Investors are facing a bit of a Catch-22 at the moment.
With the S&P 500 down 17% from its all-time high, it's historically a good time to buy discounted stocks in anticipation of a new bull market. When you add in elevated inflation, bank failures, rising interest rates, and an uncertain global economy, motivating investors are flocking to safe stocks right now. The problem is, many of the safest stocks to buy are now in high demand and have unusually high valuations.
How can you buy discounted stocks that are also safe when the safe ones are all selling at a premium?
Fortunately, there are a few safe stocks out there that have an answer for this Catch-22 dilemma. Home improvement giant Home Depot (HD -0.31%), home goods retailer Williams-Sonoma (WSM -1.34%), and fintech pioneer PayPal (PYPL -1.14%) are all predictable businesses that offer a degree of safety. The three stocks also happen to trade at historically low valuations, potentially making them good buys before the next bull market begins.
1. Home Depot
According to data from real estate company Redfin, the median sales price for homes in the U.S. is down a little more than 10% since May of 2022. And periods of dropping home prices often result in lower spending at home improvement retailers. It's a near-term risk to be aware of with Home Depot as earnings could drop. Indeed, management said to expect a small drop in earnings per share (EPS) in 2023 even though revenue is expected to hold steady.
But when it comes to Home Depot's long-term safety as an investment, it helps to take a step back and consider the big picture. Even if home sales fall, it's reasonable to assume homeowners will continue spending to maintain and upgrade their properties. Home improvement isn't a dying industry. Moreover, with over 2,300 locations, it's reasonable to assume that Home Depot will continue to be a market share leader in this lucrative space. Yes, the company competes with Lowe's, but this isn't a winner-take-all industry and never has been.
Home Depot management expects EPS to drop in 2023. And this short-term problem creates a buying opportunity for long-term investors. Unless you were quick and bought in during the market crash of 2020, Home Depot stock hasn't been cheaper at any point during the past decade, at least from a price-to-earnings (P/E) perspective. Another indicator is that, apart from March 2020, its dividend yield also hasn't been higher over this time. Both suggest now is a good time to get in on the inevitable recovery for this strong earnings producer.
HD PE Ratio data by YCharts
2. Williams-Sonoma
Williams-Sonoma sells home goods through its Pottery Barn, West Elm, and Williams-Sonoma brands. This company doesn't need high revenue growth to be a winning investment. It needs to be resilient and profitable. And management needs to use profits to increase shareholder value. This has been the company's winning formula over the last decade.
Williams-Sonoma is very profitable for a retail company and generates a lot of cash flow. In its fiscal 2023, which ended in January, it generated over $1 billion in operating cash flow on around $8.7 billion in revenue.
Management for Williams-Sonoma used $880 million during its fiscal 2023 to repurchase shares. With this strategy, it's reduced its share count by roughly one-third over the past decade, increasing the value of remaining shares, as the chart below shows.
WSM Average Diluted Shares Outstanding (Quarterly) data by YCharts
Moreover, Williams-Sonoma paid $217 million in dividends in fiscal 2023 and intends to keep paying dividends in fiscal 2024. In fact, management just increased its dividend payout by 15%, marking 14 straight years of paying and raising the dividend (reflected in the chart above), which shows management's capital allocation priorities.
Finally, Williams-Sonoma management just authorized $1 billion more in share repurchases. With a current market capitalization under $8 billion, that's a meaningful plan. And management may be able to repurchase those shares at bargain prices. As of this writing, Williams-Sonoma stock trades at a price-to-sales ratio below 1. And its P/E ratio is the cheapest it's been in over a decade.
WSM PE Ratio data by YCharts.
3. PayPal
Still down 76% from its all-time high, PayPal stock is experiencing its largest drawdown ever. To be fair, it was probably overvalued at its peak, as were many tech stocks at that time. That said, PayPal is looking for a new CEO to reinvigorate revenue growth. And this business uncertainty also partly explains why it trades at close to its cheapest valuation ever.
PayPal's revenue was only up 8% year over year in 2022. And the company only expects 7.5% growth in the first quarter of 2023. Longtime CEO Dan Schulman is retiring soon and has mentioned at recent events that his replacement will need to have a vision for the ecosystem moving forward. And the quality of that vision could make or break PayPal's future growth potential. This is a big unknown for investors right now.
That said, with over 435 million active accounts, including more than 35 million merchant accounts, PayPal isn't about to disappear -- this business is still facilitating over $1 trillion in volume. And the business is still very profitable. Concerning profits, consider that it generated more than $5 billion in free cash flow in 2022.
Like Williams-Sonoma, PayPal is using free cash flow to repurchase shares right now. Indeed, it expects to spend 75% of its free cash flow on share repurchases in the coming year, which can have a positive impact on the stock.
Safe as well as cheap
As I said at the outset of this article, not all safe stocks are cheap right now. But I believe Home Depot, Williams-Sonoma, and PayPal are safe as well as cheap. All three are well-established and well-capitalized players in their respective spaces. And all three are doing things that create shareholder value, which positions them nicely for the next bull run whenever it comes.
