Cabot Stock of the Month Issue: July 13, 2023

Market Review

Manufacturing is steady; construction spending is up; and employment numbers surged to 497,000, according to ADP. That’s more than double the number that economists had predicted. In fact, the leisure and hospitality segment produced 232,000 jobs alone—more than the entire 220,000 job increases forecast. The unemployment rate for June declined slightly, to 3.6%.

All in all, the economy seems to be sailing along pretty well, and recession forecasts have dropped to about a 25% chance. We’ll just have to wait and see.

In the meantime, the markets continued their volatility over the last month, which I find exciting, as the down days provide some great opportunities for buying attractive stocks at lower entry prices.

Growth stocks continue to outpace value names. And sector-wise, Technology, Communication Services, and Consumer Discretionary stocks are the market leaders, rising 37.6%, 35.6%, and 31.1%, respectively, year to date.

Here at Cabot, we are delighted that the market is exhibiting bullish characteristics, but are not unhappy with the recent rest break. We’ll continue searching for some attractive stocks, like the one I have for you today.

Feature Recommendation- International Business Machines Corporation (IBM): Big Blue Takes on AI

You can’t pick up the paper or tune into a news channel without hearing about the latest evolution in artificial intelligence (AI). You may think it’s a technology you don’t care about and probably won’t use. But guess what? You would be wrong, as you are most likely already using AI, without even knowing it!

Every time you shop online, employ a spam filter for your email, use your car’s GPS, or charge something on your credit card, there is likely some sort of AI involved. AI is used in e-commerce, fraud prevention, autonomous vehicles, and even the facial recognition on your phone.

The opportunities for investing in AI are immense—from unknown start-ups to old established companies like Big Blue, otherwise known as International Business Machines (IBM), which has been around since 1911.

When I asked Carl Delfeld, Chief Analyst of Cabot Explorer, for some AI ideas, I have to say I was surprised when he recommended IBM, as Carl is known for finding undiscovered tech stocks. But when I understood his reasoning for the recommendation, I have to say I agree wholeheartedly.

Here’s what Carl had to say about what he calls an “underestimated blue-chip artificial intelligence (AI) and India play with a 5% dividend yield.”

“Within growth technology, the sector that has taken off so far this year has been artificial intelligence (AI).

“You may be wondering whether this is another investment stock mania or a long-term opportunity. I think it’s both.

”The internet, for example, has certainly transformed the world, but a lot of investors got burned in the dot.com boom. On the other hand, investors who stayed with established technology companies—like Microsoft (MSFT), Amazon (AMZN), and Apple (AAPL)—have done remarkably well.

“Artificial intelligence—a field of computer science that focuses on building software for machines to perform intelligent tasks like (and even better) than humans—what I call inhuman intelligence—is a disruptive development potentially more powerful than the internet or electricity. BCA Research believes that AI could boost economic growth by 30X to 100X, roughly comparable to the impact of the agricultural or industrial revolutions. There is opportunity here, and one way to invest is to try to find the new companies in the AI space that will emerge as winners in this competitive space.

“Lots of risk and a chance for big gains.

“A more conservative strategy is to invest in a blue-chip tech stock that supports AI, especially if this move is not yet recognized by the market. Known as ‘Big Blue,’ IBM now primarily helps businesses and governments manage their information technology in the cloud era.

“For IBM, the only constant is change. IBM began by making clocks and cheese slicers, and then the punched-card tabulator. After that came one innovation after another: typewriters, vacuum tube calculators, magnetic tape, the first disk drive, the memory chip, FORTRAN, fractals, ATMs, mainframes, mini-computers, personal computers, and supercomputers.

“In 2005, IBM’s personal computer business was sold to China’s Lenovo since it was evolving into a low-margin commodity business. Most recently, the company has moved from hardware into higher margin consulting and services business and is focused on helping clients migrate to the cloud.

“IBM does not sit on its reputation. About 6% of its revenue is poured into intensive research and development. This firepower yields thousands of patents each year as the company masterfully leverages its global network of staff and nine research labs. IBM is now an active player in 170 countries. Sales to emerging markets have boomed, and it might surprise you to learn that about 30% of its workforce is based in India.

“IBM has also been blessed with outstanding leadership at the top. Founder Tom Watson is of course famous as the gruff but driven founder readily handing out cash on the spot for ideas he liked.

“Getting back to artificial intelligence (AI), consider that the world now creates astronomical amounts of data each day. AI is the only way to effectively process and use all this information. It enables computers, robots, and other connected devices to instantly share information and copy human perception, learning, and problem-solving. This allows machines to independently perform specific tasks with increasing accuracy.

“It can be argued that IBM is already the world leader in AI. It has been working on applications in this field for over four decades and has deeper AI knowledge than virtually any company. Its supercomputer Deep Blue beat world chess champion Gary Kasparov in a six-game match in 1997.

“Recently, IBM launched an all-new version of Watson, called watsonx, to help customers create AI applications of their own, to squeeze more value out of their data.

“The complicating factor for us is that IBM won’t say how much of its revenue is tied to AI because it is so difficult to break out of each of its market segments.

As IBM CEO Arvind Krishna put it recently...

Our mainframes have AI circuits—so is the mainframe business AI? I am going to do storage backup in the future with AI—is storage backup AI? Maintenance applications use AI. All of cybersecurity is going to use AI. Before the next five years are done, everything is going to have AI fused inside it.

“IBM is also constantly on the lookout for acquisitions. Just this week it announced it is acquiring software company Apptio for $4.6 billion, marking the seventh acquisition this year as CEO Arvind Krishna pushes the company’s transformation into a hybrid-cloud and artificial intelligence business.

Finally, compared with many other AI-related stocks that have made major moves already this year, IBM is a bargain. The stock sells for about 14 times projected earnings for the next 12 months while the S&P 500 multiple is 19 and the information technology sector’s forward earnings multiple is 27.

“IBM also has a dividend yield just under 5%, and the company has paid a dividend every quarter since 1916. And the company has had 28 consecutive years of dividend increases. BUY A HALF”

The shares of International Business Machines Corporation are garnering some additional hedge fund attention, as 49 funds now hold the stock, up from 43 in the prior quarter.

Earnings estimates are rising for the company, too, with EPS now estimated at $2.01 on $15.58 billion in revenues. And price targets are also edging up, with the consensus high forecast now at $162.

A sterling example of not just surviving but a track record of thriving with new innovation, IBM is a leader in cloud and hybrid computing, software, and consulting.

And for investors, its amazing history of dividend increases provides an attractive yield of 5.03%, while we anticipate share price appreciation. Moderate.

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About the Analyst: Carl Delfeld, Chief Analyst, Cabot Explorer

Carl received his Master’s in Law and Diplomacy at the Tufts Fletcher School; worked for the First National Bank of Boston (now Bank of America) in London, serving as director of the Japan and South Korea Group; served as vice president at the investment bank Robert W. Baird & Company, developing new business in Tokyo, Hong Kong and Sydney; was Asia advisor to the U.S. Congressional Joint Economic Committee, the U.S. Finance Committee and the U.S. Department of the Treasury; wrote for Forbes Asia and the Far Eastern Economic Review; served as a member on the U.S. National Committee on Pacific Economic Cooperation and the Japan-U.S. Friendship Commission; was chairman of the Asian Pension Forum. Carl has recently released his latest book: Power Rivals: America and China’s Superpower Struggle.

Additional books Carl has written include:

Red, White and Bold: The New American Century Paperback,

Think Global, Grow Rich: 7 Principles for Building a Global Portfolio,

The New Global Investor: Using ETFs to Build Smarter, Simpler and Safer Portfolios.

International stocks—other than Latin American companies—have had a tough go of it recently, despite their leading technology innovations. Experts are forecasting modest growth for both China and India’s stock markets this year. But with the constant chatter about artificial intelligence (AI) and electric vehicles (EVs), and the work from tech companies in both arenas, I decided to consult our international expert, Carl Delfeld, to get his latest thoughts on these markets. Here is our interview:

Nancy: I’m amazed at the breadth and depth of your newsletter, Cabot Explorer, covering so many regions of the world and cutting-edge stocks. Would you share with my readers your basic methodology for finding such interesting companies to write about?

Carl: I try to first identify the most promising trends and sectors and then explore what might be the best stocks to play them. If possible, we offer both a conservative and aggressive play and from time to time an ETF as well. Basically, I just read widely and stay alert for new ideas.

Nancy: You have recently written about the artificial intelligence (AI) industry, including opportunities in India and China. What are your current thoughts about which countries will be the leaders in AI, and why?

Carl: I think the U.S. will lead in AI, but China will be a key rival as they are in almost everything. But all the developed countries with a strong tech sector will have to be focused on it as the stakes are so high. It really comes down to talent and the resources to develop the talent as well as computing power.

Nancy: In a recent update, you mentioned India’s influence in the semiconductor industry, in addition to its AI work. Which particular sub-sector do you think will be India’s primary focus?

Carl: India is a strong leader in information technology with multinationals around the world outsourcing this work to lower costs and boost margins. India is trying to become an alternative to Taiwan as a place to fabricate chips, but this will take some time and enormous amounts of capital.

Nancy: Your portfolio is tech-heavy, including ideas in the electric vehicle (EV) arena. Where are the top three areas in which you see this industry progressing over the next year or so?

Carl: Electric vehicles (EVs) are an exciting growth sector that has a tech angle because of the importance of battery technology. But its supply chain extends from mining and refining critical metals to semiconductors and of course marketing and branding. There is also a political aspect here as China is clearly the center of the global EV ecosystem. Right now, the market is very competitive and many of the players will probably merge or run out of money, so you need to stick with the leaders.

Nancy: Which sectors are attractive to you for the rest of this year? And why?

Carl: The market has been very narrow so far in 2023 and I expect it will broaden out a bit. The momentum is with quality tech growth, and this will likely continue but there are some great values out there.

Some of the international markets, such as Japan, are in “catch-up” mode relative to the U.S., and emerging markets are quite cheap as well.

Nancy: I’ve known you for many years as an astute ETF investor, Carl. And I recently enjoyed reviewing your Money Show presentation on opportunities for building several ETF portfolios to fit different investing goals and strategies. Would you please explain a bit more about your idea?

Carl: I think most investors would benefit from separating their investments into several portfolios with the foundation being what I call a “Hammock” portfolio of ETFs that seeks to provide some upside but lower risk and volatility. This gives an investor some freedom and security to layer more aggressive stocks and ETFs on top of this foundation. Stocks and ETFs can easily be blended together to raise the probability that one reaches their financial goals.

Portfolio Updates

And speaking of AI, Tom Hutchinson, Chief Analyst of Cabot Dividend Investor and Cabot Income Advisor, updated his view on Qualcomm Inc. (QCOM), saying, “Like INTC, QCOM has pulled back in the last couple of weeks after its initial AI surge. It’s bouncing around as investors fluctuate between confidence in the company’s future and waning AI excitement. Qualcomm describes itself as the ‘on-device AI leader,’ and the company should benefit mightily from the increasing shift towards AI and profits are now likely to soar sooner than previously expected. HOLD”

Shares of QCOM have disappointed, but with the momentum for AI building exponentially, its upside looks attractive. I’m going to hold it a while longer, and we can enjoy the 2.71% dividend yield while we wait for share appreciation.

Devon Energy Corporation (DVN) will announce earnings on August 1, 2023. The company is expected to report EPS of $1.35 on revenue of $3.7 billion. I love the 9.23% dividend yield, so will be patient for a bit longer. Hold.

Citigroup (C), says Bruce Kaser, Chief Analyst of Cabot Turnaround Letter and Cabot Value Investor, “like its major peers, looked strong in its annual Federal Reserve CCAR stress test, which evaluates how banks’ capital and earnings would hold up in a severe recession. With more than adequate capital to weather the grim scenario outlined in the test assumptions, Citi announced that it is raising its quarterly dividend by 4%, to $0.53/share, starting with the third-quarter dividend. The bank has already repurchased $1 billion of its common shares this quarter (following the news that it will be using an IPO to divest its Mexico consumer operations rather than a sale).

“Does passing this year’s stress test mean that Citi is free to become more aggressive in producing profits? Unfortunately, it does not. As a result of the test, Citi will be subject to a higher minimum capital requirement. Starting in about a year, the bank needs to have a minimum CET1 capital ratio of 12.3%, up from 12.0% currently. Most other majors have either a decrease or no increase. So, Citi remains a riskier bank, relative to others, given the ‘Doomsday Scenario’ outlined in the tests.

“What does this mean for bank investors? It means that banks are increasingly becoming highly regulated entities like utilities, if they aren’t already. For major banks, this might actually be a positive in that smaller banks will be disproportionately weakened by the new rules. They have fewer resources to understand, battle and implement them, and they have little to no direct experience with the rules. Another positive is that the majors are perceived as being safer, almost to the point of earning a ‘Good Housekeeping Seal of Approval’ from the Fed. This will likely help them continue to attract deposits at the expense of smaller banks.

“Banks have become low-return businesses. But their stocks don’t need to be. Buying bank shares when they are out of favor tilts the odds in the value investor’s favor. Citi shares trade at a remarkable discount of nearly 50% to their tangible book value. Once the bank can demonstrate that it has cleaned up its operations, is as sound as its high capital ratios imply, and that its underlying profitability is reasonably steady (even at a low-return level), investors will likely bid the shares to closer to tangible book value. We will remain patient and collect a 4.5% dividend yield while waiting. Buy”

Warren Buffett is still a big believer in Citi’s stock, adding another 89,000 shares in the first quarter, bringing his ownership to 2.86% of the bank’s outstanding shares.

And Wall Street agrees, pushing up its 12-month price target by 23% over its current share price. Buy.

Michael Brush, Chief Analyst of Cabot Cannabis Investor, who recommended Curaleaf (CURLF), says good news may be coming for the cannabis industry “when Washington, D.C. lawmakers return from their July 4th break on July 10, they are likely to get down to serious business on the SAFE Banking Act.

“This proposed law would boost investor interest in the space because it would allow banks to work with cannabis companies. This would help cannabis companies in several ways.

“The bill may also include provisions that allow cannabis companies to more easily graduate to bigger stock exchanges from the over-the-counter exchange. This last benefit is more of a wild card.

“Here are some other potential July catalysts for cannabis.

1) Maryland starts recreational use sales on July 1. This is well known, and possibly priced into the stocks. Nevertheless, headlines around the event may attract investor interest.

2) Some analysts think we could get a Florida Supreme Court decision in July on the wording of a proposed referendum that would allow Floridians to vote on legalizing recreational use in the 2024 elections. Florida is a potentially big market given its population of 22 million and the 138 million tourist visits per year. Approval is probably not priced into cannabis stocks since the Florida Supreme Court has a conservative bent. Conservative politicians are aware that a cannabis referendum would bring out voters on the left. Florida, where medical use is permitted, is currently a $2 billion annual revenue market. That would go up to $6 billion with the legalization of recreational use, believes Rivers at Trulieve, the biggest operator in the state. Trulieve has funded the referendum effort.

“Projections of a court decision in July could be premature, since the court has until the end of April 2024 to decide. Buy.”

These shares are for the long term; buy for the speculative section of your portfolio.

The recommendation of Shift4 Payments (FOUR) was recently updated by Mike Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader, saying, “FOUR enjoyed a solid (albeit low-volume) four-day rally to finish last week, though it’s reversing some of that move so far this week on more economic fears. A strong rally from here would look very good on the chart—finally rounding out its launching pad. At this point, though, FOUR is basically in the middle of its two-month range, so we’ll stay on Hold and see how it goes. HOLD”

The shares of FOUR were recently upgraded by SVB MoffettNathanson to Outperform from Market Perform and the firm raised its price target to $80.00 from $75.00. This was based on a 15% rise in the company’s gross merchandise volume (GMV) and more favorable profitability than its competitors. Hold.

Tyler Laudon, Chief Analyst of Cabot Early Opportunities and Cabot Small-Cap Confidential, reported that TransMedics Group (TMDX) “moved 8% higher over the last five sessions on no news. We’ll take it. The Q2 earnings call should be a significant event here. That’s not just because we’re looking for confirmation that the company should grow revenue by about 87% this year and be on track to deliver first profits in 2024, but because management has discussed getting into an aviation business to fix supply chain challenges in the organ transplant market. HOLD THREE QUARTERS”

Nancy’s update: TransMedics had a great first quarter, reporting revenues up 162% year over year, and an excellent improvement in the company’s net loss—$2.6 million from $10.6 million a year earlier. The company also raised its revenue guidance to $160 million to $170 million from its previous estimate of $138 million to $145 million. Hold.

Reporting on Brookfield Infrastructure Partners (BIP), Tom Hutchinson, Chief Analyst of Cabot Dividend Investor commented, “The infrastructure company stock has pulled back from the recent high and was down in June. But BIP is still around the higher levels of the recent range. The stock got new life after a sluggish period because Brookfield reported a solid earnings quarter with funds from operations (FFOs) per share growth of 12.5% over last year’s quarter. BIP is still reasonably priced with a good dividend ahead of a promising second half of the year. (This security generates a K-1 form at tax time). BUY”

Brookfield anticipates its funds from operations (FFO) will grow 10% this year, yet the shares trade at a P/E of just 12.7. That’s half of the S&P 500 P/E of 25.53. And don’t forget about the 4.29% dividend yield. There’s lots of room for this stock to grow. Buy.

Our newest recommendation, NOV, Inc (NOV) was updated by Bruce Kaser, noting, “The shares of this high-quality, mid-cap company, trade at the low end of their 20-year range due to investor expectations for an uninspiring future. We see this consensus view as overly pessimistic, given the company’s strong position in an industry with improving conditions, backed by capable company leadership and a conservative balance sheet.

“NOV shares rose 3% in the past week and have 54% upside to our 25 price target. The dividend produces a reasonable 1.2% yield. BUY”

Wall Street is forecasting a price target of $24.89 for the shares of Nov Inc., which is 43% upside from its current price.

The company will announce earnings on July 27, 2023. Consensus estimates are for EPS of $0.30 on $2.08 billion in revenues. Buy.

Portfolio

*Aggressive (A), Moderate (M), Conservative (C)

ETF Strategies

Currently, First Trust Water ETF (FIW), iShares U.S. Energy (IYE), ALPS Medical Breakthroughs ETF (SBIO), Vanguard Dividend Appreciation Index Fund (VIG), Vanguard U.S. Momentum Factor ETF (VFMO), and Communication Services Select Sector SPDR Fund (XLC) are showing positive returns.

This month, I’m selling AGF U.S. Market Neutral Anti-Beta Fund (BTAL), due to its disappointing performance. I am also removing U.S. Medical Devices Ishares ETF (IHI) and Innovator Ibd Breakout Opportunities ETF (BOUT) from our Watch List and adding them to our portfolio.

Our Watch List has three names remaining:

O’s Russell Smallcap Qlty Divd ETF (OUSM)
GX U.S. Infrastructure Development ETF (PAVE)
Russell Top 200 Ishares ETF (IWL)

New Additions to Our ETF Portfolio:

Recommendation #1: U.S. Medical Devices Ishares ETF (IHI)

5 stars
Above average risk
Large Cap Blend

The fund will invest at least 80% of its assets in the component securities of the index and in investments that are substantially identical to the component securities of the index and may invest up to 20% of its assets in certain futures, options and swap contracts, cash, and cash equivalents, as well as in securities not included in the index, but which BFA believes will help the fund track the index. The fund is non-diversified. Aggressive.

Top 10 Holdings (70.86% of Total Assets)

Recommendation #2: Innovator Ibd Breakout Opportunities ETF (BOUT)

5 stars
Above average riskBlend, Growth

The fund normally invests at least 80% of its net assets (including borrowings for investment purposes) in the equity securities that comprise the index. The index seeks to provide opportunistic investment exposure to those stocks with the potential to “break out,” or experience a period of sustained price growth beyond the stock’s recent “resistance level,” with consideration for various market conditions. The fund is non-diversified. Aggressive.

Top 10 Holdings (20.62% of Total Assets)

Artificial Intelligence Is Ushering in the Next Big Wave of Technology Profit Opportunities

Although artificial intelligence may seem like the latest “hot” technology, the term was actually coined by John McCarthy in 1950.

He said, “Every aspect of learning or any other feature of intelligence can in principle be so precisely described that a machine can be made to simulate it. An attempt will be made to find how to make machines use language, form abstractions, and concepts, solve kinds of problems now reserved for humans, and improve themselves.”

And as I mentioned earlier, IBM caught onto the idea of AI very early and began working on the concept and how it might change our lives, some forty years ago.

Today, the industry is exploding. According to Statista, global revenue from the AI software market is expected to reach $126 billion by 2025. Research firm Gartner reports that 37% of organizations have implemented AI in some form, and the number of companies using AI has grown 270% over the past four years.

Furthermore, Servion Global Solutions reported that by 2025, 95% of customer interactions will be powered by AI.

AI has vast potential and according to https://www.simplilearn.com/, it is already being employed in:

1. e-Commerce, which uses your browsing history, preference, and interests to offer purchase recommendations (can you say, pop-up ads?)

2. AI-Powered Assistants, like chatbots and shopping assistants that use natural language processing. Yes, it can be tedious, but this technology is improving rapidly. I just spent some time with a Home Depot chatbot to check on an order that was overdue, and it actually wasn’t a bad experience.

3. Fraud Prevention, such as those text messages that are sent when you make an unusual credit card purchase. I don’t know about you, but I really appreciate those! Additionally, we know that many product “reviews” are fake, and AI is making strides in identifying those fake reviews.

4. Education, used by teachers for grading papers, sending personalized messages to students, arranging parent meetings, and managing enrollment. AI is also creating smart content to digitize video lectures, conferences, and textbook guides, which can be customized according to need. And AI is providing additional learning material or support via voice assistants, and managing student data to provide a customized learning experience.

5. Lifestyle applications such as autonomous vehicles, spam filters, and facial recognition.

6. Navigation

7. Robotics, which utilize real-time updates to sense obstacles in its path and pre-plan its journey instantly.

8. Human Resources to process applications.

9. Healthcare, to build sophisticated machines that can detect diseases and identify cancer cells. Artificial intelligence can help analyze chronic conditions with lab and other medical data to ensure early diagnosis. AI also uses the combination of historical data and medical intelligence for the discovery of new drugs.

10. Agriculture to identify defects and nutrient deficiencies in the soil. This is done using computer vision, robotics, and machine learning applications, AI can analyze where weeds are growing. AI bots can help to harvest crops at a higher volume and faster pace than human laborers.

Those are just a few of the innovations that AI is providing. To see the whole list, visit https://www.simplilearn.com/.

Of course, AI is not without its critics. Of late, I’ve seen lots of articles about the dangers of AI, including the spreading of misinformation through fake images and videos (known as deepfakes), elimination of jobs, loss of privacy (we’ve been dealing with “big brother” for a long time!), discrimination, market and financial volatility, and a so-called singularity in which AI surpasses human intelligence.

The graph below depicts the substantial increase in AI concerns.

Granted, there are legitimate pros and cons to AI, including these provided by https://towardsdatascience.com/:

Pros:

1) Reduction in human error.

2) Takes risks instead of humans, such as defusing bombs, mining, natural disasters.

3) Available 24x7.

4) Helping in repetitive jobs.

5) Digital assistance, saving human resource costs.

6) Faster decisions and actions from machines.

7) Daily applications like Apple’s Siri, Window’s Cortana, Google’s OK Google are frequently used in our daily routine whether it is for searching a location, taking a selfie, making a phone call, replying to an email and many more.

8) New inventions.

Cons:

1) High costs of creation.

2) Making humans lazy.

3) Unemployment.

4) No emotions.

5) Lacking out of box thinking.

Only time will tell, but I think it’s too late to put the technology back into Pandora’s box. We can only trust that AI will be used for ‘good’ to help humankind progress. And since AI is here, doesn’t it make sense to depend on a steady company that has changed with the times, continuing to innovate at a pace often only seen with small start-ups? That’s IBM—undervalued and paying a hefty dividend.

Portfolio

*Aggressive (A), Moderate (M), Conservative (C)

The next Cabot Money Club Stock of the Month issue will be published on August 10, 2023.