Over the last century, there have been several market downturns, but each one has been followed by an even longer stretch of rising stock prices. If retirement is still a long way off, market history says investors should be more aggressive in adding to their stock holdings when the markets are down than when they are up. You get more value in buying shares.
With inflation receiving a lot of attention this year, it's not surprising that retail stocks have been hammered. Higher prices for goods are cutting into consumers' wallets and could further reduce their buying power.
These concerns have sent shares of Levi Strauss (LEVI 1.23%), RH (RH 0.19%), and Home Depot (HD -0.60%) plummeting to new lows. But these companies continue to invest to improve operations and capitalize on substantial long-term growth opportunities in their businesses. Here's why these companies should emerge from this downturn stronger than ever.
1. Levi Strauss
Despite inflationary pressures on the consumer, Levi Strauss continued to report strong operating results through the fiscal second quarter ending in May. Revenue advanced 20% year over year on a currency-neutral basis, and profits grew even faster thanks to improvement in margins.
Those numbers translate to a bargain for investors, considering the stock trades at a price-to-earnings (P/E) ratio of just 11.8 times this year's earnings estimates. Generally, when a stock's P/E is at a significant discount to the company's underlying earnings growth (also known as the PEG ratio), it indicates a severe mispricing by the market. Levi's PEG is currently 0.79.
LEVI PEG ratio (forward). Data by YCharts.
Levi's momentum could persist in the near term. Management credited the casual-dress trend at the office for driving strong sales. The company also reported strong sales growth for its other brands, Dockers and Beyond Yoga.
While Levi's direct-to-consumer channel is performing well, with sales up 16% in the quarter, management still sees tremendous growth potential to better connect with customers through its e-commerce business, which currently makes up only 7% of total revenue.
To capitalize on this opportunity, Levi's just established a new chief digital officer position, with plans to leverage the power of data and artificial intelligence to realize the full potential of the online business.
CEO Chip Bergh said, "The Levi's brand is stronger than it has ever been, and the demand is stronger than it has been in my career here at Levi Strauss." That's a bold statement in a challenging economic environment, and why the stock is a great deal at these low share prices.
2. RH
Shares of RH, formerly known as Restoration Hardware, are another bargain trading at a forward P/E of 11.4. The market is undervaluing RH's transformation from a pure seller of luxury furnishings to a services business that offers design concepts across a range of categories. This strategy has significantly expanded its long-term addressable market and profitability.
Over the last 10 years, RH grew revenue from $1.2 billion to $3.7 billion, and management sees the potential for its design galleries to generate at least $5 billion in annual revenue in North America alone over the long term.
Another reason the market is undervaluing the business is the improvement in operating margin. RH has several levers it can pull to send profits higher and fuel shareholder returns. It's transitioning to a membership model, redesigning its distribution network, and lowering costs while improving the customer experience.
These investments have already resulted in operating margin increasing from single digits to 24% over the last five years, and management believes there is more to come.
RH operating margin (TTM). Data by YCharts. TTM = trailing 12 months.
The market is worried about management's near-term sales forecast that calls for a revenue decline of 2% to 5% year over year in fiscal 2022. With the stock already trading at bargain-basement prices, the first sign of revenue stabilization and a return to growth will likely send the share price soaring.
3. Home Depot
Higher interest rates could weigh on home sales and remodeling projects, which is why shares of this home improvement retailer have fallen 28% year to date. But at a market-average forward P/E of 18, long-term investors have more to gain than to lose.
Home Depot has delivered tremendous wealth to shareholders over the last 40 years. A $1,000 investment in July 1982 would be worth $7.9 million today. That includes holding the stock through several recessions and weak real estate markets, such as the mortgage crisis in 2008.
An important reason Home Depot is still a great investment is management's focus on profitably growing the business. The company earns a phenomenal return on invested capital of 43%. That means the company earns about $0.43 for every dollar invested in the business, and it's a key reason the stock has delivered so much wealth to shareholders.
Management is driving more efficiency out of the supply chain. The company's investment in new fulfillment centers has expanded the product assortment and offers faster delivery. This has led to higher incremental sales, but management is continuing to look for ways to reduce costs and speed up efficiency in the supply chain while delivering the best shopping experience.
Revenue growth accelerated during the pandemic, with more people spending on their homes. While a large retailer like Home Depot won't be able to sustain high double-digit growth, management believes its addressable market is larger than before the pandemic, at over $900 billion in North America alone.
This top retail stock is conservatively valued ahead of these opportunities and offers an above-average dividend yield of 2.37%.
