A Few Years From Now, You'll Wish You'd Bought This Undervalued Stock

Using the S&P 500 as a proxy for the market, the index gained nearly 26% this year (period ended on Nov. 7). Growth stocks have taken the lead, with the S&P 500 Growth Index appreciating 34.5%. The S&P 500 Value Index trailed with a 15.8% increase.

However, value stocks offer an opportunity to outperform the market, if you have the patience and willingness to bear extra risk. After all, there are reasons investors have shied away from these stocks and why they sell at lower valuations. But if you do your homework, you can uncover companies with good long-term prospects selling at a discount.

Wayfair's (NYSE: W) shares have been on a rollercoaster, but buying now may prove lucrative down the road. While it's not an opportunity for everyone, it's time to uncover what the market may be underappreciating about the company.

Image source: Getty Images.

Fallen star

Wayfair's stock caught investors' attention during the early days of the pandemic as people went on an online buying spree when they were stuck at home. The company's 2020 revenue grew 55% to $14.1 billion. It earned $1.86 a diluted share, reversing the previous year's $10.68 loss per share.

The share price skyrocketed, gaining about 150% in 2020. However, it's subsequently fallen 82%.

Wayfair couldn't maintain the initial operating momentum, and the top line has dropped. Third-quarter revenue fell 2% to $2.9 billion. Management blamed economic pressures that affected consumer spending. Its loss narrowed to $0.60 a share versus a $1.40 loss last year, but that's not much consolation.

It's not just Wayfair feeling the effect. These economic factors have hurt other companies, too. These include home improvement chains Home Depot and Lowe's.

However, there are reasons that the company may see its fortunes reverse in the coming years when conditions improve.

Better economic environment

Pricing pressures have eased, giving consumers more breathing room. Inflation has been dropping, increasing 2.4% year over year in September. The Federal Reserve remains confident that the tide has turned. It cut its key short-term interest rate by 50 basis points at its meeting that month, and by another 25 basis points at its recently concluded meeting. The central bank's rate cuts are designed to spur spending, which should benefit Wayfair.

Additionally, the company's results are undoubtedly tied to the housing market. Housing sales have slumped amid high mortgage rates and limited supply. Existing home sales fell 1% in September, and despite the Federal Reserve's actions, long-term mortgage rates have risen for several weeks. The 30-year fixed mortgage rate was about 6.5% in early November.

However, with short-term interest rates dropping, people will likely feel more confident spending money. This should spur economic growth and fuel housing sales. It's always risky trying to predict mortgage rates, but they should come down, providing long-term inflation remains contained.

Valuation

Wayfair's stock performance has resulted in a better valuation. The shares trade at less than a 0.5 price-to-sales (P/S) ratio. The shares have a 10-year median P/S of 1.3.

The stock also currently sells at a fraction of the overall market. The S&P 500 has a P/S multiple of 3.

Naturally, there's no certainty regarding the timing of the housing market turnaround. However, that's cyclical, and it's only a question of when, not if, home sales will rebound. When they do, Wayfair, with its convenient online offerings targeting a range of income groups, remains in a good position to benefit.

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Lawrence Rothman, CFA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Home Depot. The Motley Fool recommends Lowe's Companies and Wayfair. The Motley Fool has a disclosure policy.