Buying the dip is a popular investing strategy, though not every sell-off is a buying opportunity. The problem, according to Warren Buffett, is that "turnarounds seldom turn." As an investor looking to buy the dip, you need to be able to differentiate between stocks that are down temporarily and those that are more fundamentally impaired for structural reasons that won't easily change.
Two retail stocks currently down more than 25% are Target (TGT 0.18%) and Home Depot (HD 0.94%), but they should eventually recover. Here's why I'm not worried about the decline in these two popular retail stocks.
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1. Target
Target was one of the big winners in the retail sector during the pandemic. With its multi-category business model, the company was well-positioned for the crisis as it carries necessities like groceries, allowing it to stay open, though it makes most of its revenue from discretionary goods like home furnishings, electronics, toys, and apparel.
After surging during the pandemic, Target has struggled lately as consumer spending has shifted away from goods and toward services like travel and restaurants that were off-limits during the pandemic. Comparable sales have declined in recent quarters, and the stock is now down 51% from its peak during the pandemic.
Target is clearly facing challenges. Comparable sales are falling and profitability is well below the company's own targets and its previous peak. The retailer also continues to struggle with losses from theft.
However, the bar has gotten low enough with Target that even a modest performance in the third quarter was enough to send the stock soaring. While comparable sales fell 4.9% in the quarter, adjusted earnings per share vaulted 36% to $2.10 as the company lapped a particularly weak performance in the quarter a year ago and better controlled its inventory, leading the operating margin to expand from 3.9% to 5.2%.
That room for improvement is one reason I'm not worried about the stock. Another is that Target's competitive advantages are still intact. The company has a unique positioning among a small group of multi-category retailers with a reputation for "cheap chic" products, and it's also strong in urban, suburban, and rural areas with stores in all 50 states. Finally, Target has excelled at using its stores to fulfill online orders, which is more cost-effective than shipping them from distribution centers, giving the company an edge over peers Walmart and Amazon.
Consumer demand will eventually return and Target will be ready to capitalize on it with rising sales, expanding profit margins, and a healthier stock price.
2. Home Depot
Like Target, Home Depot is also down for cyclical reasons. Shares of the home-improvement retailer have pulled back as the pandemic-driven housing boom has come to an end, and rising mortgage rates have slammed the brakes on home sales, putting pressure on the company.
In its third quarter, comparable sales fell 3.1%, and earnings per share declined 10% to $3.81. Like Target, Home Depot is experiencing pressure in discretionary goods, noting a decline in big-ticket discretionary items, such as appliances.
Home Depot stock is now down 25% from its previous peak, and investors should be confident that the stock can return to those heights. After all, the housing market is cyclical, and home sales should eventually pick back up.
It's unclear where interest rates will go in the short term, but the Federal Reserve's most recent long-term forecast calls for the federal funds rate to fall from its current level of 5.25%-5.5% to 2.5% over the next few years, which should help bring mortgage rates down and support a rebound in the housing market.
Home Depot continues to perform well in the Pro segment, which serves contractors, and management sees that category as one of its biggest growth opportunities. The company is also investing in its omnichannel platform, focused on giving customers a frictionless shopping experience.
Home Depot essentially competes in a duopoly with Lowe's Companies and is able to generate high margin because the industry has high barriers to entry. The business is still strong, though it's in a cyclical lull. The stock will recover as the housing market does, and Home Depot stock should eventually set new record highs.
