2 Stocks To Buy, What's Next For The Market

Includes: HD, NFLX, SPY
by: David Ristau

Market Outlook:

The market has continued to bounce up and down on various developments over the past week, and we believe this volatility will continue for some time. The market has risen very strongly over the past few months, and it has to have some healthy correction periods to allow for money to cycle back into stocks. At the same time, the Fed's QE continues to push capital into the market, furthering buying of equities. The constant back and forth of these two developments has created some large moves up and down as of late. For Thursday, it will be the last day of the quarter, so we should see some potential want to push the market higher. The S&P 500 (NYSEARCA:SPY) is very close to a record currently, and it would not be shocking to see the market push for it on the last day of the quarter. The major news will be initial jobless claims, GDP, and Chicago PMI. Look for a strong move off of that data on Thursday.

Stocks To Trade:

Today, we are looking at bullish positions in Home Depot (NYSE:HD) and Netflix (NASDAQ:NFLX).

Home Depot is continuing to look very solid, and we believe that the company remains a great investment. The company combines great growth, solid value, fair yield, and solid near-term catalysts. First off, HD has fairly good value right now. The company's future P/E sits at 17 and price/sales at 1.4. The company's price/sales ratio shows solid value while future P/E is fair valued. What that means is that the company needs to increase margins to see further upside in price. Can HD increase its margins?

We believe so. First off, the company is expected to grow 3-4% in both of the next two years while earnings are expected to grow 13-15%. HD's expanding earnings is due to the company's attention to increasing margins. The company has a focus on cutting SG&A and supply chain efficiency improvements. In the past four years (2009-TTM), the company has seen revenue rise 2%. SG&A, though, has dropped 10%. The company has trimmed down its business, improving its bottom line. We believe its continued increase of margins will be very helpful to helping the company's price. On top its potential improvement in margins, we believe HD will continue to offer a strong yield. The company currently offers a 2.2% yield to investors. On top of its good yield, we believe it has strong cash flow that will continue to offer safety for its dividend as well as potential for increased dividends. The company has increased free cash flow from $3.68B to $5.06B in the past four years. FCF/Sales has improved during that time from 5.2% to 7.0% as well. We believe the company's continued cash flow provides great stability for its dividend.

In the near-term, we see lots of potential for HD as the company continues to benefit from the Superstorm Sandy rebuild as well as a secular rise in housing. We believe that growth demands are strong for the company, and with a lot of other attractive long-term aspects of the company, HD is a perfect company to own.

Trade: HD, Long

Entry: Break of $71

Another stock we like right now is Netflix. The stock continues to rise higher, and during market weakness over the past several weeks, the stock has continued to rise higher. Right now, we like the company's growth catalysts and believe that it has strong support moving forward. Analysts are expecting the company to see 18%+ growth in revenue this year along with over 350%+ growth in earnings. Much of this growth, though, is already priced into the stock as seen by its future P/E of 63.6. Yet, when we look at NFLX's price/sales ratio, it is just 2.9. We look for value under 3. For a high growth stock like NFLX, the under 3 level is attractive.

Why is there such a discrepancy of value between its P/E ratio and price/sales ratio? NFLX has thin margins right now, which is due to large costs of doing business, international expansion, declining DVD business, and increasing domestic streaming business. Those margins do not show any signs of increasing. So, why do we believe NFLX has potential at these high valuations?

Two points that people miss with NFLX when they comment about this margin issue and value increase is international potential and declining marketing costs to subscriber assumptions. Over the past twelve months, NFLX has reduced their marketing costs 25% in the past year. Yet, in that same timeframe, the company saw subscribers grow 11%. While the breakdown over time will move towards instant streaming, the company is paying less for marketing. The cost of doing business during that same period - operating margins grew as well. While contributing margin breakdown moves towards some lower margin goods, the company also continues to see subscriber additions to continue to balance it out (the cost of doing business per user becomes less for every new user).

Further, we believe that many are not giving the international market its fair potential. While Europe is definitely in a troubling state as of now, NFLX has seen great growth in its international markets that we believe over time will offer better margins as well. The company saw an increase of 40% in international sales quarter/quarter at the end of 2012. That growth market is very solid, and the company is getting no addition to margins from it at this point. Over time, the international market will provide contributions to margins as well. As of now, they are limiting NFLX due to the high costs of starting the business.

We believe that NFLX has lots of potential still to move higher, and we see it as a strong stock right now. To take advantage of this strength, we like selling an options spread in it.

Trade: NFLX, Apr20, 170/165 Bull Put Spread

Max Gain: 12%

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.