With the focus on earnings reports, many investors may be missing out on the burgeoning bubble in used car stocks. Due to low new car inventories, used cars are flying off the lot. That is great news for stocks such as Advance Auto Parts (AAP), LKQ Corporation (LKQ), and AutoZone (AZO).

While most investors and traders are focused on Q1 earnings, I’ve found a little corner of the market that should see solid gains over the next couple of months. As most industries are recovering this year, new car sales are down considerably in 2021.

This is due to lower production in 2020 and a current worldwide chip shortage. But this has been a blessing for used car sales and companies that serve this market. As used cars take center stage, there will be an increasing need for auto parts.

This provides us a unique opportunity to take advantage of auto parts stocks that should see their shares rise in the months ahead. That’s why I’m recommending Advance Auto Parts Inc (AAP - Get Rating), LKQ Corporation (LKQ - Get Rating), and AutoZone, Inc. (AZO - Get Rating). But first, let’s recap the week before I dig deeper into these companies.

Market Commentary

Stocks finished slightly down on Monday as investors awaited corporate earnings reports and economic releases. The market was mixed the following day as Wall Street digested an uptick in consumer price inflation and adverse vaccine developments. Headline CPI rose 0.6% last, with a rise in gasoline prices accounting for half the increase.

Investors were also concerned with the FDA halting Johnson & Johnson’s (JNJ) vaccine. The market was mixed again on Wednesday as JPMorgan Chase (JPM) and other U.S. banks reported strong profits. Early gains were erased by the end of the day. Bitcoin hit a new record (above $64,000) as crypto platform Coinbase (COIN) officially started trading.

Stocks finished much higher on Thursday after an influx of strong corporate earnings reports and upbeat economic data. So far, first-quarter earnings reports are easily beating estimates. Retail sales for March beat estimates coming in at 9.8% over February. Plus, initial jobless claims over the past week were 576,000, much less than the expected 710,000.

Stocks were mostly higher today, with both the S&P 500 and Dow Jones Industrial Average hitting new closing records. The market was supported by robust economic data from China and better than expected domestic housing data in the U.S.

Market Outlook

Both the data coming from China and our own U.S. housing data, along with yesterday’s upbeat economic reports, show the global economy is improving rapidly, which justifies bullish sentiment going forward. But if we drill down to an area of the market poised for upside, its car parts.

Due to the reasons I mentioned earlier, it’s hard to find a new car. While that’s resulted in sticker shock for some used car buyers, it created a new bubble in the market for companies that cater to used vehicles.

For instance, the Manheim used-car index, an industry pricing gauge, is up 26.6% year over year. Used cars need considerably more attention than new ones, which creates a perfect setup for auto parts stocks. This is why I am highlighting the three stocks below.

Advance Auto Parts Inc (AAP - Get Rating)

AAP is one of the industry’s largest retailers of aftermarket automotive parts, tools, and accessories to do-it-yourself customers in North America. At the end of last year, the company operated 4,976 stores and serviced 1,277 independently owned Carquest stores. Plus, the company’s Worldpac unit is a premier distributor of imported original equipment parts.

The company should benefit from a favorable outlook for auto aftermarket retailers due to the used car bubble and higher-maintenance needs of used vehicles. AAP has been taking several initiatives to strengthen and streamline its supply chain to meet its customers’ needs. For instance, it continues to make progress on its Do It Yourself (DIY) omnichannel e-commerce platform.

AAP has an overall grade of B, which translates into a Buy rating in our POWR Ratings service. The company has a Growth Grade of B, which isn’t surprising as Wall Street analysts expect the stock to report year-over-year earnings growth of 184.6% in their upcoming report. The company also has a Momentum Grade of A as its stock has shown bullish momentum since mid-February.

We also grade AAP based on Value, Stability, Sentiment, and Quality. You can find those grades here. AAP is ranked #11 in the A-rated Auto Parts industry. You can find other top stocks in that industry by clicking here.

LKQ Corporation (LKQ - Get Rating)

LKQ is a leading global distributor of non-OEM automotive parts. The company was initially formed in 1998 as a consolidator of auto salvage operations in the United States. It has expanded its scope to include the distribution of new mechanical and collision parts, specialty auto equipment, and remanufactured and recycled parts in Europe and North America.

In addition to favorable fundamentals for auto parts distributors, LKQ should continue to benefit in the long term from organic growth, as well as domestic and international acquisitions. LKQ has also developed relationships with auto insurance companies as the largest supplier of alternative collision parts to repair shops.

The company has an overall grade of A or a Strong Buy Rating in our POWR Ratings system. The company has a Value Grade of B, which makes sense as it’s currently undervalued with a forward P/E of 15.92. LKQ also has a Quality Grade of B, which means it has a healthy balance sheet. The company has a current ratio of 2.0, which means it has more than enough liquidity to handle short-term debt.

To access the rest of LKQ’s grades (Growth, Momentum, Stability, and Sentiment), click here. LKQ is rated #8 in the same A-rated industry (Auto Parts) as AAP.  

AutoZone, Inc. (AZO - Get Rating)

AZO is one of the nation’s largest auto parts and accessories retailers, with almost 5,900 stores in the U.S. and over 660 stores in Mexico and Brazil. It operates in the Do-It-Yourself (DIY) retail, Do-It-for-Me (DIFM) auto parts, and products markets. It is also deriving an increasing proportion of its sales from domestic, commercial customers.

The company is well-positioned as any auto parts company to benefit from the industry’s long-term fundamentals. AZO should also see stronger near-term revenue growth due to its high exposure to the DIY channel. Its leadership in this segment has given the firm a vast national store network that it can leverage to build commercial sales.

AZO has an overall grade of B, which translates into a Buy in our POWR Ratings systems. The company has a Sentiment Grade of B, which means it is well-liked by analysts. Sixteen Wall Street analysts rate the stock a Buy or Strong Buy. AZO also has a Quality Grade of A, which means it has a rock-solid balance sheet. As of the end of the most recent quarter, the company had $1 billion in cash with $250 million in short-term debt.

We also provide Growth, Value, Momentum, and Stability grades for AZO, which you can find here. AZO is ranked #26 in the A-rated Auto Parts industry.

AAP shares . Year-to-date, AAP has gained 22.65%, versus a 11.97% rise in the benchmark S&P 500 index during the same period.