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2 Absurdly Cheap Stocks That Could Double Your Money

Motley Fool - Fri Apr 28, 4:05AM CDT

Investors were happy to close the books on 2022 and look to greener pastures in the new year. While the blue chip-centered S&P 500 index and tech-focused Nasdaq Composite have rebounded around 6% and 13%, respectively, year to date, there are still interesting opportunities to score deep values.

Some companies are struggling to grow revenue right now, sending their stocks to rock-bottom prices. But some of these companies possess qualities that point to better days ahead. Because the market doesn't yet recognize the value in these companies, investors can buy them at dirt cheap valuations.

Stitch Fix(NASDAQ: SFIX) and CarMax(NYSE: KMX) are completely different businesses. One is a personal styling service, while the other sells used cars. However, both companies use data science to serve their customers.

Let's take a deeper look at why these stocks could be rewarding investments over the long term.

1. Stitch Fix

To find genuine bargains in the market, you sometimes have to look at qualitative aspects of a business that the market doesn't appreciate. That's the only way to understand the value in Stitch Fix right now, which reported declining revenue and clients in the last quarter.

The stock is down about 60% over the last year. In the most recent quarterly update, the company reported a 20% decline in revenue, with active clients using the service down 11% to 3.57 million over the year-ago quarter. Even worse, management guided for another decline in revenue of at least 20% year over year for the next quarter.

It's difficult to see value in a company that's performing this poorly, but at the current market cap of $419 million, Stitch Fix is being valued at a small fraction of its current annual revenue of $1.8 billion. That's a cheap price-to-sales ratio of 0.23. Keep in mind, this is a company that was growing revenue more than 20% a year before the pandemic and was valued much higher by the market.

Chart showing Stitch Fix's PS ratio spiking in 2021 and then falling.

SFIX PS Ratio data by YCharts

Founder Katrina Lake is back as CEO for a temporary period until the company finds a permanent leader. Lake is prioritizing profitability, which included reducing the headcount by 20% and closing one of its warehouses. This puts the company on track to be free cash flow positive in the next few quarters.

Looking beyond the near term, Stitch Fix has a tremendous advantage with its investments in data science. While the rollout of its Freestyle service got the company away from its core of delivering personalized style recommendations to clients, the ability to leverage billions of data points on style preferences, fit, and sizing for its clients is still there. I believe the weak macroeconomic environment has as much to do with the company's recent performance as much as anything else. Once the headwinds clear, Stitch Fix should deliver much better revenue performance.

Moreover, Stitch Fix is well-financed to weather the storm. It has a very strong balance sheet with over $200 million in cash and short-term investments and just $4.7 million in long-term liabilities.

The risk-reward ratio is heavily stacked in investors' favor. As soon as the company stabilizes revenue growth, the stock could easily double off these lows but still be trading at a fraction of its annual revenue.

2. CarMax

CarMax is another company with a competitive advantage not fully appreciated by the market due to temporary challenges in the auto industry.

The stock has fallen about 55% from its previous highs. CarMax is the leading retailer of used cars, with 240 locations around the U.S. That wide footprint gives the company incredible advantages in serving a lot of customers and gathering data on vehicle trade-ins and sales, but it also makes it susceptible to swings in auto demand.

Last year was the worst year for auto sales in more than a decade. Disruptions to vehicle production caused by the pandemic, coupled with macroeconomic headwinds, proved too much for CarMax. The company reported a 25% year-over-year decline in revenue in the fiscal fourth quarter (which ended in February). That brought full-year revenue down 6.9% to $29.7 billion.

But while comparable store unit sales collapsed 14%, CarMax's competitive advantage with appraising vehicles and managing inventory shone in a big way. Gross profit per retail unit was $2,277, up $82 year over year.

CarMax has been in business for 30 years, which gives it a long history of gathering data that it uses to accurately value vehicles. It further bolstered this advantage with the acquisition of Edmunds in 2021, which it uses to funnel more dealers and more sales into its MaxOffer digital appraisal platform.

During the company's investor day in 2021, management disclosed it has more than 300 million digital interactions with customers, processes over 1 million credit applications, and values over 8 million vehicles per year. This is the heart of CarMax's competitive advantage, and management continues to expand on it with investments in data science and artificial intelligence.

CarMax is going through one of the worst used car markets in history. But it will survive, and with a top online competitor like Carvana experiencing severe financial pain right now, CarMax could come out on top.

On that note, despite being the largest used car dealer in the U.S., CarMax's used market share is less than 5%, so it can grow for a long time.

This long runway of growth is significantly undervalued. The stock is trading at 22 times trailing earnings, which is in line with the average stock. But using its previous peak earnings power, the stock is trading at less than 10 times fiscal 2022 earnings a year ago. That is a genuine bargain. From these share prices, the stock could potentially double as the auto industry recovers.

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John Ballard has positions in Stitch Fix. The Motley Fool has positions in and recommends CarMax and Stitch Fix. The Motley Fool has a disclosure policy.

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