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Don’t Try to Catch a Falling Knife: Be Patient and Capitalize on Market Weakness

At some point, after the market reckoning, it will be time to uncover those stocks that have been sufficiently reset and that are showing tremendous value.

Stocks in the retail/consumer sector have been especially killed this week, with the likes of Canada Goose Holdings Inc. (TSX:GOOS)(NYSE:GOOS) losing approximately 20% in one day and 31% in the last month.

Given that Canada Goose was a high flying, richly valued stock, it was not unexpected that it would blow up as it became harder to meet sales expectations – and that’s just what it did.

But I have never been more interested in this stock as I am today.  Doesn’t mean I would go out and buy it today, but it is definitely on my radar now with the mindset of buying when it hits too low.

So at this point, we’re faced with a successful retailer that’s still reporting explosive growth and increasing profitability levels.  In the latest quarter, revenue increased 25%.  That’s a stellar growth rate, but bottom line is that the market was pricing in more so the stock plummeted.  Remember, in investing, it’s all about expectations.

It doesn’t matter that sales grew at an impressive 25% — what matters is that the stock was pricing in more.

The company has a disappointing quarter behind it and questions regarding future growth rates. At the end of the day, we know that this has reset the stock and that estimates are at risk of being reduced going forward.

The good thing here is that the stock’s valuation has been dramatically reduced, as it has gone from trading at a 50 times price to earnings multiple to current multiples of 35 times actual fiscal 2019 earnings and 28 times consensus fiscal 2020 earnings.

Much lower indeed, but not low by any stretch of the imagination. Fiscal 2019 EPS increased 62%, and if consensus fiscal 2020 EPS estimates are right, it will increase 24%. Valuation at least is more reasonable, but I think we are headed for increasingly more difficult times for retailers, so I would hold off, as I see more downside to the stock.

Aritzia Inc. (TSX:ATZ), another high-flying retail stock that has come back down to earth, is currently trading at 20 times this year’s expected earnings, but at a much better valuation. Aritzia stock has recovered quite nicely from 2018 lows of approximately $10, and it’s now approximately 11% higher than its 2016 IPO price of $16.00 as the stock continues its volatile ride.

Final thoughts

Retail stocks as a group are facing numerous headwinds at this time, including elevated debt levels, a weakening housing market, and an increasingly shaky economic outlook.

Consider sticking with defensive retail stocks at this time.

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Fool contributor Karen Thomas has no position in any of the stocks mentioned.

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