Bath & Body Works' 12% Dip Attracts Fundamental Investors

A fundamental approach to investing is as old as the profession itself. There is a good reason why it has bested the test of time and endless trial and error: It works. From Benjamin Graham to its star student, Warren Buffett, the process of finding stocks with solid financials and a reasonable discount has yielded its latest stock today.

After falling by as much as 12.4% after their first quarter 2024 earnings announcement, shares of Bath & Body Works Inc. (NYSE: BBWI) start to fit the profile of a stock that could definitely make it to the ‘fundamental’ buy list. Markets are used to seeing easy profits after the COVID-19 pandemic brought on lower interest rates and cheap money to go around, and even after rates were hiked, investors still bought stocks under the same conditions.

However, the days of easy money are now over, and even with the prospect of interest rate cuts on the horizon, today’s economy calls for businesses with strong cash flows and profitability rates. Before investors find out why Bath & Body Works stock fits these criteria, it would be beneficial to understand why the economy makes stocks like this one a must-have.

Investors' Portfolios Will Dance To a Different Tune

Economists have had to wake up to one of history's most dreaded economic environments. Stagflation was a scenario nobody wanted to see come into reality, yet here it is. Defined as low economic growth and high inflation, recent U.S. economic data throws the economy into stagflation.

Over the past quarter, gross domestic product (GDP) growth figures were revised lower to 1.3%, while inflation remained above 3%.

Boiling it down to simple terms, investors need to find businesses looking to grow above-average rates and carry products worthy of the consumer staples category so that higher costs can be passed down to customers.

While not a direct competitor, Bath & Body Works is still considered a peer to Ulta Beauty Inc. (NASDAQ: ULTA) because its products are relatively recession-proof. Whether the economy is booming or busting, people will likely find a spot in their budgets for makeup and skincare, and this demand ‘moat’ shows through its financials.

Bath & Body Works Still a Priority

Inflation-choked consumers have forced stocks like Target Co. (NYSE: TGT) and other grocers to mark down their prices on thousands of items, which is just the opposite of the sort of moat investors should be looking for in stagflation environments as it hinders growth.

On the other hand, Bath & Body Works’ quarterly financials show signs of sticky pricing power. Despite sales staying relatively flat over the year, they still beat management’s previous guidance, but that’s not the focus of today’s fundamental thesis.

Gross margins increased from 42.6% in 2023 to 43.8% in 2024 despite most products still showing rising costs. The ISM manufacturing PMI index recently showed prices were the highest reading in the report’s segments, at 57% (anything above 50% is expansion), which is why that matters.

Rising margins on flat sales can only mean that Bath & Body Works is passing on its rising costs to consumers and seeing no natural adverse effect on its business. More than that, it allows operations to remain profitable, as rising operating margins would show (12.9% in 2023 versus 13.5% in 2024).

Despite seeing rent inflation and gas prices lead the way in the erosion of buying power, consumers still found a way to buy Bath & Body Works products, or at least that’s what these financial trends show. It's worth examining the real reason fundamental investors are here.

It’s a Dip Worth Looking At: Bath and Body Works Stock Analysis

As Bath and Body Works stock traded down to 83% of its 52-week high, investors may lean more on Deutsche Bank’s valuation of $57 a share, which calls for up to 26% upside from where the stock sits today. These analysts expect to see 13.5% earnings per share (EPS) growth in the next 12 months, making it a stagflation-beating candidate.

Looking deeper into the company’s financials for the quarter, free cash flow (operating cash flow minus capital expenditures) rose from negative $49 million in 2023 to positive $30 million in 2024. With these funds, management saw fit to buy back up to $96 million worth of stock, suggesting they expect to see better days—and higher prices—ahead.

There’s also a good reason why Bath & Body Works stock has tripled the Consumer Discretionary Select Sector SPDR Fund (NYSEARCA: XLY) over the past 5 years. The company’s return on invested capital (ROIC) rates hover between 20% and 22%, making for a wealth compounder.

Annual stock price performance tends to follow the long-run ROIC rate over time, which is one-factor investors can credit for the stock’s outperformance in the consumer discretionary sector. This is another basis for believing it will keep outperforming even during stagflation.   

The article "Bath & Body Works' 12% Dip Attracts Fundamental Investors" first appeared on MarketBeat.