The stock market had a great year in 2023. The S&P 500 index climbed by 26.3% (including dividends), which is more than twice its average annual return going all the way back to 1957. It now trades just 2.1% away from a new record high.
Many popular technology stocks like Nvidia, Microsoft, and Apple are also trading near their all-time highs. These strong conditions might leave investors thinking there is little value left in the technology sector, but I've identified two stocks that appear incredibly cheap relative to their fundamentals and their historical valuations.
Redfin (RDFN 8.49%) and Sea Limited (SE 0.05%) operate in entirely different industries, and both companies faced headwinds that have sent their stocks down 90% from their all-time highs. But here's why the stage might be set for a powerful comeback in 2024.
Image source: Getty Images.
1. Redfin: Geared for falling interest rates and a stronger housing market
The U.S. housing market stalled in 2023. In October, existing home sales fell to an annualized rate of 3.79 million units, the lowest level since 2010. Interest rates were mostly to blame; the U.S. Federal Reserve increased the federal funds rate from a historic low of 0.25% all the way to 5.50% between March 2022 and August 2023. It was the fastest pace of rate hikes in its history.
Redfin is a real estate technology company with a focus on brokering. It attracts sellers by charging listing fees as low as 1%, compared to the industry average 2.5%. Redfin employs 1,744 lead agents who serve 98% of U.S. markets, so it suffered from sluggish home sales across the country last year. Redfin is due to report its 2023 full-year financial results in February, and Wall Street expects its revenue to come in at $1.1 billion. That will mark a 52% drop from 2022, but a weak housing market wasn't the only drag on its business.
Redfin was forced to exit its iBuying segment when conditions deteriorated. The company would buy homes from willing sellers and attempt to flip them for a profit -- a practice that works great when real estate prices are rising, but can lead to catastrophic financial losses when the market turns south. That segment accounted for 52% of its revenue in 2022, so its closure left a big hole in Redfin's financials.
However, iBuying was a very low-margin business and it often operated at a loss. Now, Redfin is focusing more on its services businesses like brokering, rentals, and mortgages, which are low cost, paving the way for the company to reach profitability. In fact, Redfin delivered positive non-GAAP earnings before interest, tax, depreciation, and amortization (EBITDA) in the third quarter of 2023 (ended Sept. 30), and it aims to continue that trend in 2024.
The Fed had one primary goal when it raised interest rates aggressively over the last 18 months: to tame inflation. It has largely been successful, because the Consumer Price Index has fallen at the fastest pace since 2009. As a result, Wall Street expects up to six interest rate cuts this year, which would be great for the housing market.
That might create a significant opportunity for investors. See, Redfin is currently valued at just $1.06 billion. Based on its expected $1.1 billion in 2023 revenue, its stock trades at a price-to-sales (P/S) ratio of just 1, which is far from its peak of 7.7 from 2020. I'm not suggesting it will head back to that level, but even the halfway point represents a potential tripling in Redfin stock from where it trades now.
Sure, Redfin faces challenges. But if the Fed really cuts interest rates six times this year, that will likely lead to more real estate transactions. If that accelerates Redfin's revenue growth, its current P/S valuation is going to look even cheaper than it is now, because investors will have to factor in more future revenue. Simply put, if the housing market recovers in 2024, Redfin stock is far too cheap right now.
Image source: Getty Images.
2. Sea Limited: A growth powerhouse turned profit-generating machine
Besides the real estate sector, companies that draw most of their revenue from consumer spending also felt the sting of high inflation and rising interest rates over the last two years. Singapore-based Sea Limited is one of the best examples because it operates three consumer-focused businesses: e-commerce, digital entertainment (gaming), and digital payments.
In 2021, Sea Limited's total revenue grew by a whopping 127% year over year, to $10 billion. Low interest rates, troves of pandemic-related government stimulus, and social restrictions (which drove consumers to online platforms) all played a role in that spectacular result. However, Sea Limited's revenue growth slowed to 25% in 2022, and Wall Street expects it to slow yet again to just 4% for 2023, when the company reports its official results in March.
The company's e-commerce segment remained strong last year; its revenue grew by 33% year over year through the first three quarters (ended Sept. 30). It was led by its Shopee platform, a hybrid consumer-to-consumer and business-to-consumer marketplace that dominates online retail in Southeast Asian nations like Indonesia. However, Sea Limited's digital entertainment segment was a different story.
Sea Limited is home to Garena, a leading developer of mobile games. It created popular titles like Free Fire, which amassed over 1 billion downloads, and Call of Duty: Mobile. During 2021, the company's digital entertainment segment attracted a peak of 729 million quarterly active users with the help of those leading games. But with social conditions mostly back to normal after the pandemic, Sea Limited has lost about 185 million of those active users since.
That has severely impacted the company's ability to grow its digital entertainment revenue. It actually fell 43% through the first three quarters of 2023, and it's a big reason Sea Limited's total full-year revenue growth is looking so sluggish. On the plus side, Garena could soon see an uptick in usership as Free Fire just relaunched in India following a ban in 2022.
But there's another, more positive reason Sea Limited's growth pulled back last year. The company slashed its operating costs like marketing and research and development, which meant it created fewer opportunities to generate revenue. However, it led to a net income (profit) of $274 million in the first nine months of 2023, which was a huge swing from the $2.1 billion net loss it delivered in the year-ago period.
Now, on to Sea Limited's valuation. The company has a market cap of $23.2 billion, so based on its $12.9 billion in expected 2023 revenue, its stock trades at a P/S ratio of just 1.8. That's a long way from its peak of 22.9 that was set in late 2020. Plus, there is $6 billion in cash, equivalents, and short-term investments on Sea Limited's balance sheet, with almost no debt. When you strip that from its market cap, the stock trades at an even cheaper P/S ratio of 1.3.
Like Redfin, Sea Limited could benefit significantly from the improved economic conditions that would come with lower interest rates. At a shade over 1 times sales, investors have the chance to buy in at a rock-bottom valuation right now.
