Investor Essentials Daily

This might be the best time to buy this manufacturer of expensive toys

June 26, 2023

The recreational vehicles (RV) industry is a cyclical one. The demand for these expensive toys changes with their pricing and customers’ ability to borrow cheap capital.

Early in the pandemic, RV manufacturers enjoyed incredibly high demand as both of these factors were in their favor. Interest rates were near 0%, and inflation had not surged yet.

Now, we are in a completely different market, though.

Companies like Winnebago Industries (WGO) has been struggling with high costs, high interest rates, and low demand for their products, even though they have invested a lot in improving their operations over the last few cycles.

The market is in absolute pessimism about the industry, and that is the best time to make a move for investors.

The Fed started to slow down on rate hikes, which might mean we are only a few quarters away from things picking up for the RV industry and for Winnebago, which trades at incredibly cheap valuations.

That is why Winnebago showed up on our screen. Its potential for high returns and low valuation make it a great FA Alpha 50 name.

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We may be nearing the bottom of the recreational vehicles (“RV”) cycle.

We have talked a lot about the At Home Revolution that shaped and redirected consumer demand early in the pandemic.

As people spent more time alone at home, they started thinking more about and spending on improvements in the house and their hobbies.

RVs were a big part of this trend, and they became a massively hot commodity.

People wanted to buy RVs because they considered it as a way to travel more comfortably and safely. This led to the industry experiencing an unprecedented surge in demand.

Yet, this trend did not live long, and things turned bad quickly. Tons of factors have gotten worse.

Raw material costs rose with inflation, and supply chain disruptions made it worse. RV manufacturers could not get their hands on the necessary materials on time. When they could, it was because they paid more.

Rising interest rates did not help either. RVs are typically expensive products, and most people need loans to buy them. Increasing rates led to fewer people being interested in buying such an expensive toy.

Things could not look much worse for the RV industry, and that is possibly the best news you can hear about it.

Moreover, demand for RVs is cyclical. This is not only because of the pandemic and the surging inflation after that. It has always been cyclical.

The best time to buy is at the point of maximum pessimism. That seems to be what we are seeing for Winnebago Industries (WGO) today.

As a manufacturer of RVs and marine products, the company has been impacted negatively by increasing rates and costs of production like everybody else.

Quarterly sales are down significantly after their all-time highs in 2022. Inflation does not only mean that the cost is higher, but it also affects the demand from the customers.

The company has been investing in improving its operations, so it has been able to keep expanding its returns over the last few cycles.

This improvement, combined with incredibly high demand during and right after the pandemic, resulted in a big profitability surge for Winnebago. Its return on assets (“ROA”) reached 45% in 2022 from 16% in 2018.

Yet, the market sees all the negative developments going on in the industry and puts Winnebago in the basket of names destined to fail.

We can see this through our Embedded Expectations Analysis (“EEA”) framework.

The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.

In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.

At the current stock price, the market expects the company’s ROA to collapse to 13%, with maximum pessimism about the industry.

The Fed is finally slowing down on rate hikes, which means we could be a few quarters from things finally picking up in the RV industry.

Today, the company’s stock trades at extremely cheap valuations. Combined with its proven ability to ramp up returns in a good-demand environment, Winnebago is a great FA Alpha 50 name.

Throughout financial market history, many of the world’s most successful investors have been candid in their belief that Generally Accepted Accounting Principles (“GAAP”) distort economic reality.

Warren Buffett, for example, once said investors should “concentrate on the world of companies, not arcane accounting mathematics.”

Investors who neglect the very real issues with as-reported accounting can find themselves caught up in investing with the crowd, blindly following hot “themes” without a thorough grasp of how to understand the businesses in question.

The only true way to focus on the “world of companies,” as Buffett suggests investors do, is to present a clear picture of how a business operates, something that can only be done by adjusting financial statements to reflect the arbitrary nature of certain accounting rules that leave much to discretion.

The world’s best investors understand the need to make these adjustments, which allows them to focus not on picking out the most popular companies but rather on looking for great names in sleepy areas that the market isn’t paying much attention to. From there, the goal is to then identify quality companies with significant growth potential at reasonable prices.

That’s exactly what we’ve set out to do with the FA Alpha, our monthly list of 50 companies that rank at the top for quality, high growth, and low valuations.

This list has outperformed the market by 300 basis points per year for over 20 years now, effectively doubling the performance of the market by focusing on the real fundamentals and valuations of companies with our proprietary Uniform Accounting framework.

See for yourself below.

To see the other 49 names on the list, click here.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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