It's been a challenging year for stock market investors, with the S&P 500 down more than 23% year to date. But many well-known stocks are faring even worse and, as a result, look incredibly cheap compared to previous highs.
With that in mind, here are two beaten-down stocks that could reward investors for years to come.
1. Lowe's
Similar to the S&P 500's performance, Lowe's (LOW -0.14%) stock is down about 28% year to date. But there is optimism for the world's second-largest hardware chain in the United States.
First, Lowe's is a free cash flow-generating machine. Free cash flow is an important metric because it shows how efficiently a company generates cash after paying for its operations and making any capital expenditures. For the first six months of 2022, Lowe's generated an impressive $5.3 billion in free cash flow.
As a result of its strong free cash flow, Lowe's is a Dividend Aristocrat -- a stock that has raised its dividend for at least 25 consecutive years -- and has paid a dividend every quarter since becoming a publicly traded company in 1961. The company currently pays a quarterly dividend of $1.05 per share, which yields roughly 2.3%.
Lowe's stock looks underpriced compared to its historical price-to-earnings (P/E) ratio -- a common metric to value stocks. Lowe's trades at a P/E ratio of about 14 as of this writing, which is a two-year low for the home improvement retailer. Over the past five years, Lowe's has had an average P/E ratio of roughly 23, well above its current valuation.
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Many CEOs are concerned about higher mortgage rates negatively affecting the housing industry, but Lowe's CEO Marvin Ellison is not one of them. He noted on the company's most recent earnings call: "[A]s low housing supply and high interest rates make moving less desirable, homeowners are motivated to invest in their current homes to fit their needs. This is one of the key reasons that home improvement can win in markets when housing turnover is strong and when it slows."
Still, while rising interest rates might not negatively affect Lowe's customers, it could affect the company's ability to borrow money in the future. Perhaps that's why the company recently borrowed $4.75 billion at interest rates between 4.4% and 5.8%. Before its most recent debt offering, Lowe's net debt -- total debt minus cash and cash equivalents -- reached $27.4 billion in the second quarter of 2022, up roughly 40% from $19.47 billion in Q2 2021.
A good portion of Lowe's new debt has gone to repurchasing its share count, which is down nearly 10% from 707 million diluted outstanding shares to 639 million over the trailing 12 months.
Despite the growing debt concerns, Lowe's continually puts up strong free cash flow to pay it down. The home improvement retailer will report its third-quarter earnings on Nov. 16. See if management decides to repurchase fewer shares and pay down more of its long-term debt. If so, the stock is poised for a rebound even in a difficult macro environment.
2. Nike
Despite record revenue over the past 12 months, Nike (NKE -0.74%) stock has been down 44% during that time. One reason is that the world's largest athletic apparel company, like many other companies, is dealing with inflation and higher shipping costs. Look no further than the company's gross margin -- sales minus cost of goods sold -- which was down 2.2% from 46.5% in the fiscal first quarter of 2022 to 44.3% in fiscal Q1 2023.
Nike's inventory is also skyrocketing, reaching $9.7 billion in its most recent quarter, up 44% compared to the prior year. For any apparel or retail company, rising inventories mean products aren't selling as well as anticipated. There can be many reasons products don't resonate with consumers. During Nike's most recent earnings call, Nike CFO Matt Friend noted, "[C]onsumers are facing greater economic uncertainty, and promotional activity across the marketplace is accelerating."
To combat the rising inventory levels, Nike will also participate in promotions to liquidate excess products. As a result, that gross margin, which was already facing pressure, will likely worsen in the company's fiscal Q2 2023. In fact, management guided for a 3.5% to 4% decline compared to fiscal Q2 2022.
The news isn't all bad for the popular athletic apparel and shoe maker. That's because Nike has been successfully transitioning over the past decade from relying on wholesalers and retailers to selling directly to its customers. In its most recent quarter, sales through its direct-to-consumer effort -- Nike Direct -- totaled $5.1 billion, up 8% year over year and representing 40% of the company's total revenue.
Nike Direct performed exceptionally well in the Asia Pacific and Latin America markets during fiscal Q1 2023, growing 30% year over year on a currency-neutral basis.
Today, Nike's stock trades at a P/E ratio of 25 -- the lowest level since March 2020, when the COVID-19 lockdowns began. Additionally, Nike pays a quarterly dividend with an annualized yield of roughly 1.4%. Notably, the company has raised its quarterly dividend each year since 2004.
Investors will have to be patient as Nike navigates short-term problems. Still, with a strong balance sheet, a history of innovation, and famous brand ambassadors like LeBron James, Michael Jordan, and Serena Williams, the company should receive the benefit of the doubt.
Look to Nike's next earnings call for an update on inventory levels and whether gross margin improves. If so, expect the stock to continue doing what it's been doing for the past 50 years: winning.
