After the worst start to the year in decades, the major market indexes have rallied over the last month. Most companies have reported better-than-expected operating results. That indicates that investors could be undervaluing the long-term prospects of many solid companies right now.
Three Motley Fool contributors recently selected three stocks that have fallen this year and could be poised for a rebound. Here's why they like Electronic Arts (EA 0.10%), RH (RH 4.78%), and Pinterest (PINS 2.32%).
The market is underestimating the growth opportunity in mobile games
John Ballard (Electronic Arts): There are not many industries like video games. Leading game companies can produce a game that provides hours of entertainment, which significantly lowers the cost per hour to buy a game. This is why, with the exception of disappointing results at Roblox, time spent with with video games has held up well despite headwinds in the economy.
Year to date, shares of Electronic Arts are up 2% at the time of this writing, outperforming the S&P 500 index, which is down 10%. But EA shares are off 13% from their all-time high and have been mostly trading sideways in recent years. As management continues releasing new games and expanding into new markets, it's only a matter of time before the stock breaks out and climbs higher.
In the most recent quarter, EA reported double-digit growth in bookings over the year-ago quarter. Its player base grew to nearly 600 million active accounts.
EA is continuing to see healthy player interest in its top titles, including its soccer game FIFA and the free-to-play shooter Apex Legends. Management sees a big opportunity to expand these titles in the mobile market. The company reported a record quarter for FIFA Mobile, while Apex Legends Mobile just launched on mobile devices. Last year, EA made a decisive move to go after the largest and fastest-growing market in gaming by acquiring Glu Mobile, the maker of Tap Sports Baseball, for $2.1 billion.
The video game industry is expected to grow 27% cumulatively over the next four years to reach $282 billion, according to IDC Consulting. Electronic Arts owns a gaming portfolio played by millions of people and generates a healthy profit doing so. It is ideally suited to invest in new games and capture more share of the industry. The stock also just happens to be a solid value right now, trading at a modest forward price-to-earnings ratio of 18.6.
Differentiated, resilient, and profitable
Jennifer Saibil (RH): 2022 hasn't been so kind to retailers, and it's also been tough for investors. The silver lining, though, is that opportunities abound to buy stocks on the dip. Just look at investing guru Warren Buffett. He has counseled investors to be fearful when others are greedy, and greedy when others are fearful, and he's putting his money where his mouth is. In the first quarter of 2022, as stocks began to tank, his holding company Berkshire Hathaway put more than $50 billion into eight new positions and seven existing positions. In the second quarter, it didn't buy anything new, but added more than $6 billion into nine positions.
Buffett first bought stock in luxury home furnishings company RH in 2019, and he added to his position in the 2022 first quarter. Shares are down almost 40% this year after taking a beating that most retailers are dealing with. The stock is now dirt cheap, trading at 10 times trailing-12-month earnings, even cheaper than when Buffett loaded up on shares in the first quarter.
Why does Buffett like this stock and why should you? It has a large moat, it's quite profitable, it has enormous potential, and it looks like an incredible value right now.
RH operates luxury home design centers targeting an affluent population. It only has 67 stores, or what it calls galleries, along with 39 outlet stores and 14 Waterworks (a bath design center) showrooms. It's small, and it likes it that way to maintain its exclusive image. It has a careful approach to expanding, and it's opening two galleries in the U.S. this year. It is, however, also beginning to open stores internationally, with a launch in the U.K. scheduled for sometime in 2022.
As a luxury goods retailer, it charges high prices and maintains a high operating margin, 24% over the trailing 12 months. It's also highly profitable, and earnings per share increased 190% in the second quarter to $12.16.
Investors can expect pressure for the rest of 2022 as RH faces strong comparable sales numbers from last year and challenging macroeconomic conditions. Management lowered its outlook for the full year to a 2% to 5% sales decline over last year. However, it's continuing to recreate itself as a luxury brand, offering jet and yacht rentals, opening new restaurants, and launching new collections. This focus differentiates its business from other furniture retailers. Long term, RH has tons of opportunity, and this price makes it look like a great buy.
The market is overreacting to Pinterest's headwinds
Parkev Tatevosian (Pinterest): Pinterest's stock is down 74% off its highs in early 2021. Investors who haven't taken the opportunity to buy this growth stock on the dip might regret it a few years from now. The market is arguably overreacting to short-term headwinds that have caused user engagement and advertiser spending to decrease. The company has created a unique product with 433 million monthly active users. Moreover, advertisers spent $763 billion globally in 2021.
Admittedly, its prospects are challenged in the near term as the pandemic has snarled supply chains, and the economic reopening has chased users away. However, Pinterest had demonstrated robust growth even before the outbreak. Revenue increased from $473 million in 2017 to $1.1 billion in 2019. And at the scale it has achieved, Pinterest turned the corner on profitability. Operating income rose to $326 million in 2021, up from an operating loss of $138 million in 2017. Given that Pinterest operates in the $763 billion advertising industry, it can grow much more prominent before it approaches a ceiling.
Fortunately for investors, Pinterest is still trading at a bargain valuation. At a price-to-free cash flow ratio of 23, Pinterest has scarcely ever been cheaper, according to this metric. Investors who don't buy at these prices might wish they did a few years from now.