- Stocks have sold off sharply since mid-August.
- Individual stocks usually bottom before the market does, suggesting it can pay to buy leading stocks as sentiment worsens.
- This footwear retail stock may be in the bargain bin because it's trading at a discount to its typical valuation.
A significant sell-off after mid-month turned August into a disappointing month for long-only investors. The S&P 500 ETF (SPY) retreated 8.5% since August 16, leaving a 4.1% loss on the month. Likewise, the NASDAQ 100 (QQQ) fell 10.5% since mid-month, finishing the month with a 5.1% loss.
The decline after a rapid run-up since mid-June has flipped the script on sentiment again. The volatility index (VIX) is above 25, and the total put call ratio – a measure of bearish option put trading to bullish call buying – has returned above 1.20. No, investors aren’t as bearish as they were in June, but arguably, it wouldn’t take much more pain for sentiment to worsen, potentially setting stocks up for a short-term rally.
Today's down-open/up-close reversal day (a technical analysis 'hammer') adds conviction to thinking stocks are finding their footing. Especially since the S&P 500 ETF tested support this morning near $390. Since individual stocks tend to bottom before the market, it could be smart to use recent weakness to add some stocks to portfolios on sale.
In “Let Me Show You How to Play This Stock Amid Market Ups and Downs,” Real Money Pro’s Paul Price weighs in on the recent market action. He writes:
“The chart below highlights the waves in the S&P 500 over the past year…There were six or seven major cyclical swings in the index that took it from overbought to oversold and back again…The most oversold of those periods took place in mid-June. We then saw a major rally that lasted through mid-August. At that point, the S&P 500 was near its most overbought status since the previous summer…
Out of the blue, market sentiment collapsed after that. As of Aug. 30, the SPX's oversold reading was nearing its worst of the past 12 months…We started Wednesday's trading more than two standard deviations below normal. That suggests an ultra-high probability of a renewed surge higher.”
If you look at the extremes on the chart above, buying when the S&P 500 has gotten this oversold has worked out well this year. Of course, it’s anyone’s guess if it works out as well this time, but if it does, then it could be an excellent time to pick up shares in companies delivering revenue and profit growth, such as Designer Brands, the footwear company owning the widely known DSW stores.
Back to Price:
“Designer Brands (DBI) has been a favorite of mine over the years. I made huge gains buying it during the Covid-dictated store closure period in the first half of 2020. DBI was losing money back then but had an enviable record of steady profits year after year prior to 2020. Earnings per share ranged from $1.46 to $1.88 each year from fiscal 2011 right through fiscal 2019. Despite the proven earnings power shown above, at the worst of the Covid-panic selloff, DBI was available for south of $3. That was less than two times normalized EPS…Fiscal 2021 proved to be a huge rebound year. EPS shot back up to $1.69, right in the middle of the previous range…By May of 2021, DBI once again traded above $20…Fundamentals have only improved since, yet the shares retreated from $20.50 in the spring of 2021 to $11.20 in March of this year.”
Price continues, “Company insiders didn't miss their chance to buy the pullback. There were five significant dollar insider buys against just one (smaller) insider sale during 2021. Total purchases represented close to $19 million. Much of that buying came from the firm's CEO. The average cost was $13.934 per share. Those trades worked out well. DBI was recently as high as $19.38, although it sold off with the broad market back into the $16 - $17 range.”
So, insiders used a sell-off last year to pick up Designer Brands shares at attractive prices, then the company went on to deliver year-over-year earnings growth that analysts expect to continue.
Currently, analysts are modeling $1.98 this fiscal year and $2.12 next fiscal year, up from $1.80 and $1.92 90-days ago, respectively. The improving earnings outlook is impressive, given economic conditions are leading analysts to reduce their estimates at many companies. And their view may improve further following stronger-than-expected quarterly results announced this week, resulting in management upping earnings guidance for this year to $2.05 to $2.15 from its prior forecast for $1.90 to $2 per share.
Back to Price:
What is DBI really worth? In the eight years immediately preceding the Covid-year 2020 DBI typically fetched about 16.8-times earnings. At peak moments, when traders were hot to own it (red-starred below) DBI often commanded P/Es above 20-times…
Previous best entry points (green-starred) in 2012, 2014 and 2017 rewarded traders who bought at between 9.9-times and 13.9-times forward EPS…Right now its P/E is only 7.9-times, less than half its old normalized level. Simply rebounding to a still less than normal 14-times multiple suggests DBI could bounce back to $31.50 or so by Jan. 31, 2024…That goal price would deliver 90% upside plus any dividends collected along the way.”
Of course, nobody knows if Designer Brands will reach Price’s price target, but it’s not outlandish to believe it could happen. After all, its shares traded north of $30 as recently as 2019, before COVID-lockdowns in 2020. Moreover, its EPS was $1.66 in 2019, below its current outlook for this fiscal year.
The Smart Play
Stocks can remain oversold for long periods, so buyers should accept that while we may be setting up for a short-term rally, there’s still a lot of uncertainty that could weigh down stocks over the intermediate term.
As Real Money’s James DePorre wrote today, “The first uncertainty is how aggressive the Fed will have to be in raising rates to tamp down inflation. The second uncertainty is how much the Fed will hurt the economy in the process. The Fed has pretty much given up on the idea of a 'soft landing,' and Powell is admitting that there is going to be some real economic pain in the process.”
There’s a risk that higher rates negatively impact economic activity, causing job losses that dent retail sales and making it difficult for companies like Designer Brands to meet earnings targets.
So far, Designer Brands has been immune to decelerating GDP, but that might not continue if unemployment surges. We’re already seeing cash-strained consumers rely more heavily on savings and credit cards to offset inflation. So, if inflation remains stubbornly high and job losses increase, it could be tougher to achieve Price’s target. That said, Designer Brands customers’ average household income is over $100,000, so they may be less likely to adjust their spending habits than lower-income households.
Regardless, Designer Brands is an intriguing buy. It’s delivering sales and profit growth, and it’s trading above its 200-DMA, despite declining 15% since mid-month. Additionally, it has technical support at around $16 and, again, near $15.25, thanks to a rising 50-DMA.
If you buy, consider doing so in multiple transactions down to the 50-DMA and 200-DMA and then running a stop loss below. If shares rally, consider increasing exposure if it recovers its 21-DMA and on subsequent pullbacks.