Summary
- The Fed’s fight against inflation has signaled larger rate hikes amid stronger-than-expected economic data. That's bad news for stocks with high debt and negative cash from operations.
- The DOW dropped nearly 700 points to begin this week’s trading, and the S&P 500 closed at 3,997.34, their worst downturn since December 15th.
- Broad sell-offs are increasing investor fears of a recession. Avoiding equities with negative earnings and little to no profits, limited growth, and strong sell quant ratings may help limit your downside risk.
- We’ve seen over the last year that market volatility exposes poor-performing stocks, including my three picks.
- Using Seeking Alpha’s Quant System and Factor Grades, investors can quickly identify stocks that are expensive with low growth and poor profitability.
Take a Hike: A Fed Rate Hike
In the wake of Wednesday's release of the Fed Minutes from their January 31 to February 1st meeting, the Fed maintains its hawkish stance of further increases to tame inflation. Whether to hike or not to hike rates is the overarching question among investors and policymakers. Following a broad selloff of 697 points for the DOW that amounted to a 2.06% drop, same-day, the S&P 500 slid 2%, equities and global bonds are signaling extreme volatility and dashing hopes of a Fed pivot.
After last year's consecutive 75 basis point hike cluster, market volatility has investors questioning if there will be a recession in 2023 and whether we'll see a worsening of economic conditions. Despite robust retail figures and labor data, results point to persisting inflationary pressures that could eventually give rise to a recession.
Eventually, rising rates will negatively impact goods and services that are falling victim to inflationary pressure. Decreasing demand may worsen economic conditions, and this can impact consumer spending. Currently, the Consumer Discretionary Select Sector SPDR ETF ( XLY ) is the best-performing YTD, +14%. This performance could be a reversion to the mean from last year's dismal performance and head fake for those lulled into the rally.
Changes in consumer sentiment could negatively impact stocks. Demand for many discretionary items has already declined, and personal savings have plunged from 2021 pandemic highs of 7.5% to 3.4% by December 2022. With the fear of recession, companies that were once disruptors or thriving have experienced substantial declines and may continue taking a hit. As highlighted by Seeking Alpha's Sell Recommendations below, which have underperformed the S&P 500 for more than a decade using quantitative data, several stocks carry negative analyst ratings, poor fundamentals, lag in their sectors, and are likely to perform poorly. In this environment, separating the weak from the strong and highlighting the potential poor performers is crucial to not losing money.
Companies like Carvana that felt the hurt in 2022 have been on a downward spiral and on the brink of bankruptcy. Hanesbrands, whose iconic Michael Jordan endorsement partnership has run its course, is showcasing tragic growth and profitability. Along with Warby Parker's negative earnings and poor margins, these stocks all have traits of companies that are headed for the chopping block. Let us dive into these three stocks, at risk of continuing to perform badly.
CVNA, HBI, and WRBY stocks have poor Factor Grades and one-year price performances
Quant Stocks Comparison (CVNA, HBI, WRBY) (SA Premium)
1. Carvana Co. ( CVNA )
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Market Capitalization: $1.93B
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Quant Rating: Sell
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Quant Sector Ranking (as of 2/23): 486 out of 541
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Quant Industry Ranking (as of 2/23): 21 out of 25
A once disruptor in the used car industry, Carvana Co., which developed the car vending machine, is near bankruptcy . Despite a booming industry, supply chain constraints involving chip shortages led the e-commerce platform to burn cash and increase inventory and financial debt. According to the latest CPI data, auto prices fell 1.9% from December. As fellow SA author Harrison Schwarz writes ,
"To offset the massive decline in cash flows, Carvana has relied on immense equity dilution and debt financing to maintain a positive cash balance. There are, in my view, no signs the company will see positive operating profits in the next few years. Even more, the firm's significant interest costs may make actual bottom-line profits untenable, given today's higher borrowing rates."
Not only has Carvana's share price declined more than 92% over the last year, but short interest is also at 71.37%. After losing billions of dollars over the last two years, Carvana's Q4 earnings consensus EPS is expected to be -$2.37 (-132.4% Y/Y), and the consensus revenue estimate is $3.05B, a nearly 19% decline Y/Y. Carvana announced Q4 full-year results in an after-trading-hours press release - a top-and-bottom-line miss. In addition to a 23% year-over-year Q4 decrease in retail units sold, revenue declined by 24% for the same period, a miss of $210M.
EPS of -$7.61 missed by $5.21, and the overall net loss margin is -50.8%. While historically, Carvana has experienced an increase in retail units sold, they are hemorrhaging as volumes are decreasing and advertising, inventory, and staffing levels are falling. Although its valuation grade is a B+, highlighted by forward EV/Sales of 0.62x, a -49% difference to the sector, and forward Price/Sales at a 91% discount, this stock may come at a discount, but who wants to hold a falling knife?
Carvana lacks profitability and is at high risk of performing poorly.
Like many start-ups that lack profitability and cannot generate positive free cash flow, Carvana stock has characteristics historically associated with poor future stock performance. In addition to decelerating momentum, its profitability is significantly inferior compared to its sector peers.
Equity Analyst Scott Ciccarelli suggested recently that Carvana competitor CarMax ( KMX ) has an advantage over CVNA, given improved omnichannel capabilities and its inventory. Carvana's Gross Profit Margin ((TTM)) of 10.81% compared to the sector median of 35.41% is sad. With an overall ranking of 4244 out of 4753 and 21 out of 25 in its industry, it should be no surprise that CVNA is ranked a Sell.
Carvana has relied on equity dilution and debt financing for its cash needs. With an auto recession in play, as Americans struggle to make car payments, inflation and rate hikes affect financing ; and potential borrowers are budgeting for bills - the necessities, CVNA is among the buyer-beware stocks in a cyclical industry. Investors may want to consider buying the dip on stocks with more favorable collective metrics because it's unclear if CVNA will ever ride into the sunset, even with its discounted valuation.
2. Hanes ( HBI )
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Market Capitalization: $1.88B
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Quant Rating: Sell
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Quant Sector Ranking (as of 2/23): 492 out of 541
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Quant Industry Ranking (as of 2/23): 30 out of 33
Popular Michael Jordan-supported underwear brand Hanesbrands Inc. has been a successful and highly competitive brand for a long time - until investors lost their shorts ! Despite having the leading market share in multiple categories in the U.S. and abroad, Hanes' stock is trading at decade lows of $5.27/share, having to compete in a tough competitive environment riddled with supply chain constraints, inflation and declining sales. Most recently, Hanesbrands cut its dividend following poor Q4 earnings results.
Hanesbrands Factor Grades
Hanesbrands Factor Grades (SA Premium)
Although revenue of $1.42B beat by $6.26M, this was still a near 16% decline year-over-year. Additionally, EPS of $0.07 missed by $0.01. Looking at the Factor Grades above, which rate investment characteristics on a sector-relative basis, HBI is fundamentally lacking, illustrating the company's dwindling growth, profitability, poor analyst ratings, and bearish momentum.
A D+ Profitability grade and an 'F' grade for Earnings Revisions and momentum make HBI one of the least profitable companies in its sector and one of the least favored by analysts, who have given the company ten FY1 downward revisions in the last 90 days. Despite the stock possessing an 11.15% forward dividend yield and stellar A+ valuation that includes a trailing P/E ratio of 5.49x compared to the sector 11.89x and forward Price/Sales at a 67.49% difference compared to its sector peers, like Carvana, this stock is like catching a falling knife. Not only has the company eliminated its quarterly dividend after a poor Q4 showing, the economic outlook, strong U.S. dollar, and retailers maintaining lower inventory levels are eating into Hanes' potential rise back to fame.
Where continued slowdown or potential recession in 2023 could put a major damper on Hanes' aggressive growth plans that include a change in the allocation of free cash flow to pay down debt, although undergarments can be considered a staple and perhaps having somewhat of an economic moat, consumption of clothing and discretionary items like its Champion brand and athleisure wear could experience declines as they are not necessary, similar to my final stock pick, which offers specialty eyewear products.
3. Warby Parker Inc. ( WRBY )
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Market Capitalization: $1.55B
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Quant Rating: Sell
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Quant Sector Ranking (as of 2/23): 485 out of 541
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Quant Industry Ranking (as of 2/23): 23 out of 24
Warby Parker Inc. operates 160 retail stores throughout the U.S. and Canada, offering eyewear, contact lenses, and specialty products and services for the eyes. Also possessing characteristics historically associated with poor future stock performance, WRBY's revenue deceleration has resulted from an uncertain macro environment and demand softness as consumers weigh where they want to spend their money amid inflation and rising costs. Although Warby Parker raised its full-year revenue range from $590M to $596M and adjusted EBITDA range between $25M to $27M for the same period, in hopes that its differentiated brand position and the optical retail market is somewhat recession resistant. However, as Sweet Minute Capital writes in downgrading Warby Parker :
We are downgrading our rating of Warby Parker (NYSE: WRBY ) from "HOLD" to "SELL." Our initial coverage of the stock was on September 20, 2022, and we cited "no catalysts to boost the stock price higher" such as slowing growth and exposure to macroeconomic headwinds. The Q3 earnings have reaffirmed this sentiment, and we believe that the stock has limited upside and has major downsides as macroeconomic risks endure."
A review of WRBY's Q3 results showcased an EPS of $0.01 missing. Although revenue of $148.78M beat by 8.30%, the Fed has created a risk-off mood for investors, resulting in the selloff of many retail stocks in the consumer discretionary sector. Warby Parker reported a $23.8M net loss in Q3 2022 and is set to report Q4 earnings next week.
Looking at the above profitability grades, one can see that many key underlying metrics could be more attractive. Although WRBY has attempted a pullback in spending, its negative cash from operations is a drag on already lackluster figures. It attempts to add shareholder value and present an argument for its profitability and growth. With an anticipated economic slowdown and the company's Return on Total Assets ((TTM)) -24.73% compared to the sector median of 4.36%, it's fair to say that Warby Parker is at a high risk of performing badly.
WRBY Stock Valuation & Momentum
In addition to poor profitability grades, as you can see above, the stock has bearish momentum and is overvalued. Investors are actively selling shares, and although this is driving the price of the stock lower, with large sell-offs happening in equities and a slower growth backdrop creating greater risk for the discretionary sector, "weak global growth and the strong dollar compounding the domestic drag from higher interest rates, we suspect this weakness is a sign of things to come," noted Capital Economics' Andrew Hunter .
With a D- valuation grade, Warby's forward EV/EBITDA of 58.18x is nearly 500% that of its consumer discretionary peers. The stock is not only overvalued, its share price also is -50% over the last year and -7% YTD, defending its declining momentum. Although some analysts have taken a long view of the stock's growth potential, based upon the quant ratings, this stock is a Sell, at risk of continuing to perform badly. Proceed with caution if investing in any of the three stocks mentioned above.
Should I buy stocks on the dip?
We are in uncertain times, where the market can turn anytime. Investor sentiment has whipsawed back and forth between fear and greed. During times of volatility, investors should seek investments possessing strong financial metrics and collective investment characteristics that symbolize securities with good fundamentals. Consider avoiding stocks that have already shown poor metrics and significant share price declines. The three stocks, CVNA, HBI, and WRBY, lack growth, profitability, and momentum. One is overvalued, and in the current landscape, all roads are leading to sell as fear of recession could lead to even greater selling pressure for the consumer discretionary sector and stocks with weak fundamentals.
If you own or are considering buying some of the stocks in this article, evaluate and compare their ratings and factor grades to similar stocks in their respective sectors. Although some investors are interested in buying the dip on the decline, these stocks should be cautiously approached. As we've seen throughout the markets over the last few years, stocks are volatile and can swing at any moment. Instead, consider Top Rated Stocks with strong collective metrics for valuation, growth, profitability, momentum, and upward EPS revisions.
For further details see:
3 Stocks On The Chopping Block: Carvana, Hanes, And Warby Parker