To The Moon

The U.S. stock market entered correction territory this past week. Growth stocks did worse, touching bear market territory. Investors worried about inflation and rising interest rates. Now war threatens to disrupt Europe.

The knee-jerk reaction might be to give up, sell stocks, and ride out the volatility, but that could mean missing out on bargains in quality stocks.

“What I don’t want to see people do is sell after we’ve had such a share drawdown, after we have finally entered a correction,” says SoFi Technologies head of investing strategy Liz Young. Investors can research some new ideas that can weather the current environment, looking for good deals amid market turmoil.

RBC multi-industry analyst Deane Dray says that investors should focus on high-quality stocks. That means companies with strong management teams, profit margins, and cash flow.

Earnings matter, too. “You want a company with a strong E in its P/E ratio,” says Young. Steadily growing earnings offset any compression in price/earnings ratios brought on by either inflation or geopolitical conflict.

Investors can also search for companies with more U.S. exposure as tensions rise in Europe. That can help account for the possibility that things take longer than hoped for to resolve across the Atlantic.

“Geopolitical volatility [is] an opportunity to gain exposure to longer-term positive trends,” says Baird machinery analyst Mig Dobre. “ Deere is a great example.” Deere shares (ticker: DE) are down about 15% since mid-February, possibly because roughly 6% of the company’s sales come from Russia.

Companies that can grow in all types of conditions have an advantage. CarMax (KMX) aims to sell two million cars a year in five years, up from roughly 1.2 million units in fiscal-year 2021. The company’s volume goal is one of the reasons that Baird analyst Craig Kennison put CarMax stock on his list of best ideas for 2022.

Evoqua Water Technologies(AQUA) provides water and wastewater treatment for residential, commercial, and industrial customers. About 80% of sales are generated in the U.S., and the company is less reliant than other firms on capital spending, notes RBC multi-industry analyst Deane Dray. That means if corporate budgets tighten as the global economy gets more uncertain, Pittsburgh-based Evoqua is less at risk. And everyone in the U.S. will still need water, no matter what happens overseas. Dray’s price target is $50, about 50 times estimated calendar-year 2022 earnings. That’s not cheap, but investors get stability and growth. Earnings are expected to double over the next three years.

The Moline, Ill., farm- and construction-equipment maker generates about 70% of its sales in North and South America. When commodity prices rise, due to weather—or a war in Europe—U.S. farmers can benefit. Russia remains a risk, but the combination of higher commodity prices, rising farm-equipment age, and the trend toward precision-farming technology can overwhelm any temporary hiccup. Mig Dobre, the Baird machinery analyst, has a price target of $487 for Deere (DE), up more than 40% from recent levels. That works out to about 21 times Wall Street’s estimated calendar-year 2022 earnings of $23.19. Those earnings are expected to increase almost 20% from 2021 earnings of $19.61 a share.

“Anytime water utilities do poorly, or just have a period of poor performance, we start going to work,” says Jay Rhame, CEO and portfolio manager at Reaves Asset Management, a firm dedicated to investing in infrastructure and utility stocks. “They are so reliable, so consistent—getting a cheaper valuation doesn’t come often.”

American Water Works (AWK) shares dropped more than 20% to start 2022, and now trade for about 33 times estimated 2022 earnings. That might look pricey, but earnings have grown like clockwork for years and are expected to advance at 8% or 9% a year for the foreseeable future. The company has boosted its dividend at about 10% a year on average for a decade.

Atlanta-based Southern Co. (SO) has defensive, high-quality characteristics. Its dividend has grown at about 3% a year on average for the past decade, and shares now yield 4.3%. The shares of the multistate electric-and-gas utility trade for about 17 times estimated 2022 earnings of $3.55 a share. Rhame, of Reaves Asset Management, points out that in 2008, when the market dropped about 38%, Southern stock held its own. The stock is down almost 10% this year, partly because the company pushed back the timeline to start up new nuclear-power generating facilities in Georgia by three to six months. Two new reactors are now slated to be up and running by the end of 2023.

Benchmark analyst Mike Ward says car dealerships are good businesses. “Costs are variable, inventory is largely financed by vehicle manufacturers, and parts-and-service revenue offsets about 75% of fixed costs,” he says. Shares of Richmond, Va.–based CarMax (KMX), the largest used-car dealer in the nation, are down about 20% this year, trading for roughly 14 times estimated calendar-year 2022 earnings. Used-car prices are at record levels, a function of low inventories and low new-car production. Falling used-car prices are a risk, but Craig Kennison, the Baird analyst, says investors should focus on dealerships that can increase volumes so that earnings can grow, even if car prices dip.

Before Covid, Constellation Brands (STZ) was one of the fastest-growing large-capitalization beverage stocks, according to J.P. Morgan analyst Andrea Teixeira. Coming out of Covid, volume growth is accelerating as the U.S. wine and beer distributor continues to invest in its brands, such as Corona beer. Shares are down about 15% this year. Investors are worried that profit margins will take a hit as the company ramps up new capacity. But Teixeira notes that new capacity will result in higher volume and improving profit margins. Shares trade for about 19 times estimated calendar-year 2022 earnings per share of about $11.34. Earnings growth is expected to be about 13% a year on average for the next few years.