The past year was a good reminder that investors always have to be prepared for anything in the markets. While the stock market is one of the greatest wealth-building machines ever created, periods of over exuberance are often followed by market corrections, where stock prices must wait for actual business value to catch up before a new bull market can start again.
As we look ahead to a new year, some beaten-down stocks are due for a rebound. Here's why three Motley Fool contributors believe the time is right to bet on Wayfair (W -6.50%), Smith & Wesson Brands (SWBI -1.49%), and Nike (NKE 1.20%).
One of the worst stocks of 2022
Jennifer Saibil (Wayfair): Wayfair was on top of the world when the pandemic started and people bought home furnishings online in droves. Now it's on the other side of that, and it's not looking good.
Sales have declined year over year for the past six quarters, including a 9% decrease in the the 2022 third quarter. After finally becoming profitable when sales exploded, after years of losses, Wayfair is back to losing millions of dollars.
W Net Income (Quarterly) data by YCharts
Wayfair is facing the same challenges as many other retailers, such as inflation, tough comps to beat from last year, and the need to cut costs after expanding quickly to meet heightened demand. But it's posting poorer performance than some of its peers, which is alarming.
However, there are reasons to be confident that Wayfair can bounce back. For starters, it has an active, loyal customer base of more than 22 million, which was the glimmer on an otherwise dark third-quarter earnings report. Repeat customers accounted for 77.8% of total orders, up from 76.3% last year, and average order value increased from $283 to $325.
The company is doing the hard work to cut costs, and CEO Niraj Shah said that it had "direct visibility to over half a billion dollars of savings" and the means to reach that goal in 2023. If it can do that successfully, it will be well positioned to start operating profitably, and it can then begin to focus on capturing greater market share.
It's already good at that, and as a more efficient company, it should be even better. With $12.4 billion in trailing-12-month revenue, Wayfair has a fraction of what it says will be a $1.2 trillion market by 2030. It works with 23,000 suppliers, and that variety has helped it overcome many of the world's ongoing supply chain problems.
Wayfair stock is down 83% this year, and it trades at the extremely low price-to-sales ratio of .27. If you have confidence in its prospects, this is an incredible deal. However, it still looks risky, so most investors should wait it it out. It could be a huge winner in 2023, though, so definitely keep it on your watch list.
The leading firearm manufacturer is on sale
John Ballard (Smith & Wesson Brands): Buying shares of a gun manufacturer might seem controversial, but if you're looking for an undervalued business that could deliver asymmetric returns in a bear market, Smith & Wesson could do the trick.
The company makes firearms ranging from pistols to sporting rifles for law enforcement, military agencies, and individuals, and it's been in business since 1852. Smith & Wesson is the leader in a very fragmented industry with 17% market share. An estimated 30% of American adults own a firearm, but the stock has fallen this year due to lower gun sales, which is a great opportunity to add shares of this solid dividend stock.
After a surge in gun sales during the pandemic, retailers have been reducing inventory as demand returns to pre-pandemic levels. This is expected to continue into 2023, which will pressure Smith & Wesson's revenue and profits, but this is already reflected in the stock's valuation.
The stock's forward price-to-earnings (P/E) ratio is dirt cheap at 6.1 times this year's earnings estimates. The stock price undershoots the value of the company's long-term earning power, especially its history of generating profits through the cyclical swings in demand.
Smith & Wesson is built to handle adversity. The business is debt-free and holds over $100 million of cash on the books. Even with revenue expected to decline by 32% next year, analysts expect earnings per share to come in at $1.64, which would still put the P/E at a lowish 10.
To keep profits up during periods of weak demand, the company uses its manufacturing capabilities to serve third parties, including machining and tooling work. This provides extra revenue during periods of lower gun sales. When gun sales increase, it outsources manufacturing to respond quickly to demand, which leads to another boom in profits.
Income investors will love Smith & Wesson's dividend. The stock's decline this year has brought the dividend yield up to 3.08%, or double the S&P 500 average, based on a low payout ratio of just 13%. The low payout means Smith & Wesson has ample room to raise the dividend payment even with lower earnings, which is another indicator that the stock is undervalued and due for a rebound.
One big-brand stock that's ripe for a comeback
Jeremy Bowman (Nike): Nike has faced its share of challenges in 2022, including bloated inventory levels, COVID-19 lockdowns in China, and a stronger dollar, but they're all short term in nature. That means that after falling 36% year to date in 2022, the stock looks well positioned for a comeback as overall demand for Nike's products is still strong.
For example, outside of China, every market in Nike's most recent quarter grew currency-neutral revenue by at least 13%, though investors have chosen to focus instead on declining profits, which are a result of the challenges above. The good news is that those issues seem likely to fade in 2023.
In China, for example, there are signs that its zero-COVID policy is weakening. The government said it would lift some restrictions for international travelers, and investors are hopeful that protests can help push the government to take other reopening measures. Nike stock has responded favorably to good news out of China, and it's likely to continue doing so, especially if the economy reopens.
Efforts to reduce its inventory have also weighed on profits, but those are likely to be completed in the next quarter or two. Inventories were up 44% as of Aug. 31, and the company said on its September earnings call that it was "taking decisive action to clear inventory." This will impact gross margin in the short term, but position the company for long-term growth once it rightsizes its inventory position.
Finally, the U.S. dollar is weakening and the dollar index is on track for its worst performance in a decade in November. If that trend continues into 2023, it will make Nike's international sales more valuable.
Nike is still in a strong competitive position, especially as rival Adidas deals with the fallout from its relationship with Kanye West, but investors are punishing it for short-term headwinds. Once those fade, the sportswear stock could recoup much of its recent losses in 2023.
