During bouts of market volatility like the current one, stocks that actually generate earnings and cash flow can be godsends. Honestly, this may be true in all market environments, but it is especially true when stocks are sliding. Knowing that there is actual cash flow to back up the value of the businesses you own can help you sleep at night.
If you ventured further than you'd like into the unprofitable, high-growth sector over the past year, you're likely looking for some more value-style names to balance out your portfolio. Sprouts Farmers Market (SFM 0.15%) and Nintendo (NTDOY -0.33%) are two wildly undervalued stocks to consider buying in 2022. Here's why.
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Sprouts Farmers Market
Sprouts is a grocery store chain focused on serving healthy and specialty food items at a reasonable price (think of it as a combination of Whole Foods and Trader Joe's). It has over 360 stores focused in California, the southwest, Texas, and the Southeast.
After seeing deteriorating margins and a falling stock price, Sprouts brought in new management in 2019. Jack Sinclair, who used to be in charge of U.S. grocery at Wal-Mart, was hired as CEO to turn around the business. His first initiative was to stop sending out unsustainable discount coupons, which were driving unprofitable customers to its stores and killing operating margins. This had the negative side effect of hurting same-store sales growth, but has helped Sprouts almost double its profit margins from its 2019 lows. From an investment perspective, I believe it is a net positive as long as same-store sales stabilize over the next few years. This is an important metric for investors to watch in the coming years.
SFM Free Cash Flow Per Share data by YCharts
The great thing about Sprouts is that even though it is reinvesting for growth, the business still generates a lot of cash. Outside of when the pandemic rush depleted inventory levels (lower inventory levels artificially raise cash flow), Sprouts has steadily grown its free cash flow per share ever since its IPO in 2014. It currently sits at $2.42. Compared to a price of $28.50, that gives the stock a price-to-free-cash-flow (P/FCF) of 11.8. This is quite cheap compared to the market average.
If Sprouts succeeds with its store growth plans of 10%+ after 2022, maintains its current unit economics, and continues repurchasing shares, free cash flow per share should continue to rise over the next decade, bringing the stock price up along with it.
Nintendo
Nintendo is one of the largest entertainment companies in the world, and dominates the video game industry. It owns well-known franchises like Mario, Zelda, and Animal Crossing, and has a stake in the Pokémon Company, giving it priority access in publishing the company's games.
Unlike a lot of gaming companies, Nintendo focuses on both gaming hardware/distribution and developing games themselves. This unique model is self-reinforcing, as many gamers purchase Nintendo hardware because it is the only way to play the latest Mario or Zelda game. Nintendo's latest hardware device is the Nintendo Switch, which has been a smashing success since its launch in 2017. Projections are that Nintendo breached 100 million units sold by the end of 2021, putting it in rarified air with top consoles like the PlayStation 2, PlayStation 4, and the Nintendo Wii.
Hardware sales lead to software (game) sales, which is where Nintendo makes most of its money. For the fiscal year ending in March, Nintendo is guiding for 200 million software sales, leading to approximately $4.6 billion in operating profit for the full 12-month cycle. At an enterprise value of $43 billion, Nintendo stock trades at a price-to-operating-income (P/OI) of 9.3, which is even cheaper than Sprouts Farmer Market.
If you believe Nintendo's top franchises will remain popular over the next decade, as they have for the last four, while the company continues innovating with gaming hardware, then now could be a perfect time to buy this entertainment stalwart and hold for the long haul.
