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I love a good underdog stock. When the crowd thinks a company's fortunes are in decline, I like to take a closer look to see if there's solid evidence to support their point of view. Often there's not.
As a contrarian, I've repeatedly made outsized profits trading what others shy away from. But rather than the "Dogs of the Dow," I prefer the underdogs of the S&P 500.
In particular, I'm excited about the prospects for the world's largest multinational consumer electronics retailer, Best Buy (NYSE: BBY).
The bears will argue the company's glory days are over. Consumer electronic sales are slumping, with researcher NPD projecting they will drop 2.6% in the second quarter.
More important, the bears will tell you, consumers are more apt to purchase their electronics online than in brick-and-mortar stores. With e-retailers like Amazon.com (NASDAQ: AMZN) operating on thinner margins, they can offer lower prices.
BBY has seen the trend toward online buying and is fighting back. Online revenue is growing quickly, jumping 29% year over year in the first quarter.
The company recently improved its website by adding a more accurate search function. The site now offers recommendations based on purchases and gives more detailed product and pricing information.
In addition to its eight distribution centers, Best Buy has initiated ship-from-store at its 1,400 locations to help fulfill orders faster and cut down on shipping time. With the option to purchase online and pick up in store and a "low price guarantee," Best Buy is becoming stiffer competition.
In addition to its increased online focus, Best Buy has introduced rigorous cost-cutting measures. It's "Renew Blue" program is a turnaround strategy aimed at enhancing supply chain efficiency, improving customer experience, optimizing store space and minimizing the cost of returned merchandise. So far, Renew Blue has allowed Best Buy to slash $860 million in costs. Management hopes to achieve $1 billion in annualized cost savings.
As you can see in the chart, BBY is on the verge of bullishly breaking the major downtrend line after a long basing period. This would be an excellent technical entry point, as traders would be buying close to important support at a time when the stock is likely to change direction and move quickly higher.
BBY bottomed around $11 in December 2012. By November 2013, it had more than quadrupled in price, hitting a peak of $44.66.
Not surprisingly, the shares experienced profit-taking. A major downtrend line formed as the stock surrendered much of its gains. At the beginning of 2014, shares plummeted 29% in one day when the company reported disappointing holiday sales.
Shortly thereafter, the stock found support around $23, and has since consolidated in a narrow range between $23 support and resistance near $28.
This week, shares poked above $28 resistance and are in a minor uptrend. BBY appears headed toward a key test represented by the intersection of the major downtrend line just above $29.
If the downtrend line is broken, the next major resistance level would be near $37.50, which was an area of support during the late 2013 topping period. This target is roughly 30% above current levels.
To minimize downside risk, I suggest waiting for the stock to break out above $29.11 before purchasing shares, which can be done using a using a buy-stop order.
Turning to the fundamentals, sales in the second quarter and full-year fiscal 2015 (ending in January) are expected to slip 3% and 2%, respectively. While revenue is projected to drop marginally, earnings should rise due in part to cost cutting. Second-quarter earnings are expected to be flat at $0.32 per share, but full-year earnings are estimated to rise 10% to $2.28 from $2.07 in the prior year.
That means the stock is selling at a very reasonable forward price-to-earnings (P/E) multiple of 12.5, well below that of the S&P.
Risks to consider: Amazon is a formidable competitor and could launch a counterattack to protect market share at any time. However, BBY seems to have turned an important corner with its cost-cutting measures and use of stores as distribution centers. A breakout of the downtrend line should signal traders believe this strategy is sound.
Recommended Trade Setup:
-- Place a buy-stop order on BBY at $29.11
-- Set stop-loss at $23.85, just below current support
-- Set initial price target at $37.45 for a potential 29% gain by late 2014
How the market resolves an indecision area this week could end up being the springboard for a new trend.
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