There's no sure thing in investing, but one of the best ways to make money in the stock market is by finding an undervalued stock that has a clear path to growth.
One such stock now is Signet Jewelers (SIG 2.15%), the world's largest retailer of diamond jewelry. Signet owns brands like Kay, Zales, Jared, Diamonds Direct, and Blue Nile, giving it a scale advantage in a fragmented industry and the ability to leverage digital sales in a way that independent jewelers can't.
The stock looks dirt cheap at the moment, trading at a price-to-earnings (P/E) ratio of less than 8 based on its guidance on adjusted earnings per share for the year.
While the company is facing headwinds at the moment, Signet laid out a compelling case for its growth opportunity in its latest quarterly earnings report, which came out a week ago.
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Temporary challenges
Signet stock rose following the second-quarter earnings release even though it reported declining revenue and profits. Overall revenue was down 8.1% to $1.61 billion, ahead of estimates, while same-store sales declined 12%. Adjusted earnings per share, meanwhile, fell from $2.68 to $1.55, ahead of the consensus at $1.45.
That decline might seem concerning, but it's mostly a result of fleeting factors, including a slowdown in wedding engagements due to the impact of the pandemic and macro-level headwinds, especially in the consumer discretionary category.
CFO Joan Hilson said in an interview with The Motley Fool that the company saw demand at its lower price points improving sequentially in June and July, indicating reason to be optimistic heading into the holiday season and next year.
Its bridal business makes up roughly 50% of revenue, and the company closely tracks indicators showing that wedding engagements should begin to rebound in the fourth quarter, going from a headwind on the business to a tailwind. The company estimates that the slowdown in engagements will cost it $600 million in revenue this year.
That rebound in the bridal business should drive both sales growth and margin expansion.
A path to $15 in earnings per share
At its Investor Day conference in April, the company issued a set of bold targets, including $14 to $16 in adjusted earnings per share in three to five years. Based on the stock current's price, it's trading at just five times that earnings forecast.
To get there, the company is counting on a rebound in the bridal business and a stabilizing macro environment as well as a few key initiatives. Those include growing its accessible luxury business, driving $1 billion in new revenue through improved assortments at Jared, expanding the footprint at Diamonds Direct, and growing Blue Nile.
It also expects to grow services revenue by $500 million, focusing on repairs, which was bolstered by an acquisition in the quarter; design services; and lifetime service plans that cover ring sizing, refinishing, and polishing, among other features. Services are particularly appealing as a growth avenue because they offer a much higher margin than merchandise, and they strengthen customer relationships.
Lastly, the company also sees an opportunity to grow its digital and connected commerce by $500 million, leaning into an area it has already leveraged as an opportunity for differentiation through rewards programs and other offers that keep its customers engaged online.
Altogether, the company expects $9 billion to $10 billion in revenue in that time frame, up from an expected $7.1 billion to $7.3 billion in revenue this year. It also forecasts adjusted operating margin to improve to 11% to 12%, and for U.S. market share to reach 11% to 12%.
Time to buy?
Jewelry is a mature industry, but it's still growing by the low- to mid-single digits. Signet is well-positioned to gain market share and has a history of making acquisitions, which gives the stock additional potential.
The current management team has also driven a successful turnaround, improving profitability and positioning the company for growth through channels like digital sales and services as well as updating its store footprint as it moves away from mall-based stores. At a P/E of around 8, the stock is being priced as if it won't grow. But if the company can deliver on that $14 to $16 EPS guidance, the stock has a good chance of moving substantially higher from here.
CORRECTION: The original version of this report misstated Joan Hilson's title. She is Signet Jewelers' chief financial officer.
