Internet stocks have been crushed during the bear market. For investors looking to take advantage of the bear market, they can increase their chances of success by looking for companies with attractive valuations, strong cash flow, and established businesses. That’s why I want to discuss my stock of the week Cars.com (CARS), which has all three of these characteristics and should outperform if conditions for growth stocks continue to improve.
One of the biggest stories in financial markets over the past year and a half has been the bear market in Internet stocks. It started in early 2021, and we have seen losses of more than 80% in some of the most popular and best-performing stocks during the pandemic. Examples include Snap (SNAP), Carvana (CVNA), and Etsy (ETSY).
These companies reached egregious valuations which were unsustainable. Now, there are some signs of stabilization over the last couple of weeks, with bonds catching a bid and some forward-looking inflation measures starting to bend. Therefore, I believe investors should once again turn their attention to growth stocks, as this group has historically outperformed after bear markets.
Though economic conditions remain shaky, investors can increase their chances of success by looking for companies with attractive valuations, strong cash flow, and established businesses. That’s why I want to discuss my stock of the week Cars.com (CARS), which has all three of these characteristics and should outperform if conditions for growth stocks continue to improve.
CARS primarily operates a digital marketplace to connect car sellers with car shoppers. It offers buyers and sellers data, resources, and digital tools needed to make buying and selling decisions. It also offers services for dealers and OEMs to increase sales. Some of its well-known properties include DealerRater, DealerInspire, Auto.com, PickupTrucks.com, and NewCars.com
CARS has dealt with 2 bearish headwinds. One is that chip shortages led to diminished inventory for interested buyers. This situation is resolving itself, as auto production is increasing and is expected to reach full capacity by the end of the year. The other headwind is the weakness in growth and Internet stocks, however, CARS is rare among this group in that it’s profitable and has positive cash flow.
A major catalyst for CARS that could persist over the next couple of years is the rebound in new car production back to full capacity. We are already 50% higher from September 2021 when only 84,000 cars were made in the US. By the end of the year, the US should be close to producing 300,000 cars per month. This will lead to more inventory, lower prices, and more transactions in the used car market which should benefit CARS.
Another catalyst is that many of CARS’ competitors are faltering due to a business model that prioritized growth over cash flow. Now, they are forced to pivot with uncertainty about whether they will succeed. In essence, CARS was competing with these venture-backed companies who were willing to lose money to gain market share. CARS should flourish without this competitive pressure.
Finally, market conditions are improving for Internet stocks with many finally catching a bid. Of course, there remains a risk, and new lows could be on the horizon if market conditions further deteriorate. However, we are finally starting to see some signs of cooling in terms of inflationary pressures which is capping rates. And, this has been the major headwind for Internet stocks since early 2021.
For much of the last decade due to low rates and low inflation, investors have prioritized growth over cash flows. This has suddenly changed in 2022, and companies and investors are responding.
In the corporate world, we are seeing companies freeze hiring plans or slash headcount, while they discuss plans to boost margins on conference calls. In public markets, high-multiple stocks have crashed in many instances, while cash-flow positive stocks are outperforming. This is evident with the Pacer US Cash Cows 100 ETF’s (COWZ) 7% gain vs the 25% drop in the iShares Russell 2000 Growth Stock ETF (IWO).
CARS is also a standout in terms of cash flow with nearly $100 million generated in 2021 which equates to about 14% of its market cap. This should increase by about 6% in 2022 as it had $26.4 million in free cash flow in Q1. It’s using this cash flow to buy back $200 million in shares over the next 3 years, adding a nice tailwind for EPS.
The POWR Ratings are also bullish on CARS as it is rated a B which translates to a Buy. B-rated stocks have an average annual performance of 19.7% which compares favorably to the S&P 500’s annual performance of 7.3%.
CARS is also rated a B for Value which is consistent with its low forward PE of 4.7 which is significantly cheaper than the S&P 500. It also has a B for Growth due to expectations of steady 7% earnings growth over the next 3 years. To see more of CARS’ component grades including Quality, Stability, Sentiment, Industry, and Momentum, click here.
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CARS shares were trading at $10.18 per share on Wednesday morning, down $0.17 (-1.64%). Year-to-date, CARS has declined -36.73%, versus a -13.28% rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles.