Three U.S. stocks with potential to outperform this year

These stocks returned more than 55% in 2018, but are still trading close to, or below, our fair value estimates, indicating potential to rise further in 2019

Vikram Barhat 2 January, 2019 | 6:00PM

After a year of spectacular gains in 2017, North American stock markets ended in the red in 2018. The stocks surrendered all the gains made in the first half of the year, thanks to volatility and weakening sentiment in the latter half. Some market analysts are bullish on market turn around, but they are outnumbered by those warning that the worst may not be over yet.

All the negative microeconomic headlines and the approximate -7% returns for the S&P 500 index, however, could not keep some stocks making hefty gains. In fact, the ugly benchmark numbers only served to amplify returns clocked by the year’s best performing stocks, some of which more than doubled in value in 2018 before giving up a portion of those gains and ending the year with more than 50% returns.

However, despite delivering outsized gains, the following stocks have room to run as they are trading below or close to their fair value, offering some margin of safety. The solid performance of these stocks in a year of negative index returns is a testament to their robust fundamentals and competitive strength in difficult market conditions. Moreover, a market rebound could push these stocks to even greater heights. Investors taking annual stock of their portfolio may find compelling opportunities in these companies.

TripAdvisor Inc
Ticker: TRIP
Current yield: -
Forward P/E: 2.33
Price: US$53.55
Fair value: US$58
Value: 8% Discount
Data as of Dec. 28, 2018

The world’s leading online travel company, TripAdvisor (TRIP) offers over 700 million reviews and information on 4.9 million restaurants, 1.2 million hotels, as well as nearly a million vacation rentals. The company’s hotel segment accounted for 77% of the 2017 revenue, while its non-hotel segment -- vacation rental, experience, and restaurant revenue -- contributed most of the rest.

Despite intense competition, TripAdvisor’s network advantage is expected to remain unmatched over the next decade, “supported by a solid global position, low penetration of travel advertising spending allocated online, and continued marketing spending,” says a Morningstar equity report.

The company’s enviable cache of user-generated reviews and travel content continue to drive traffic. “We see this network effect remaining intact, driven by both organic and inorganic actions,” says Morningstar equity analyst, Dan Wasiolek, who is encouraged that the company is girding up against growing competition by “allocating capital toward acquisitions in the restaurant, vacation rental, tour, and attraction markets,” areas of online travel space that have strong growth opportunities.

TripAdvisor’s undeniable network advantage positions it well to benefit from the increasing global trend of booking through mobile applications, adds Wasiolek, who recently upped the stock’s fair value from US$57 to US$58.

Advance Auto Parts Inc
Ticker: AAP
Current yield: 0.15%
Forward P/E: 19.46
Price: US$155.46
Fair value: US$172
Value: 10% Discount
Data as of Dec. 28, 2018

Advance Auto Parts (AAP) is one of the industry’s largest retailers of aftermarket automotive replacement parts, tools and accessories to DIY customers across North America. The company operates 5,183 stores and generates 58% of its sales from commercial clients, up from 30%-40% before the General Parts acquisition deal.

The acquisition created operations inefficiencies leading to some economic drag which caused the company to lag its peers in profitability. However, Advance’s ongoing turnaround effort can unlock superior performance as it capitalizes on its balanced professional-DIY segment exposure, says a Morningstar equity report.

“Early signs of progress in its turnaround have coincided with recovering industry conditions; fundamental indicators, including miles driven and average vehicle age, are conducive to long-term growth,” points out Morningstar equity analyst, Zain Akbari. Although the auto part supplier’s 2017 ROI (6.1%) and operating margins (7.3%) lagged its peers, Akbari asserts that the company “has ample runway for profitability growth over the years ahead.”

Advance’s extensive store and distribution network affords the company greater cost advantage relative to smaller peers. This cost advantage, coupled with its stellar brand equity, form “a durable competitive advantage that should shine through as the turnaround begins to deliver results,” says Akbari, who recently lifted the stock’s fair value from US$165 to US$172.

Fortinet Inc
Ticker: FTNT
Current yield: -
Forward P/E: 34.97
Price: US$70.34
Fair value: US$70
Value: Fairly Valued
Data as of Dec. 28, 2018

A cybersecurity vendor that develops and sells network security solutions, Fortinet (FTNT) focuses on small to midsize businesses (SMBs). The firm generates revenue from two segments, products (39% of revenue in 2017) and services (61%).

The company popularized the unified threat management (UTM) device, which combines several network security solutions into a single, affordable product for small or midsize businesses. Continued and frequent global data security breaches create a tailwind for long-term growth, says Morningstar equity analyst, Mark Cash, who asserts that the global pivot to Internet of Things and autonomous driving will create “new vectors of security disruption.”

Fortinet has been a swift grower, seizing nearly 20% revenue share of the UTM market supporting SMBs, and nabbing 14% of the revenue share of the overall firewall equipment market, according to research company Gartner. “The firm has historically been a leader in the SMB space, where businesses constrained by information technology budgets opt for Fortinet’s tools that consolidate an ever-changing platform of network security products,” says Cash, who puts the stock’s fair value at US$70.

He acknowledges the company has successfully moved upstream, gaining market share. “We estimate the firm has around 300,000 total clients, with 30,000 reported clients at the enterprise level, or 10% of its total users in fiscal 2018,” says Cash, who projects Fortinet to grow at 12.5% annually for the next five years and 9% over the next 10 years, as the revenue mix shifts to the higher-gross margin Services segment.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Advance Auto Parts Inc136.45 USD-0.11
Fortinet Inc81.65 USD1.23
TripAdvisor Inc38.53 USD1.42

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Vikram Barhat

Vikram Barhat  Vikram Barhat is a freelance writer.