Investing in unloved stocks can be daunting. Taking the less-traveled path and avoiding the popular, mega-cap names like Microsoft and Apple to go after stocks the market doesn't seem to favor can bring more risk and uncertainty to your portfolio. But if you buy quality businesses at a discounted valuation, over the long run the potential for high returns can be worth taking the risk.
If you have $10,000 that isn't needed to pay bills, boost an emergency fund, or pay off short-term debt, consider using it to buy shares of Nintendo (NTDOY 1.25%) and Sprouts Farmers Market (SFM 0.43%), two stocks currently trading at bargain-bin prices. Here's why.
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1. Nintendo
Even if Nintendo's stock isn't well-loved lately, the company is one of the most well-known and loved entertainment operations in the world. It has been a leader in the video game hardware and software markets for decades, building up some of the most popular gaming franchises like Mario, Zelda, and Animal Crossing. It also owns a large stake (estimated to be around 32%) of the Pokémon Company, the top-grossing media franchise of all time, giving Nintendo exclusive rights to publish its video games on its hardware devices.
Over the years, Nintendo has sold many different gaming devices, which form the foundation for its business model. Most recently, it has done well with its new hybrid mobile/console system called the Nintendo Switch. The device started selling in 2017 and it was on pace to sell over 100 million units by the end of 2021 (final results have yet to be reported). Selling hardware units is important for Nintendo as it directly leads to sales of its software products (aka games), which is where it makes the majority of its profits.
For its current fiscal year, which ends in March, Nintendo is guiding for 200 million software unit sales. This would be down a good amount from the 231 million units Nintendo sold last fiscal year if it hits this guidance number. However, Nintendo is always extremely conservative with its forward guidance, so there's a good chance it will beat this 200 million number. For example, on its second-quarter earnings report last year, which is where this current 200 million software guidance number is coming from, Nintendo only guided for 170 million software unit sales for its full fiscal year; in reality, it ended up selling 231 million units. If Nintendo beats its software sales guidance, that should translate into beating its own operating profit guidance as well.
Right now, Nintendo management is guiding for $4.36 billion in operating profit this fiscal year. Backing out its cash position, Nintendo has an enterprise value of $41 billion, which means the stock trades at less than 10 times its (conservative) forward operating profit guidance.
So clearly, Nintendo stock is cheap. But the big question for investors is whether its annual profits are sustainable as the company has had bouts of cyclicality in the past. Buying this stock is a big risk for Nintendo investors going forward. If you are confident in sales of the Switch and its eventual successor, the risk may be overblown, providing a buying opportunity for any long-term investors.
2. Sprouts Farmers Market
Sprouts Farmers Market, like Nintendo, is relatively unknown and unloved by investors. But the bull case on the stock is a lot simpler. The company operates health-focused grocery stores (think of a cross between Trader Joe's and Whole Foods) that sell fresh produce and specialty items at reasonable prices. It has 366 stores operating in 23 states across the country, with a focus in Arizona, California, Texas, and Florida.
Sprout's growth strategy is simple: It plans to grow its unit count by 10%-plus after 2022 (subject to supply-chain constraints), bringing its store concept to all major markets in the U.S. If the company is successful with these growth plans, revenue and profits should also grow at a 10%-plus rate as long as same-store sales numbers stay positive. However, right now that is not happening, which is why Sprouts' stock only trades at a price-to-free-cash-flow (P/FCF) ratio of 12. In its latest quarterly report, issued in Q3, Sprouts' comparable-store sales dropped 5.4% year over year and 2.1% from 2019. This doesn't look good on paper.
Management claims the drops in comparable sales are pandemic-related (in 2020, grocery stores saw strong demand growth with restaurants closed) and because the company decided to stop putting out unsustainable discount programs that artificially boosted sales in 2019. If you're thinking of investing in Sprouts' stock, you have to decide whether you believe management's claims.
I tend to think the claims are correct, and that these same-store sales woes are temporary. One key metric I'm looking at is operating margins, which have risen from a paltry 2.7% in Q3 of 2019 to 5.7% in Q3 of 2021. To me, this bump in operating margins demonstrates that giving up big discount programs is worthwhile; the sacrifice in sales is actually leading to higher profit numbers, which is what investors should want.
Sprouts Farmers Market isn't the sexiest stock pick. But if store count can continue growing while margins stay steady and same-store sales growth recovers, this could be a fantastic company to own over the next decade.
