Since the end of August, the S&P 500 has fallen 2.5% as the markets have started to tighten up. There's good reason: Many stocks were simply overvalued and trading at levels that do not appear to be sustainable. The index is still trading at an average price-to-earnings (P/E) ratio of 31. And while that number has come down this year, it's far higher than it has been in previous years (prior to 2020, the multiple was typically lower than 24).
But not all stocks are obscenely overvalued. Two growth stocks that are relatively cheap and could provide investors with some solid returns in the near future are Petco Health and Wellness (WOOF -6.02%) and Wendy's (WEN 2.39%).
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1. Petco
Shares of pet care company Petco only began trading on the Nasdaq on Jan. 14 of this year. So far, it hasn't been a great ride for the stock -- it has fallen 25% while the S&P 500 has climbed 16%. It's a bit surprising that the stock hasn't done better, especially with the continued growth in the pet industry.
The American Pet Products Association says that spending on pets (including treats, vet care, supplies, and services such as training and grooming) reached $103.6 billion in 2020 -- the first time it hit the $100 billion mark. That was 6.7% higher than in 2019, and analysts expect it to rise to $109.6 billion this year (an increase of 5.8%).
The company is benefiting from all that growth, having achieved a record-breaking quarter. For the period ended July 31, Petco's net revenue rose by 19% year over year to $1.4 billion and operating income increased by 13% to $73.5 million. The company's CEO, Ron Coughlin, sees a "significant runway for continued growth," and Petco has hiked its guidance for both its top and bottom lines for 2021. The business expects to generate at least $5.6 billion in revenue, up from $4.9 billion last fiscal year, and an adjusted per-share profit of $0.81 to $0.85. Previously, the company was estimating $0.73 to $0.76.
On a forward P/E basis, the stock trades at a multiple of 26 (cheaper than the 32 times future earnings for animal health stock Elanco). Multiple brokerages see shares of Petco potentially rising to as much as $30 -- about 35% higher from where it is today. With lots of growth potential on the horizon, Petco may be an underrated buy.
2. Wendy's
Fast-food chain Wendy's has been a popular stock with meme investors this year. On June 8, the stock soared 25% in a single day after gaining steam on Reddit, propelling it to a 52-week high of more than $29 that it hasn't come close to reaching since.
But there's a more compelling reason to invest in the stock besides its popularity with the Reddit crowd. Wendy's has been reporting some strong numbers this year. Over the first six months of 2021, revenue rose by more than 18% year over year to $953.5 million. And net income soared by 173% to $107.1 million thanks to an increase in the number of customers and a higher average check.
Like Petco, Wendy's is also projecting some better numbers for the full year. Previously, it forecast sales growth of between 8% and 10%. However, given the strong results so far this year, Wendy's now projects revenue to rise by at least 11% and as much as 13%. It also expects a higher adjusted per-share profit of $0.79 and $0.81 (up from a range of $0.72 to $0.74).
Aside from the surge in June, Wendy's stock has been fairly tame this year, rising less than 2% thus far. It trades at a forward P/E of 27, which is right around the valuation of fast-food giant McDonald's. Both stocks could benefit from a strengthening economy and people returning to their normal, day-to-day lives as COVID-19 case numbers fall.
However, given its significantly smaller market cap ($5 billion vs. $185 billion for McDonald's) and popularity with retail investors, Wendy's stock could have more potential to increase in value over the long run, making it the better option for growth investors. On average, analysts see a potential 22% upside for Wendy's stock, compared to just 8% for McDonald's.
