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Investing, Stocks  | September 11, 2020

A speculative fever from the bulls pushed the market to historic heights, but have the bears now been vindicated? Following a record breaking five-month rally, stocks have dipped from their record highs. The recent decline had been preceded by warnings, which had been making the rounds for weeks, that a reality check was overdue.  

Weighing in for Wells Fargo, senior global equity strategist Scott Wren stated, “We have not had much give back in this gigantic run that we’ve had. So inevitably the stock market sell-off was bound to happen.” This, however, is not to say that exciting plays can’t be found in the current financial environment. “Certainly, pullbacks are opportunities in our minds,” the strategist explained.

Taking Wren’s strategy to heart, the analysts at Wells Fargo are pounding the table on three stocks. According to these pros, each could gain over 50% in the year ahead.

Running the tickers through TipRanks’ database, we wanted to find out what makes them such compelling opportunities.

Houghton Mifflin (HMHC)

As a leader in pre-K-12 educational content and services, Houghton Mifflin combines digital innovation and research to make learning more engaging and effective. Given the need for digital and remote schooling solutions, Wells Fargo sees big things in store for this name.

Representing the firm, analyst William Warmington believes Q2 billings are not a cause for concern, with the result falling in-line with his expectations. The limited selling activity in April and May was to blame for the weak result. That being said, Warmington believes the figure will improve at a “greater-than-usual" pace given the return of normal seasonal demand levels in June and the delay of orders from Q2 to Q3.

Warmington does mention that the acceleration to digital will play a key role in the company’s success. According to the analyst, at least half of school districts are going completely virtual or hybrid, which will drive increased demand for flexible and digital learning solutions. To this end, districts have bumped up their device-to-student ratios, enabling greater adoption of digital instructional materials, in Warmington’s opinion. He noted, “We view these hardware investments as a critical step in accelerating the adoption of HMHC’s digital products.”

Expounding on this move to digital, Warmington stated, “We believe HMHC is well positioned to meet this need/demand primarily through HMH Anywhere, an online integrated learning platform that (1) enables instructional materials to be delivered digitally and (2) will primarily be sold on a subscription basis, reducing volatility and production/delivery cost.”

The implication? Warmington argues the shift to digital has the potential to “improve HMHC’s revenue visibility and margins and ultimately drive a re-rating of the stock.”

Adding to the good news, HMHC repaid $150 million of revolver borrowings with free cash flow generation, which reduced leverage and improved liquidity. Warmington also highlights that it is going through “another cost structure review with results expected by Q4 2020, potentially further lowering breakeven billing level (currently $1.23-1.28 billion) and positioning for margin improvement over the cycle.”

Although falling tax receipts and the device and hardware purchases are taking a toll on school budgets, potentially delaying the near-term purchase of instructional materials, Warmington remains optimistic about the long-term.

Based on all of the above, Warmington rates HMHC an Overweight along with a $5 price target. Should his thesis play out, a potential twelve-month gain of 121% could be in the cards.

Looking at the consensus breakdown, 1 Buy and 2 Holds have been published in the last three months. As a result, HMHC gets a Moderate Buy consensus rating. Given the $3.50 average price target, shares could rise 56% in the next year.

Gap (GPS)

Retail player Gap has scored significant Wall Street attention recently, as its Q2 results beat the estimates across the board. Following the quarterly release, Wells Fargo is standing squarely with the bulls.

Looking more closely at the print, revenues came in at $73 million, flying past the Street’s -$165 million call. Trends bounced back throughout the quarter, with the e-commerce growth rate of 95% remaining relatively stable.

However, even though gross margins exceeded expectations, MMs declined by 270 basis points due to higher shipping and fulfillment pressure. Wells Fargo’s Ike Boruchow notes that “while fulfillment headwinds will continue into 2H, they should be much less than Q2 (as ship from store dynamics have normalized).”

The analyst added, “Q3 sales are expected to improve sequentially, and while no quarter-to-date trend was given, GPS stated that they expect back-to-school selling to extend longer this year (something several retailers have now called out). Growth is expected to be led by Old Navy and Athleta, with BR likely remaining weak... Op-ex is expected to rise in 2H, as safety measures for newly opened stores will lead to higher store investment.” Reflecting an additional positive, Boruchow argues that Athleta’s solid performance indicates “the brand continues to benefit from category tailwinds.”

But what does all of this mean for GPS going forward? It might be time for a “little breather,” so says Boruchow. Expounding on this, he stated, “While the quarter was strong and the outlook sounded favorable, given a slew of positive news on the stock the past several weeks (including multiple upgrades and chatter around an Athleta sale) we wouldn’t be surprised to see the stock take a breather. Fact is, the stock has been on a big run the past several months and we wouldn’t be surprised to see some profit taking.”

However, this doesn’t alter the analyst’s conclusion that the “story is getting better and stock remains long.” Boruchow explained, “The story remains very compelling to us and Q2 should lead to a meaningfully positive revision to estimates – with improvements at Old Navy, strength at Athleta and call options around value creation still on the table (with an October analyst day set as the next potential catalyst).”

It should come as no surprise, then, that Boruchow stayed with the bulls. To this end, he kept an Overweight rating and $28 price target on the stock, suggesting 58% upside potential.

Turning to the rest of the analyst community, other pros are more cautious. 3 Buys, 12 Holds and 1 Sell add up to a Hold consensus rating. At $18.20, the average price target implies a modest 2% upside.

Splunk (SPLK)

Last but not least we have Splunk, which is a fast, flexible and scalable data platform service designed to provide security, IT and DevOps solutions. Based on its solid performance in its most recent quarter, Wells Fargo believes this company’s long-term growth narrative is strong.  

Writing for the firm, 5-star analyst Philip Winslow was impressed by SPLK’s AAR growth, which landed at 50% year-over-year thanks to the acceleration in event data growth and semi-structured log creation. This result indicates that the company was able to continue the “impressive momentum with no meaningful sign of deceleration after having reported 52% in fiscal Q1, 54% in fiscal Q4, 53% in fiscal Q3, and 52% in the year-ago period,” in the analyst’s opinion.  

Winslow added, “Specifically, as more networks and enterprise systems are accessed remotely, more devices are connected to networks, and more transactions are processed through digital commerce—driven by work-from-home and trends due to the COVID-19 pandemic—semi-structured log data, which is one of the underlying drivers of Splunk’s ARR growth, increases further.”

On top of this, Splunk Cloud delivered a bang-up performance, as it made up 53% of total bookings (versus 36% in the year-ago period), pulling forward the company’s 60% cloud mix target by two years. SPLK also reported a 45% year-over-year increase in customers with over $1 million in ARR.

The above results strengthen Winslow’s belief that “Splunk’s breadth of enterprise-class capabilities and scale are unmatched, which continues to drive our positive outlook on (1) the sustainability of growth of the core Splunk Enterprise index and the shift to Splunk Cloud and (2) the company’s ability to successfully expand into both data stream processing and observability.”

Speaking to this expansion, the company has released Data Stream Processor and Data Fabric Search, as well as acquired SignalFx and Omnition. Winslow sees these moves as “augmenting Splunk’s value proposition for CIOs who want broader and more deeply integrated platforms (i.e., data at rest, data in motion, data from any source) that address a wide range of data analytics (i.e., unbounded learning) and observability requirements.”

Summing it all up, Winslow commented, “We believe that Splunk’s differentiated, disruptive technology set positions the company to take advantage of the massive growth in unstructured and semi-structured data... We expect the combination of these drivers to enable Splunk to sustain robust recurring revenue and cash flow growth to meet (and more likely exceed) management’s long-term targets and consensus expectations.”

All of the positives prompted Winslow to leave his bullish call and $300 price target unchanged. This target conveys Winslow’s confidence in SPLK’s ability to climb 51% higher in the next year.

Are other analysts in agreement? Most are. 25 Buy ratings and 4 Holds have been issued in the last three months. Therefore, the word on the Street is that SPLK is a Strong Buy. Given the $239.79 average price target, shares could gain 20% in the next year.

A revolutionary initiative is helping average Americans find quick and lasting stock market success.

275% in one week on XLF - an index fund for the financial sector. Even 583%, in 7 days on XHB… an ETF of homebuilding companies in the S&P 500. 

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