Top 3 Stocks For The Contrarian Investor

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Top 3 Stocks For The Contrarian Investor
Top 3 Stocks For The Contrarian Investor

The consumer discretionary sector (XLY) was hit hard, down more than 30% YTD. So you’re probably wondering why I would invest in this sector, especially as people avoid becoming spendthrifts in this higher rate environment, as the cost of goods and services continues to increase? For exactly that reason.

 

As the markets crash, investor sentiment is low, and fear takes investors on a volatile rollercoaster ride. In the words of Warren Buffett, “Be fearful when others are greedy and greedy when others are fearful,” which is why we’ve identified three consumer discretionary industries that have been affected by the bear market and volatility. Each is a solid consideration for a portfolio because they provide several staples and/or services that are near recession-proof.

 

As recession talks increase, this article provides investors with three options that may prove resilient during times of market downturns. If you’re sitting in cash, a contrarian point of view is a way to consider investments that prevent sitting in cash too long. As billionaire Ray Dalio put it, “Cash is Trash, And Equities Are Even Trashier!” Citing high inflation as a way to lose in the current market environment, he believes the key to navigating the markets is to consider opportune times to buy. As I wrote in Investing For a Potential Recession: Top Consumer Staple Stocks, “It’s about time in the market, not timing the market.” Although this article focused on consumer staple stocks, the same holds true for these three discretionary picks. Focusing on quality stocks with solid balance sheets, prudent management, and overall fundamentals is a way to seek out strong buys to consider in anticipation of a recession.

 

CNN Fear and Greed Index

CNN Fear and Greed Index (CNN Fear & Greed Index)

 

As fear continues to be the driving emotion moving the markets, people are avoiding big and luxury purchases because the cost of goods and inflation are outpacing wage increases. As such, people are making less money on a real basis. When push comes to shove, consumers will continue to spend money on necessary goods like shelter and food, which are up significantly over the last year, leaving little room for consumer discretionary spending. However, we have found three stocks that, while part of this sector, offer necessary goods and services and should serve to benefit the contrarian investor.

Top Consumer Discretionary Stocks

Unlike consumer staples, consumer discretionary stocks are getting crushed. Down more than 30% YTD, as economies contract, investors tend to flock to lower-risk investments. We see the consumer discretionary space as an opportunity to benefit from the market downturn when others fear the sector. Selecting the right investments that stand to benefit, using our quant ratings is a great way to focus on the below three strong buy recommendations in the consumer discretionary space.

1. H&R Block (NYSE:HRB)

  • Market Capitalization: $5.46B
  • Quant Rating: Strong Buy
  • Quant Sector Ranking (as of 6/24): 2 out of 520
  • Quant Industry Ranking (as of 6/24): 1 out of 12

H&R Block (HRB), one of the world’s leaders in tax preparation, is a unique consumer discretionary company. Where some would think it leans towards the financial sector given they provide income tax return preparation, it’s part of specialized consumer services. Headquartered in Kansas City, Missouri, the company, through its subsidiaries and many retail office spaces, offers do-it-yourself (DIY) and assisted income tax preparation in the United States, Canada, and Australia.

We selected this stock because, like death and taxes, which cannot be avoided, H&R Block has a consistent track record of serving millions of customers in their tax preparation. It includes more than 60,000 employees over the last year. As proof of their growing success, HRB acquired Wave Financial for $537M in 2019. The rapidly growing payment processing platform aids small businesses with their financial and payroll needs and is a perfect complement to HRB. Wave is a fintech company, and as fellow Seeking Alpha contributor Mike Coppola, CFA writes, “New initiatives to take advantage of technology and digital to increase customer retention and penetration into new markets are just beginning.” This type of initiative showcases a desire to stay relevant and take advantage of how financial services embrace digital transformation. In addition, H&R Block is rated a strong buy through our quant rating system that showcases solid fundamentals, and the company has been on a longer-term bullish trend with A+ momentum.

H&R Block Momentum & Valuation

HRB outshines its sector peers quarterly, and HRB’s prior performance continues to improve.

 

HRB Momentum Grade

HRB Momentum Grade (Seeking Alpha Premium)

 

Year-to-date, the stock is +42%, and over the last year, +43%. Although its valuation grade of C- is less than ideal, the stock still trades at a discount, with forward P/E of 9.92x and a PEG (TTM) -99.12% difference to the sector. The stock is relatively undervalued while strong on metrics like Growth, Profitability, and Earnings Revisions. Let us dive in further to discover why our quant ratings give this stock a strong buy recommendation.

HRB Growth & Profitability

With tremendous free cash flow, twice the yield compared to the S&P 500, A+ Growth Grade, and an overall A- Profitability grade, H&R Block continues to deliver great earnings results. Q3 2022 EPS of $4.11 beat by $0.36, and year-over-year revenue beat by more than 568%, justifying HRB’s track record of paying its shareholders a consistent dividend over the last 32 years. HRB’s forward dividend yield of 3.10% continues to showcase its strong earnings and profitability.

 

HRB Profitability Grade

HRB Profitability Grade (Seeking Alpha Premium)

 

HRB’s strong gross profit margins and EBIT margins above significantly outperform its sector. HRB has consistently increased its market share over the last two years, garnering 300,000 new clients, and has grown its revenue by 10%, up 25% for Q3 2022.

 

HRB Q3 2022 Revenue Growth

HRB Q3 2022 Revenue Growth (HRB Q3 2022 Revenue Growth Investor Presentation)

 

“Driven by strong marketing and more advanced tax grow training, our small business assisted tax clients grew 5% on top of the 4% growth reported last year. We also realized strong growth in net average charge this season of approximately 8%, primarily driven by a favorable mix as we serve more complex businesses…over the last several years, especially in light of the macro backdrop. We’ve grown revenue and improved our value proposition while returning significant capital to shareholders. The H&R Block story is strong. We produced significant cash flow, pay a growing dividend, continue to be opportunistic with share repurchase, and are making great strides” –Jeff Jones, HRB President & CEO.

H&R Block continues to be a leader in tax prep. With its foresight by expanding into other market segments to account for customers’ desire for mobile services, HRB’s business model should be strengthened. While H&R Block is a consumer discretionary stock, it is very cyclical from a revenue stance because taxes are typically completed by April unless an extension is granted. Because most people do not know how to prepare and file their own taxes, to reduce the risk of error, companies like HRB should almost certainly be forever in demand because taxes are inevitable. Thus, HRB stands to make money on an annual basis. Because H&R Block is considered a low-cost preparer, it has an advantage over other tax preparers as the Dollar Tree of tax preparers, in that they typically offer their services at a lower cost point than a Deloitte, Ernst & Young, or private CPA. HRB’s entry point is more attractive, thus saving people money, which is crucial in the current environment and also why our next stock is perfect for portfolios.

2. Dollar Tree, Inc. (NASDAQ:DLTR)

  • Market Capitalization: $34.92B
  • Quant Rating: Strong Buy
  • Quant Sector Ranking (as of 6/24): 3 out of 520
  • Quant Industry Ranking (as of 6/24): 1 out of 9
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In times of recession and high inflation, people flock to saver stores hoping to save a buck on necessities. As consumers feel the wrath of price increases, with groceries at the top of the list, many consumers are willing to forego their preferred retailers and alter their spending habits to shop at a discounted retailer like Dollar Tree for a fraction of the cost.

Operating in two segments, Dollar Tree and Family Dollar, both retail stores offer discounted merchandise, candy, food, personal care items, and more. Because Dollar Tree and Family Dollar carry staples, they are primed as go-to shopping options.

Dollar Tree vs Other Retailers 1-year Price Performance

 

Dollar Tree vs Other Retailers 1-year Price Performance

Dollar Tree vs Other Retailers 1-year Price Performance (Seeking Alpha Premium)

 

As Larry Cheung, CFA, writes in his article Dollar Tree: A Welcoming Destination During Recessions (Unlike Target), “Dollar Tree is a counter-cyclical name that has stronger appeal during recessions…Dollar Tree can be positioned as a macro hedge against uncertainty as a reasonable priced defensive name.” This retailer is a strong buy according to our quant ratings for portfolios for these reasons and its solid fundamentals.

Dollar Tree Valuation & Momentum

On the heels of big retailer Target’s May 18, 2022 earnings report, Dollar Tree dropped 20%, like many other retailers who experienced a massive selloff. The news of Dollar Tree being oversold caused DLTR’s valuation to contract. As a result, Dollar Tree’s current valuation comes at a premium with a 19.23x forward P/E ratio and a current PEG of 4.21x.

Dollar Tree 6-month Price Increase

 

Dollar Tree 6-month Price Increase

Dollar Tree 6-month Price Increase (Seeking Alpha Premium)

 

Despite the stock being overvalued, we believe that as inflation and recession fears continue to mount, consumers will continue to look for discounts on products that would otherwise cost a premium at standard retail prices as the economic outlook grows bleak. For this reason, we believe DLTR possesses A+ momentum.

 

DLTR Momentum Grade

DLTR Momentum Grade (Seeking Alpha Premium)

 

On a longer-term uptrend, DLTR has had tremendous momentum over the last year. Year-to-date, the stock is +11%, and over the last year, up nearly 60%. As showcased by the above Momentum Grades, Dollar Tree outperforms its sector peers. We see this stock as recession-resilient, and we believe the growth and profitability outlook for DLTR to be strong.

Dollar Tree Growth & Profitability

Reporting excellent top and bottom-line beats for Q1 2022 earnings, Dollar Tree analysts gave the company 22 upward revisions within the last 90 days. With an EPS of $2.37 beating by $0.39 and revenue of $6.90B beating by $137.25M, the company’s stock soared +21%. It was the top S&P gainer following the announcement, and its gross profits jumped 19.2% from the previous year.

DLTR EPS

 

DLTR EPS

DLTR EPS (Seeking Alpha Premium)

 

With strategic planning to increase prices to account for inflation as well as offering $3 and $5 items, Mike Wytinski, Dollar Tree President & CEO, said,

“The Dollar Tree team successfully completed its conversion to the $1.25 price point, contributing to both sales and margin improvements…Shoppers are responding favorably as the new, greater-value products hit our shelves…We are taking the necessary actions now to position ourselves for accelerated growth in what I view as the most attractive sector in retail, especially in the current economic environment…Value and convenience are more important than ever to our shoppers and the communities we serve.”

Wytinski couldn’t have said it any better, given the current outlook and uncertain environment we’re living in. As the Fed and consumers try to fight inflation, stocks like Dollar Tree are proving to be strong buys, as evidenced by the above charts and earnings.

3. AutoNation, Inc. (NYSE:AN)

  • Market Capitalization: $6.51B
  • Quant Rating: Strong Buy
  • Quant Sector Ranking (as of 6/23): 4 out of 520
  • Quant Industry Ranking (as of 6/23): 1 out of 26

AutoNation, Inc. (AN) is an auto retailer that offers domestic, import, and luxury vehicles through subsidiaries. In times of recession and market downturn, this sector typically sees plummeting sales because, like most luxury and discretionary spending, items like cars, boats, and trips are the first items to be cut when spending is tight. But, as we are strategic in our strong buy recommendations, AutoNation also offers some cushion in a diversified revenue mix that includes more than 30% of their gross profits from parts and services. For this reason, we believe AutoNation is a true contrarian pick in terms of auto sales while also a strategic contrarian pick that stands to benefit from alternate revenue streams.

When consumers are budget-conscious, and car sales decline, rather than buying new and used vehicles, customers buy the parts or plan to repair their vehicles to save. This is where AutoNation stands to gain even more from this business unit, supplementing as the other segments may see a pullback in sales and financing. Let us dive into the growth and profitability of AN.

AN Growth & Profitability

AutoNation offers customers a broad range of products and services, including new and used vehicles, financing and insurance offerings, and vehicle repair and maintenance. Record Q1 2022 top and bottom-line results were showcased in AutoNation’s recent earnings. With an EPS of $5.78 beating by $0.53, an increase of 103%, and revenue of $6.75B beating by more than 14% year-over-year, 11 analysts revised their earnings.

“Success in the used car market, basically dictated by your ability to manufacture great quality, well priced desirable used cars, and this clearly covers key elements of the business, including efficient and effective reconditioning…we self-sourced 94% of our pre-owned vehicles that we acquired.” –Mike Manley, AutoNation CEO.

 

AutoNation EPS

AutoNation EPS (Seeking Alpha Premium)

 

Vehicle sales have been strong, and the company has done an impressive job of increasing margins while controlling expenses. This shows in their profitability, including a total variable gross profit increase of 31% year-over-year.

“The combination of strong growth in gross profit, strict cost discipline, and opportunistic share repurchase generated net income for the quarter of $362 million or $5.78 per share. EPS was up 107% versus prior year adjusted EPS of $2.79. This reflects our eight consecutive quarter of all-time high adjusted EPS” Joe Lower, AutoNation EVP & CFO.

With consumer spending down and market volatility continues to be a concern, this company is positioned well with a diversified revenue mix that drives profitability, as outlined in the images below.

 

AutoNation Diversified Product Mix

AutoNation Diversified Product Mix (AutoNation Q12022 Investor Presentation)

 

As auto sales begin to decline and fewer customers seek financing due to less discretionary spending dollars and higher interest rates, AutoNation can shift focus to its parts and service division. Already accounting for 34% of their gross profits, this should prove a resilient service and business segment, thus, driving their momentum.

AutoNation Valuation & Momentum

Up +25% over the last year and possessing an A- overall valuation grade, AN comes at a discount. In addition, forward P/E of 4.99x is a -56.17% discount to the sector. In addition to it being extremely undervalued relative to its sector peers like Carvana, Lithia Motors, and Penske Automotive Group, AN possesses stellar upward momentum.

 

AutoNation Valuation Grade

AutoNation Valuation Grade (Seeking Alpha Premium)

 

Although the economy is slowing, AutoNation’s momentum continues its bullish trend. Interest rates are increasing, causing the cost of financing also to steepen, so people are assessing whether they need new vehicles or would rather pay the price to repair and service their current automobiles.

 

AutoNation Momentum Grade

AutoNation Momentum Grade (Seeking Alpha Premium)

 

All of this, we believe, bodes well for AutoNation, whose A+ momentum grade showcases how the company has consistently outperformed its competitors quarterly. The executive leadership for each of our stock picks is planning for the future and the headwinds changing the spending patterns. We believe that our stock picks are excellent contrarian picks that will benefit from the downturn that could be on the horizon.