Markets that go through cycles are good since they create opportunities for patient investors who watch for the best deals in the stock market. Today, a shift in the U.S. economy is causing some stocks to come into and out of favor, a most welcomed sign of the rinsing effect that brings on compounding opportunities.
After the U.S. consumer sentiment index had its lowest reading in over 7 months, some companies in the consumer discretionary sector have fallen to unjustifiably low valuations. This is where these patient and watchful investors have a chance to add names like Lululemon Athletica Inc. (NASDAQ: LULU), Starbucks Co. (NASDAQ: SBUX), and even Ulta Beauty Inc. (NASDAQ: ULTA) to a potential ‘buy the dip’ watchlist.
These stocks have more in common than just being in the NASDAQ index; they all share an almost obvious brand moat and predictability regarding their future cash flows, but these only come quickly to the savvy investor. As every investment is valued as the present value of all future cash flows, here’s why these businesses could make a quick rebound after disappointing sentiment readings.
Lululemon's 7-Year Low Valuation: A Dip Investors Can't Ignore
Shares of Lululemon are now down to only 59% of their 52-week high prices, sending the company into deep bear market territory. According to Wall Street, a bear market is a 20% or more decline from recent highs. With this in mind, here’s why the stock may not stay down for much longer.
Its 24.5x price-to-earnings (P/E) ratio is the lowest valuation the stock has seen since 2017, making it a potentially once-in-a-cycle opportunity for those bullish on the brand. As long as Pilates moms, sorority sisters, and finance bros exist, Lululemon is expected to see predictable demand.
And even if U.S. consumers are down and out, Lululemon has strategically expanded into international markets to cushion these domestic cycles. According to the company's latest quarterly earnings report, America's net revenue increased only 3%, while international revenues jumped by 35%.
Knowing that economies of scale and market risk diversification could help the brand reach a higher valuation, analysts at Telsey Advisory Group decided to boost their price targets for Lululemon stock to $470 a share. To prove these analysts right, the stock must rally 53.5% from its current level.
How Starbucks' Financials Reinforce Its Status as Social Currency
There’s a reason nobody walks into a business meeting holding a Dunkin’ Donuts coffee cup or a Dutch Bros Inc. (NYSE: BROS) branded coffee either. Those who want to feel confident and be seen as ‘cool’ or respectable will walk in carrying their green medusas.
When brands become synonymous with objects, investors like Warren Buffett get excited. People don’t say “Internet it”; instead, they refer to “Google it” when trying to find some online information, and the same is true for Starbucks.
People don’t set up a study session or a catch-up meeting at a “coffee shop”; they often say that they will meet at a Starbucks, and that’s the type of social currency that keeps the brand in its pricing power status. Starbucks’ financials show an average gross margin of over 27%, allowing the company to pass enough capital down for intelligent allocation.
This smart allocation nets investors an average of 20% of return on invested capital (ROIC), which is one of the hidden gems in wealth compounding. That is why analysts at Bank of America felt so comfortable placing a $112 valuation on Starbucks stock, or 40.7% higher than today’s stock price.
This should be a welcome sign for the stock’s price action, which has fallen to only 74% of its 52-week high price, giving investors the initial pillar to build a potentially ‘undervalued’ case for Starbucks stock.
Ulta's Unique Advantage Lies in Products Not Impacted by Consumer Sentiment or Financial Limitations
That’s right; regardless of whether the economy is booming or busting and whether consumer sentiment is at all-time highs or lows, people will always find room in their budgets for make-up and skincare products. This fact isn’t far from coffee economics, which benefits Starbucks, but that’s beside the point.
Because Ulta’s revenue comes mostly (95%) from loyalty program members, its revenue streams are as predictable as betting on thousands of consumers brewing coffee every morning. This is why management feels comfortable buying back as many as 588,004 shares off the open market for $285.1 million.
The company’s financials also showcase gross margins at 42.7%, allowing management to deploy capital into further growth initiatives beyond stock buybacks. These initiatives translate into ROIC rates of up to 28%, boosting sentiment amongst Wall Street analysts, even if consumer sentiment remains depressed.
Those at J.P. Morgan Chase & Co. saw it fit to slap a $544 a share price target for Ulta stock, daring it to rally by 39.2% from where it sits today, which also happens to be 68% of the stock’s 52-week high prices.
