Investing in stocks on sale can be a savvy move for long-term growth. Legendary investor and longtime Berkshire Hathaway chief Warren Buffett once famously penned in his 2008 annual letter to shareholders: "Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down."
By purchasing stocks at a discounted price, investors position themselves to benefit from potential future appreciation if and when the market sentiment eventually turns in their favor. However, it's essential to determine if a depressed stock is a value play or a value trap.
Let's look at three beaten-down stocks at various stages of the business cycle and determine if they are ready to bounce back.
1. Chewy
Despite record revenue and profitability in its most recent quarterly earnings, Chewy(NYSE: CHWY) stock is down 26% this year.
Perhaps one reason the market has turned its nose up at the online pet food and products retailer is that the company's active customer base is going in the wrong direction. Specifically, Chewy recorded 20.4 million customers at the end of its fiscal 2023's first quarter, which was down 0.9% from the year-ago quarter.
Any time a growth company stops growing its customer base, investors might start focusing on profitability. In Chewy's case, the online retailer posted $126.8 million in free cash flow for its first quarter, representing a significant jump from $6.4 million in its fiscal Q1 2022.
Another positive is its balance sheet. At the end of its most recently reported quarter, Chewy had $803 million in cash and cash equivalents and almost no long-term debt. This means interest expenses won't weigh the company down like many companies trying to pay back debt in a high-interest-rate environment.
Additionally, management still expects revenue to grow to between $11.15 billion and $11.35 billion in its fiscal 2023, representing an increase of roughly 10% to 12% from fiscal 2022.
CHWY Price to Free Cash Flow data by YCharts
Chewy shares are not cheap, trading at roughly 47 times free cash flow. For comparison, rival retailer Petco Health and Wellness trades at 33 times price to free cash flow. But with a solid balance sheet and strong revenue growth, Chewy is not a stock that investors should write off just yet.
2. Harley-Davidson
Harley-Davidson(NYSE: HOG) celebrated its 120th anniversary this summer. It has been a publicly traded company since 1986 and a dividend payer since 1993. Yet, the motorcycle manufacturer has struggled in recent years as demand has waned among consumers over the past decade, resulting in the stock being cut in half during that time.
As a mature business lacking substantial growth, Harley-Davidson has pivoted toward maximizing profitability and returning capital to shareholders, and that has translated to record-high earnings per share (EPS).
To illustrate, the company generated total revenue of $2.75 billion and a gross profit of $975 million during the first six months of 2023, representing a year-over-year increase of 8% and 23%, respectively. That growth significantly surpasses the increase in worldwide Harley-Davidson motorcycle shipments, which saw only a 2.4% uptick to 105,171 units during the same period.
But the real key to Harley-Davidson's potential rebound comes with the company's share repurchases. Over the past decade, management has reduced the company's outstanding share count by 36%, making each remaining share more valuable. As a result of management's capital allocation strategy, the company has generated a diluted EPS of $3.27 in the first half of 2023, up 12% from the first half of 2022.
Harley-Davidson's diluted EPS of $5.32 over the last 12 reported months is also near an all-time high. So, as Harley-Davidson's EPS has grown and its stock price tanked, the result is an incredibly low price-to-earnings (P/E) ratio of 6.3. For comparison, the stock's five-year median multiple is 11.4, meaning that even if the company is in a stagnant growth phase, it's still trading at an incredible price for an iconic American brand that has withstood the test of time.
HOG EPS Diluted (TTM) data by YCharts
3. Warby Parker
Warby Parker(NYSE: WRBY) went public via a direct listing in late 2021 at $40 per share. It was expected to disrupt the eyewear industry as an online-focused retailer. Since then, the stock has fallen 77% as the company's modest revenue growth and lack of profits have made many investors head for the exits.
Nonetheless, there is optimism for the troubled stock, with management pivoting to physical retail locations as a one-stop shop for people seeking corrective vision solutions. Specifically, Warby Parker has added 39 net new stores over the trailing 12 months, bringing its total store count to 217 locations, or a growth rate of 22%.
Coincidentally, the company's retail revenue increased 22% from second-quarter 2022 to Q2 2023, outpacing its overall revenue growth of 11%.The retail boom is also a driver behind Warby Parker's management recently raising the company's 2023 revenue outlook to $655 million to $664 million, representing an increase of 9.5% to 11% compared to its 2022 results.
Secondly, Warby Parker is another company on this list with a debt-free balance sheet as it works its way to becoming free cash flow positive. Warby Parker had $213 million in cash and cash equivalents at the end of its most recently reported quarter, so the company shouldn't have to take out expensive debt anytime soon with a long cash runway.
Image source: Getty Images.
One concern management will need to address is the company's growing outstanding share count with its stock-based compensation packages. Since going public just two years ago, Warby Parker's outstanding share count is up 5%, meaning investors' ownership stake is being continually diluted as time goes on without any plan for management to reverse the trend.
While Warby Parker's initial growth rate didn't meet investors' initial expectations, the company's strong balance sheet has put the stock in an excellent position for a rebound if and when it can grow its revenue and become profitable through expanded retail locations.
Are these struggling stocks worth buying?
Investors should never buy a stock solely because it has dropped; you must understand the reasons behind it. Sometimes, the market can forget about a company after years of slowing growth (like Harley-Davidson), its valuation starts to matter (like Chewy), or its thesis changes (like Warby Parker).
Nonetheless, these three stocks are leaders in their respective industries with loyal customers, so if investors can take a long-term approach, they might just buy them at significant discounts right now.
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Collin Brantmeyer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chewy. The Motley Fool recommends Topgolf Callaway Brands. The Motley Fool has a disclosure policy.
