Sometimes Wall Street can be very slow to understand the real value of a business. The competitive advantage and growth strategy of a company can be misunderstood, leading to depressed valuations and underperforming share prices.
Investors who can see through the stock volatility and focus on the key signals that set a company up for long-term success can be rewarded with outsize gains over time.
Here are two stocks of market-leading brands that are trading well off their previous highs and could be significantly undervalued.
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1. RH
RH (RH -0.01%), the company formerly known as Restoration Hardware, emerged as a prominent luxury furniture brand over the past decade. In the past year, however, the business struggled with several macroeconomic headwinds, such as a weak housing market and uncertainties over tariffs.
Questions about near-term demand have sent the stock down 52% this year, but this is a great buying opportunity for a long-term investor.
RH's trailing-12-month revenue of $3.3 billion is below its previous peak of $3.9 billion a few years ago, but it just reported a strong first quarter. Revenue grew 12% year over year in the quarter, outperforming the rest of the industry.
RH is expanding its addressable market to hospitality offerings in its design galleries, such as restaurants and wine bars, which has elevated the shopping experience to something that cannot be replicated by e-commerce competitors.
Moreover, the company entered the $200 billion North American hotel industry with RH Guesthouses, and it offers much more, including private jets and luxury yachts for charter in the Caribbean and Mediterranean. All this creates an ecosystem of services meant to showcase the RH lifestyle and raise the brand to something more than just furniture products.
It's for these reasons that RH has a history of reporting much higher margins than the average furniture store. Its adjusted operating margin was 7% in the first quarter, below its previous 10-year average of 12%. It should return to those higher margins in a strong housing market, and this is not reflected in the stock's valuation.
Over the last 10 years, the stock traded at a price-to-sales multiple ranging from 0.48 to 6.59. The average was just over 2 times sales, with the stock currently trading at a multiple of 1.16. Investors who buy shares at these lower discounted prices and hold until the housing market is fully recovered should be well rewarded.
Image source: Getty Images.
2. Roku
Roku (ROKU -0.52%) is another beaten-down stock whose long-term prospects are not fully reflected by its current share price. The stock is trading about 32% below where it was five years ago, but the platform continues to show double-digit growth in revenue that sets up a potential bull run.
Roku is a leading connected-TV streaming platform that is benefiting from a growing digital advertising market, which is how the company generates most of its revenue. It also gets a small percentage of revenue from selling its streaming devices, but that is a low-margin business.
Advertising can be cyclical with the broader economy, and that's what caused the stock to collapse a few years ago. But Wall Street is missing the real value of the company's platform. It is fundamentally a TV operating system that has achieved tremendous viewership in the U.S. through its affordable Roku TVs and streaming devices.
The company reaches half of U.S. broadband households. This large viewership led to 35.8 billion total streaming hours on its platform in the first quarter, representing a year-over-year increase of 16%. This opens up a lot of opportunities for growth over the long term, as evidenced by a recent deal with Amazon.
Roku just announced an integration with Amazon Ads, which could have a significant impact on Roku's advertising revenue. This partnership will allow advertisers to access 80% of U.S. connected TV households through Amazon's demand-side platform, sending more business to Roku.
The streamer's revenue grew 16% year over year in the first quarter, indicating more advertising by big brands that want exposure to its large user base. This reach provides tremendous negotiating power with content providers, retail brands, and other media companies that would like access to Roku's audience.
The stock is priced at a 2.74 price-to-sales multiple, which is at the low end of its past trading range. As Roku continues attract more advertising investment, investors who patiently hold the stock will be rewarded.
