing-12-month revenue and $2.6 billion in net income, Kroger's market capitalization today is just $24 billion. Sure, Kroger's bottom line saw a temporary boost this year as sales spiked during lockdowns. But the grocer still trades at a cheap valuation relative to analysts' average estimate for Kroger's more normalized earnings next year. The supermarket specialist trades at just 11 times analysts' consensus forecast for next year's earnings.

But how can a company growing as slowly as Kroger reward investors? 

First, there's Kroger's dividend. The company currently has a 2.3% dividend yield. In addition, this dividend is increasing rapidly. It jumped by 13% this year and it has risen for 14 years in a row. Further, Kroger's dividend has averaged a double-digit compound annual growth rate since 2006.

Kroger can also create shareholder value as a mature business by repurchasing shares with its excess cash. Management is doing this aggressively in 2020. It has repurchased $989 million worth of shares year to date, with $304 million spent on repurchases in Q3 alone.

Consider the risks

Anyone considering buying Kroger stock should consider the many risks that come with buying any individual security. There's always a chance that things don't go as planned or that competition proves tougher than anticipated. Further, unpredictable broader-market conditions could negatively impact Kroger.

2021 will be particularly interesting for Kroger since the company will be up against incredibly tough comparisons from 2020. Analysts, for instance, are currently modeling for a 20% and 3% decrease in revenue and earnings per share, respectively, next year. This could spook some investors.

Despite these concerns, the stock looks like a good bet for investors willing to buy and hold shares for the long haul. Kroger was already demonstrating accelerating growth in same-store sales going into the pandemic -- and the pandemic itself illustrated just how critical companies like Kroger are to our daily lives.

Kroger may not be a "sexy" growth stock. But it could help round out many investors' portfolios, particularly after growth stocks have swelled to pricey valuations and likely comprise much of many investors' capital. Kroger offers investors a quality business, a dividend, and a great price relative to its long-term potential.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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