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Fool’s “Top Non-Tech Stocks under $30,” part two — “Up-and-Comer in Home Entertainment”

Another "growth stock for people who are bruised after getting clobbered by tech stocks" idea teased by the Motley Fool

By Travis Johnson, Stock Gumshoe, April 19, 2022

We looked at the first stock teased for the Motley Fool’s “under $30 non-tech stocks” promo yesterday, and today, as promised, I’ll move on to number two (they don’t hint at number three, so you’re on your own there).

This is the intro from their order form…

“What if you could pore over every stock recommendation from the last few years, and pluck out the top non-tech stocks to reinvest in right now?

“I’m talking about the stocks we believe can give investors the greatest chance at potentially minting fortunes over time — stocks we believe have multibagger potential (even in this market).

“It would be foolish not to load up on these stocks…right?

“Especially, since the tide appears to be going out on tech stocks presently.”

And what specific clues do we get about this particular stock? This is from the marketing email…

“This stock is an up-and-comer in the home entertainment system space. And its easy-to-use modular system allows customers to easily build and expand their home entertainment.

“In fact, this stock has built up a core customer base of more than 12 million households – and it believes it can serve 10X that amount with time….

“With a $3B market cap and an addressable market worth nearly $90 billion – consisting of nearly 350 million households, we believe this stock has only captured 2% to 4% of its longer-term opportunity!”

And that’s about it, other than the clue that the price is “under $30” … so what’s this secret stock?

Thinkolator sez they’re teasing Sonos (SONO), the maker of wireless sound systems and TV sound bars. Their systems are modular (meaning you can buy one speaker, and later add on with more to cover more rooms or get richer sound)… and, yes, the stock is under $30, with a market cap near $3 billion, and they do have a “core customer base” of about 12 million households, and say in their presentations that their first target as an “addressable market” is the roughly 120 million affluent households (350 million, as teased, is the total number of households in their core geographic markets).

So that’s a good match. What’s to like and not like about this particular stock?

Well, the business model is intuitively appealing… they provide a high-quality product that is pretty universally beloved among audiophiles, so they have a valuable brand in at least a decent niche market, with maybe the ability to grow that, and they’re not so much competing at the low end of the market (with Amazon’s cheap Alexa “Echo” speakers, etc.), and they have been able to establish a trend whereby they’re spending less on customer acquisition, and yet still driving revenue growth because their core customers are spending more and adding more speakers to their systems over time.

Like many home electronics companies, they enjoyed a surge in revenue late in 2020 and early in 2021 when people were flush with cash and stuck at home, but they’ve never been a real “nosebleed” growth company — they averaged something like 10% revenue growth per year, with ups and downs, from 2016-2020 before getting that spike in late 2020 and early 2021 (to 29% growth). So it was a disappointment that revenue growth over the past two quarters, once we lapped the pandemic year, has now tailed off to low-single-digits (3% revenue growth in the fourth quarter), and their expenses continued to rise, so the net income actually dropped by 6-8% or so in the key fourth quarter (like most consumer products companies, their revenue is at least partially holiday driven, so their fourth quarter sales are usually twice as large as any other quarter of the year — and that’s also when almost all of their annual profit comes in).

That was doubly challenging for SONO, because it had developed a following of growth stock investors who were excited about their strong “beat and raise” quarters last year, so there’s been some pain felt as the stock has drifted back down to prices that might better reflect its growth profile and earnings power.

It’s not necessarily a “dirt cheap” stock, and since they depend on holiday season sales we’re stuck waiting for a while before we get really meaningful earnings reports, but right now the expectation is that SONO will earn $1.85 in adjusted earnings per share this year, up from $1.77 last year. That means, at ~$26, that you’re paying about 14X expected earnings for SONO, which sounds pretty reasonable, that’s less than the average market multiple (the forward PE for the S&P 500 has been dropping for months, but is still at about 18 — though, to be fair, the smaller-cap S&P 600, which includes SONO, also has a forward PE of about 13-14 right now… small stocks are cheaper, in part because of the big weighting of mega-tech stocks in the S&P 500). On the other hand, SONO is also growing at a below-average rate, with expected earnings growth this year of less than 5%. If that picks up next year with the supply chain problems finally being eased, and SONO earns $2.24 in 2023, as is currently predicted by the few analysts who follow the stock, then it’s a pretty easy buy here (that’s roughly 20% earnings growth) — if the low growth persists, or worse, it could easily still disappoint from here.

This is the first time I’ve looked at SONO, and I’ve never used one of their products, but what initially stands out for me is the relatively steady gross margins, which mean they’ve been able to grow without cutting prices, which further reinforces the notion that they have a strong brand and quality product… and, perhaps more importantly, they’ve been accumulating cash at a solid clip. Partly that’s driven by stock option exercises and stock-based compensation (which they’ve recently helped to smooth out by doing some buybacks), but thy’ve also genuinely been generating growing free cash flow, if you smooth out the COVID collapse and recovery, so if it ends up that we’re going into a bad economic environment or there’s some other challenge for SONO coming up, there’s some solace in the fact that they’ve got $600+ million in cash and they’re genuinely profitable.

If I were interested in SONO but feeling conservative, I might think about looking for the valuation to drop back down to pre-COVID levels, it was around 10-15X free cash flow in 2019 and right now is trading at about 20X free cash flow, but if you’re at all optimistic about the brand and their ability to grow again, either this year or over time, as the economy steadies out and supply chain challenges get easier, the current valuation seems pretty rational. One good thing about a company like SONO is that you can really do the important research yourself — is the brand still widely respected? Are YOU convinced that their product is better than the competition and should grow strongly once people realize that? If you build that kind of confidence in a stock, it can be easier to hold it through the inevitable ups and downs — being new to Sonos myself, I’m not there yet, but maybe you are. Feel free to chime in with a comment below if you’ve got an opinion on SONO or its competitors.

And just on the broader issue of The Motley Fool copywriters and their huge historic claims of big wins, yes, I should note that they are good at pulling up some of their all-time best ideas to sell readers on how important it is to “get in early” (and therefore, of course, punch in your credit card numbers and subscribe RIGHT NOW), and readers are often very skeptical of those kinds of claims (and rightly so)… here’s an excerpt from the order form for this particular offer:

“If we take a deeper look at our favorite recommendations from above, you can clearly see the value of getting in early.

“For example…

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“NVDA: Re-recommend in Stock Advisor at $25.66 on January 20, 2017. (Currently trading at $259.31)
“SHOP: First recommended in Rule Breakers at $21.02 on February 24, 2016. (Currently trading at $702.92)
“TTD: Re-recommended in Stock Advisor at $6.36 on October 20, 2017 . (Currently trading at $71.97)”

And that’s true, as far as it goes — those are real past picks, the Fool did honestly recommend those stocks long ago, at much lower prices than they carry these days. Actually, they undersold it a little by including a couple “re-recommend” stocks — according to my Teaser Tracking spreadsheets, David Gardner was first pitching NVIDIA for Stock Advisor back in 2014 (the hook back then was that it was “Warren Buffett’s Worst Nightmare” because NVDA was enabling self-driving cars)… so it was actually down around $4 the first time I saw them recommend the stock. Shopify (SHOP) they didn’t use as a promotional teaser stock for Stock Advisor until July of 2016, but we’ll take them at their word that it was a Rule Breakers pick a few months before that and just didn’t get used in their teaser ads… and The Trade Desk (TTD) started to be aggressively teased as a Motley Fool favorite in October of 2017, though I didn’t know it was a re-recommendation at that time.

So yes, they did make all those picks, at least at roughly those times, and they liked those stories enough that they also used them in their promotional emails and I ended up covering them — and actually, in the case of TTD and SHOP, those are stocks I first learned about because I was covering the Fool’s teaser ads, and I still own them (I also own NVIDIA, though that was pitched by lots of folks and has been around much longer), so I guess I should thank them for those solid choices.

But that’s not typical. Those are some of the biggest winners from newsletters that have collected recommended hundreds of stocks in those five years, to be clear. That’s the Motley Fool philosophy — you buy a lot of stocks, hold on to all of them for many years, even the ones that look awful sometimes, and hope that a few will be the mega-winners that generate 1,000%+ returns. The idea is that a couple big winners like that more than make up for all of the losers you also held along the way, and will also grow to have much more weight in your portfolio, so the losers are quickly forgotten and you’re effectively leaning more and more on the “winners” over time.

It’s compelling math, a 1,000% gain makes up for a lot of 30-50% losses, but it’s not necessarily a strategy that everyone feels comfortable with… and, of course, they don’t highlight the stocks that fell 50% in their advertising, or mention that there are typically close to 50 stocks a year picked by Rule Breakers and Stock Advisor (though some are re-recommendations), and most of them don’t turn out to be those “mega winners”, so don’t put too much faith in a single idea.

And know that even if you were a subscriber to a few Fool newsletters for the past ten years, you probably didn’t buy all 500+ stocks they recommended, so if you missed a few big winners and got a few big stinkers, well, you may be pretty grouchy about the Fool — and if you ended up buying Shopify and The Trade Desk and a handful of other huge winners, you probably adore them. There’s no substitute for using individual judgement, knowing what kind of investor you are, and also maybe getting a little lucky.

That’s all from this ink-stained wretch… back to you, dear reader, have thoughts on Sonos or other favorites you want to share? Let us know with a comment below.

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aclany
Member
April 19, 2022 1:04 pm

A big part of the Sonos story is going to be the patent infringement actions it has been successful in pursuing, including against Google and Amazon, that will contribute royalty streams to their bottom line.

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Thomas Booth
Thomas Booth
April 19, 2022 1:08 pm

Sonos is a good stock, I owned it last year and sold it in February of this year, but I would be tempted to buy it back at a lower price . Plug is looking attractive as it is doing a deal with Walmart .

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shamanjeff
shamanjeff
April 19, 2022 1:49 pm

We have had the same Sonos system in our store for 8 years with very little problems sound quality is great I don’t own stock but if Travis thinks it financially would be good I’d like the product

alexho
alexho
April 19, 2022 2:36 pm

Nothing new or patentable about this product. If there was a real demand for remote speakers scattered around the home, it would have been met years ago by cheap imports. Wired intercoms offered a similar capability over past decades, but how many new homes owners really wanted the feature?

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Darren Fitzpatrick
Member
Darren Fitzpatrick
April 19, 2022 3:00 pm
Reply to  alexho

I own a lot of Sonos stuff and it’s very good quality but the app stinks. Most of the time I stream music to it from Apple Music because their app isn’t very good. (I just use the app to determine which speakers streaming the music to). I like the company but would not invest- they’ve been around for awhile, I’m not convinced they’ll capture more market share.

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Karen
Member
Karen
April 21, 2022 4:45 am

Hi
If I was a paid subscriber would I be able to purchase US stocks from the UK or are you purely recommending stocks not available for purchase here

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