The stock market has been on a nice run lately. Over the past month, the S&P 500 is up 3% while the Nasdaq Composite has grown 4%. While it's always nice to see more green than red in my brokerage statement, a run-up in the market also means stocks are more expensive to buy. As someone who buys stocks regularly, I find this can be a double-edged sword.
When I buy stocks, I'm on the lookout for the businesses I think are doing well but are not getting recognition from the market. In my view, this is where I have the best chance to find some deals. Let's take a look at two of the cheapest stocks I own and why I think they're worth buying today.
Target
Popular retailer Target (TGT 0.18%) has had a strange few years. After it got through the pandemic successfully, trouble started brewing in 2022 when the company reported second-quarter results. The headline was a 90% drop in earnings due to an inventory glut resulting from buying too many of the wrong items at the wrong time. This left Target in the position of needing to slash prices on large bulky items in order to clear out its inventory.
The story since then has been all about recovery, and the story has gone well. Target's earnings per share (EPS) have been on a consistent path up and to the right ever since the Q2 2022 low point of $0.39. In the most recent quarter, EPS came in at $2.10. Additionally, it's safe to say the inventory woes are behind the company. Inventory was down 14% year over year, and down 1.5% over the Q3 2021 inventory level.
This recovery has really been a story about the bottom line as revenue has remained essentially flat over the last two years. In addition to the improvement in profitability, Target has started generating more cash recently. Through the first nine months of the year, Target has generated more than $5 billion in cash from operations. This is a substantial increase over the first nine months of 2022 when the company only generated $550 million in cash from operations.
All this turmoil has led the market to sour on Target's stock. Even after a 17% Q3 2023 post-earnings bump, the stock is still down 51% from its late-2021 high. Target shares trade for only 17 times trailing earnings. That's below its historical average and also lower than the P/E multiple of the overall market. It's also significantly cheaper than one of its main competitors, Walmart, which trades for 26 times earnings.
Outset Medical
Medical device company Outset Medical (OM 0.84%) is having the kind of year in 2023 that Target had in 2022. A series of challenges, both within the business and externally, have absolutely crushed Outset's stock. At the time of this writing, the shares are down 80% year to date.
Outset makes a device called Tablo, which lowers the cost of kidney dialysis treatment in an acute medical setting and also allows patients to get treatment at home. Considering the size of the dialysis market and the burden of treatment on patients, there's no shortage of reasons this company could be a huge success if it can get past this rough patch.
The trouble started in August when the company took one of its products off the market in order to submit more paperwork to the Food and Drug Administration (FDA) after receiving a warning letter from the regulatory body. This was followed by news that the weight-loss drug Ozempic showed positive signs of reducing kidney disease and a pre-release of Q3 2023 earnings that reported a larger-than-expected impact from the FDA warning letter.
All this led to where we are today with a stock trading for a 92% discount to its late-2020 high. Despite all this bad news, I actually think Outset will be OK. Consider that the number of kidney dialysis treatments is expected to grow by 30% by 2030. Outset believes that this is an $11 billion market opportunity.
If the company meets its 2023 full-year revenue target of $130 million, that would represent a compound annual growth rate of 71% from 2019. That's impressive growth even with this year's stumbles. Additionally, the company is guiding for annual revenue growth in the mid-teens for 2025 to 2027. I know that's a long way off, but it's an indication that brighter days may well be ahead for this company.
There's no doubt that Outset is a riskier bet than Target. However, considering the market opportunity, there's the possibility of a much higher upside as well. Outset now trades for a price-to-sales (P/S) ratio of 1.9. That's a multiple one might expect to see for a retailer. It's also significantly lower than Outset's historical P/S ratio of 17. The risk/reward from today's share price looks compelling to me.
