Hidden gems: 3 undervalued stocks with a unique competitive edge

Key Points

• Etsy, International Flavors & Fragrances and Zimmer Biomet all have strong positions in their industries but are trading below their intrinsic value.
• These stocks may be undervalued because investors have focused on short-term metrics or news.
• It can be difficult to quantify intangibles like brand loyalty or proprietary technology, but patient investors may find opportunities in these stocks

Companies with unique competitive advantages aren’t always rewarded by the market: Etsy Inc. NASADQ: ETSY, International Flavors & Fragrances Inc. NYSE: IFF and Zimmer Biomet Holdings Inc. NYSE: ZBH are examples of stocks that appear to be trading well below their intrinsic value, based on earnings projections. 

A company with a competitive advantage may be undervalued because investors sometimes overlook its long-term potential, focusing instead on short-term metrics.

It can be hard to put a dollar value on intangibles such as strong brand loyalty or proprietary technology, leading investors to instead look at revenue and earnings projections for the next few quarters.

However, for investors with some patience, and who are willing to buy a stock that may be less of a momentum play than popular growth names, there could be an opportunity for substantial returns as the market gradually recognizes the company's value.

Here are three undervalued stocks of companies that have competitive advantages in their industries, through mechanisms such as strong brand identity, high switching cost or economies of scale, among others.

Etsy

The online marketplace has moved well beyond crafts, and now features artisan-made furniture, paper goods and home decor items, among other products.

When the company reports 2023 results on January 31, Wall Street expects earnings to grow by 53% to $4.12 a share. Using MarketBeat’s Etsy earnings data, you can see the recent turnaround from several quarters of earnings declines. 

The company recently said it would slash 11% of its workforce as customers have cut back on discretionary spending.

That said, Etsy’s position as a marketplace for creative rather than mass-market design helps it stand out. In addition, it differs from other sales platforms, such as Shopify Inc. NYSE: SHOP in that buyers can serendipitously discover new products on Etsy, without having to be searching for one specific company’s items. 

The Etsy chart shows the stock pulling back with the broader market the first week of January, putting a stop, at least temporarily, to an uptrend that began in early November. Watch for the next earnings report, particularly with regard to guidance, as a possible catalyst for an upside move. 

International Flavors & Fragrances

It’s far from being a household name, but the $20.31 billion market cap company is tracked with basic materials stocks in the Materials Select Sector SPDR Fund NYSEARCA: XLB.

The stock has a three-year revenue growth rate of 35%, although both earnings and revenue have been declining recently. Wall Street expects earnings to be flat in 2023 at $3.37 per share. IFF reports fourth-quarter and full-year results on February 5. 

The company develops and manufactures products in the categories of food, beverage, health and biosciences, scent, pharmaceuticals and cosmetics, as well as other natural ingredients. solutions and 

Its products are sold principally to manufacturers of dairy, meat, beverages, snacks, and other food products, personal care products, soaps and detergents, cleaning products, perfumes and cosmetics, dietary supplements, and pharmaceuticals, in addition to other end users. Pharmaceutical and oral care products. 

With those categories encompassing many consumer staples, you may be wondering why revenue declined. In an August 2023 earnings report, CEO Frank Clyburn said, “The continued customer destocking and volume pressures in the second quarter reflect the broader macroeconomic challenges facing our industry, and for IFF.” 

In other words, business customers were deliberately reducing their inventories in response to inflationary concerns and consumer belt-tightening. Clyburn added that those effects were largely isolated to the company’s food-related segments. 

But as inflation eases, and with the much-predicted recession yet to show itself, analysts expect the company’s earnings to bounce back this year by 19%. Another attractive feature is the International Flavors & Fragrances dividend yield of 4.07% and the company’s 20-year track record of boosting its shareholder payout.

Zimmer Biomet

You may know people who have had hip or knee replacements, or perhaps you’ve had one (or two) yourself. You’ve probably not thought about it much, but those new body parts have to come from somewhere, and Zimmer Biomet is often the place.

Zimmer Biomet earnings grew in 2021 and 2022 as the pace of surgeries picked up after Covid restrictions slowed things down in 2020.

The company warned that the pace will slow down this year, although analysts expect earnings to grow by 7%, versus an expected decline of 22% in 2023. 

It’s that rebound, and re-set expectations, that have Wall Street more bullish on the stock these days. The Zimmer Biomet analyst forecasts show a consensus view of “hold,” with a price target of $138.40, an upside of 15.14%. 

For the record, it’s not just aging Baby Boomers who are the end customers of Zimmer Biomet’s products; younger patients, including those with mobility issues, are a fast-growing market segment. That bodes well for future growth.