As the saying goes, you have to pay up for quality. This logic carries over to stocks -- many believe that the best stocks to own will necessarily have pricey valuations. And this is often true. After all, the best businesses in the world attract many buyers, boosting their valuations.
However, there are good stocks trading at cheap prices out there, too, including iRobot (IRBT +0.00%), United Rentals (URI 2.11%), and WEX (WEX 1.39%). These are three of the cheapest stocks I own. Read on to see what each company does, and why I believe they're great stocks to buy and hold for the long term.
Image source: iRobot.
1. iRobot: A market-share leader facing short-term headwinds
When it comes to autonomous floor-cleaning robots, iRobot is the global market-share leader by a mile. According to the company, excluding China, it has a whopping 62% of the estimated $2.5 billion market. However, according to Fortune Business Insights, this market is expected to grow at a 24% compound annual growth rate through 2027, meaning iRobot could lose market share and still easily double the size of its business.
iRobot might cede some market share in the coming years, but I wouldn't count on it losing too much. Some skeptics rightly point out cheaper robotic vacuum options from competitors. However, iRobot's premium position is well-earned, and it's clear to me that consumers love the product. After all, consider that 12.5 million iRobot customers have voluntarily signed up for communications and software updates as of the third quarter, up 60% year over year.
Thanks to strong, growing relationships with its customers, iRobot management hopes it can drive more direct-to-consumer (DTC) sales when people upgrade to newer vacuum models. That would help increase the company's profit margins by cutting out third-party retailers and other middlemen. There's already reason to be optimistic here, considering Q3 DTC revenue was growing faster than total revenue and already made up 9% of the mix.
Moreover, iRobot management hopes its direct relationship with consumers can drive ancillary product sales. Its hand-held vacuum is already selling well, and sales for replacement accessories are also growing nicely. Furthermore, the company recently acquired Aeris Cleantec so it can sell air purifiers to its existing customer base. The acquisition is just one step toward its goal of building out "a larger ecosystem by entering new adjacent robotic and smart home categories."
Right now, iRobot is facing supply-chain headwinds and ongoing tariffs on its products made in China. These two things are eating into its bottom line and spooking the market. However, the company remains profitable. If these headwinds are only temporary, profitability will rebound. Therefore, there's risk but opportunity. And investors are being offered shares of iRobot today at one of their cheapest valuations ever at just 1.2 times trailing sales. That's a bargain, in my opinion.
Image source: Getty Images.
2. United Rentals: A cash-flow snowball opportunity
Many investors buy stocks with exorbitant valuation, trying to find investments that can go up 10 times in value in just 10 years. They don't think a stock trading at a modest 20 times trailing earnings could possibly grow tenfold. Those extreme returns usually go along with lofty expectations and sky-high valuation ratios. Right?
And yet, that's exactly what United Rentals stock has done over the past 10 years. Its stock has traded for 20 times trailing earnings or cheaper for most of that time.
Like iRobot, United Rentals is the market-share leader in its industry: equipment rentals. However, unlike iRobot's stellar 62% market share, United Rentals only has 13% of its chosen target market. This suggests the space is extremely fragmented, with small players making up the majority of the sector. And this reality helps us understand why United Rental's goal is to be a consolidator in its industry. For a recent example, it acquired General Finance for about $1 billion in April.
The market-consolidation strategy works particularly well for United Rentals, in my opinion, because of the company's cash flows. Consider that the company's free cash flow margin was 16%, 17%, and 29% in 2018, 2019, and 2020 respectively. Last year's margin was a bit of an anomaly considering management was conserving cash in an abundance of caution. However, its free cash flow margin is 18% through the first three quarters of 2021, which is an outstanding result.
United Rentals' competitors are also highly profitable, meaning acquisitions immediately contribute to its cash flows. And beyond snapping up market share, the company also makes a habit of using cash flow to reward shareholders with share repurchases. For example, its outstanding share count has been down 15% over the past five years, boosting shareholder value in the process.
I expect acquisitions and share repurchases to continue going forward, meaning United Rentals stock could beat the market in the future for the same reasons it's been a market-beater in the past.
Image source: Getty Images.
3. Wex: A fully recovered business with big growth plans
While both iRobot and United Rentals are cheap stocks worth owning, I believe Wex stock is the best long-term opportunity among these three.
But first, here's what it does: Wex is a niche financial technology stock. It provides corporate payment solutions so companies can manage expenses related to their fleet of vehicles and also manage corporate travel expenses. The company has recently added services for corporate healthcare plans, giving it three fairly diverse business segments. In the most recent quarter, its Fleet segment accounted for 59% of revenue, the Travel and Corporate Solutions segment was 19%, and the Health and Employee Benefit Solutions segment was 22%.
The COVID-19 pandemic ravaged normal business operations for most of Wex's customers, so it's not surprising that the stock fell hard in early 2020. What is surprising, however, is how well the company's revenue ultimately held up. Full-year 2020 revenue was only down 10% from 2019, a reminder of how mission-critical Wex's services are -- even in difficult times.
However, the market hasn't rewarded Wex's resilience. The stock is still down 46% from the all-time high it reached shortly before the pandemic started. Fortunately, the business has already fully recovered. It generated a record quarterly revenue of $483 million in the third quarter. Moreover, at the midpoint of its guidance, it's projecting full-year 2021 revenue of $1.83 billion, a 6% increase from 2019's reading.
Wex's management believes it can grow its top line between 10% and 15% annually with a mix of organic growth and acquisitions. And profitability is expected to grow faster than that. These are market-beating growth rates that should be taken seriously, given the company's history of delivering on growth targets. Looking at its current price-to-sales ratio of just 3.4, the only time in the last five years that it was cheaper to buy Wex stock was in the darkest depths of the 2020 market crash.
Why Wex is the winner today
To conclude, iRobot is trading at a historically cheap valuation but is still facing some uncertainty going forward. For its part, United Rentals should continue to perform well, especially with infrastructure spending being prioritized. However, the stock has been even cheaper many times during its history. So while it's cheap in comparison to many other stocks, it's currently trading at the high end of its historical range.
That's why I like the balance between risk and reward that Wex provides in relation to iRobot and United Rentals. Not only has Wex fully recovered, its resilience in 2020 was demonstrative of how important its corporate services are. I believe these will remain important, and the business will continue to grow as it has in times past. For this, investors who buy today get a cheap valuation, making this an attractive long-term opportunity.
