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Wall Street Is Bullish on These 3 Top Stocks: Are They a Buy?

Motley Fool - Sat Sep 30, 2023

The markets have given investors a wild ride over the last three years, and that has resulted in several promising companies selling at deeply discounted prices. Investors who sift through the wreckage carefully are likely to find some gems that will earn them big returns in the years to come.

Top consumer discretionary companies are a great sector to look for bargains at the moment. High inflation and lower consumer spending have pressured these companies' revenue growth and scared away many short-term traders. But Wall Street analysts are high on the long-term prospects of Chewy(NYSE: CHWY), Sonos (NASDAQ: SONO), and Lovesac(NASDAQ: LOVE). These three consumer discretionary stocks trade well off their recent highs, and analysts are forecasting near-term price targets well above their current share prices.

Still, Wall Street analysts aren't always right, so let's find out more about these three companies to see which ones are worth buying.

1. Chewy

Chewy is growing into a leading online destination for millions of pet owners to buy pet food and other essentials for their furry family members. After launching in 2011, Chewy quickly scaled into a large business with over $10 billion in annual revenue. However, slowing growth has sent the stock price down 85% off its previous highs.

The pet products and services specialist offers a wide selection with thousands of brands available on its website. A key strength of Chewy's business model is customer loyalty. About three-quarters of its online sales come from its auto-ship program, where customers can have select items shipped on a regular schedule. This is a great reason to buy the stock since a high volume of repeat business helps lower business risk and gives management a degree of visibility into future sales trends.

Moreover, Chewy padded its sales growth by expanding its offering to health services, which further differentiates the experience for customers and encourages repeat purchase behavior.

The risks for Chewy include increasing competition from Amazon and other e-commerce pet stores. Active customers fell 0.6% year over year in the most recent quarter. It's unclear whether this reflects slowing growth in the number of pet households during this period of high inflation or its impact from the increased competition.

Still, the stock is cheap, so investors might want to give Chewy the benefit of the doubt. The long-term upside could far outweigh the downside. The company delivers solid top-line growth, with net sales up 14% year over year in the second quarter, and management sees profitability improving over the next few years as it builds more automated fulfillment centers that will help reduce costs.

CHWY PS Ratio Chart

CHWY PS Ratio data by YCharts.

Most Wall Street analysts rate the stock a buy, with an average near-term price target of $36, or double the current share price. Chewy's price-to-sales (P/S) ratio of 0.71 significantly discounts the potential for greater operating efficiency to improve the company's profitability.

The current P/S multiple implies a price-to-earnings ratio of about 14, assuming Chewy can achieve a below-average net profit margin of 5% over the long term. That is cheap for a profitable e-commerce business posting double-digit sales growth.

2. Sonos

Sonos is a leading brand of audio products, including home theater speakers, soundbars, smart speakers, and other accessories. Over the last seven years, revenue doubled to over $1.7 billion through fiscal 2022 (ended in October), but the company was hit hard by macroeconomic headwinds that sent the stock tumbling well off its highs.

Rising inflation pressured sales of consumer electronics over the past year, although the market is expected to grow over the long term. But home audio is highly competitive. There are numerous brands to choose from at all price points, and we can see how this impacted the company's performance.

Sonos' gross profit margin hovers in the mid-40s, and even fell from fiscal 2017 through fiscal 2019. As a result, Sonos struggled to generate consistent earnings growth.

Through the first three quarters of the current fiscal year, revenue declined 6% year over year, while higher expenses cut operating profit from $149 million last year to less than $8 million this year.

The reason why an investor might consider buying the stock at these discounted share prices has to do with where the future of audio is trending. More home audio enthusiasts are looking for products that can be easily controlled with an app while accessing a variety of streaming services. Sonos is meeting this demand, and it's doing it in a unique way.

Top competitors like Apple's Homepod and Amazon's Echo are more focused on high-tech features like voice assistant technology and don't meet the needs of audio enthusiasts, while traditional high-fidelity brands are focused only on acoustic sound quality with no app integration. Sonos distinguishes itself with a focus on sound quality and software integration.

Like Chewy, most analysts rate the stock a buy, with an average price target of just over $20, or nearly 60% above the current share price. Indeed, the stock trades at a low price-to-sales ratio of 0.98, which could undervalue the company's growth and profitability in a stronger consumer spending environment.

SONO PS Ratio Chart

SONO PS Ratio data by YCharts

The world of home audio is rapidly evolving with technological advancements, so I would be cautious about buying Sonos. I would favor Chewy due to the stock's lower valuation and the company's recurring revenue streams from its auto-ship program, which makes Chewy less dependent on winning new customers to justify its valuation.

3. Lovesac

Lovesac is a fast-growing home furnishing brand that is standing out in a competitive industry. It makes modular furniture, or what it calls Sactionals, that allows customers to customize their seating arrangements, which resonates with buyers. But despite strong growth during a weak environment for home goods, the stock is down 80% off its previous peak.

Lovesac's direct-to-consumer business model, focus on quality manufacturing with eco-friendly materials, and commitment to building durable products explain the brand's impressive growth, as net sales grew 30% in fiscal 2023 ending in January.

However, sales growth slowed to 9% year over year in the fiscal first quarter. Management blamed a higher promotional sales environment and higher interest rates, which made financing a purchase more expensive.

Lovesac is obviously not immune to a possible recession, but the stock's low valuation seems to undervalue the company's profitable growth. While selling furniture can be a tricky business to sustain long-term growth, considering it's generally a one-time purchase that doesn't lead to repeat purchases, the stock might be worth buying for a few reasons.

Lovesac is gaining market share in the home furnishings industry while reporting a profit. Analysts expect the company to report adjusted earnings per share of $1.93 for fiscal 2024 before growing to $2.86 next year. Sales are expected to increase by 9% this year before accelerating to 13% in fiscal 2025.

Meanwhile, the stock sells at a cheap forward price-to-earnings ratio of 9, which undervalues the brand's record of growth and where it's likely headed. Every analyst that covers the stock on Wall Street rates Lovesac a buy, with an average price target of $51, which is more than double the current share price. In this case, I believe analysts could be right.

Selling furniture can be a tough business, but Lovesac is still small with a long runway of growth, and it clearly has a unique business model that is resonating with customers looking for flexible solutions in their home.

What's more, Lovesac can pad its growth by expanding its product line in the future, as it seeks to become one of the most innovative furniture brands. For these reasons, the stock is a buy.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. John Ballard has positions in Amazon.com. The Motley Fool has positions in and recommends Amazon.com, Apple, Chewy, and Sonos. The Motley Fool recommends Lovesac. The Motley Fool has a disclosure policy.

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