Cabot Explorer Issue: January 18, 2024

Portfolio Changes: None

It’s a Stock (and Niche ETF) Picker’s Market

Resilient consumer spending is causing the Fed to push back against the idea of a near-term rate cut. The plus side is that U.S. economic growth remains encouraging.

Meanwhile, China’s post-pandemic recovery is shaky as data out last week showed prices across the Chinese economy fell for the third straight month in December. Youth unemployment is about 15%, home prices and property sales also declined, a sign of the weakening property sector that had once fueled its growth.

As we all know, the “Magnificent Seven,” Amazon, Alphabet, Apple, Meta, Microsoft, Nvidia, and Tesla, have outperformed and dominate the company weightings in the S&P 500 index and the SPDR ETF (SPY) that tracks the index. The 2023 run-up in technology has also stretched the sector’s valuation.

If you share my concern that this may not continue into 2024, you might want to move some capital into Invesco’s S&P 500 Equal Weight ETF (RSP), which weighs each stock equally.

The big idea behind the Cabot Explorer is to recommend stocks involved in global dominant changes, megatrends, and themes. If we can get the most important themes right and have a framework for understanding the world and how to invest in it, we should continue to fare well.

One way to gain concentrated exposure to big trends is through niche ETFs. ETFs can be great diversification tools, but even well-known ETFs have a lot more single-stock concentration than you’d expect. For example, did you know the Energy Select Sector SPDR Fund (XLE), which has 23 holdings, gives a 23% weighting to Exxon Mobil Corp. (XOM)? The Technology Select Sector SPDR Fund (XLK) is even more concentrated. This ETF has 64 holdings, but two stocks, Microsoft (MSFT) and Apple (AAPL), comprise 44% of it. I like niche ETFs, but they have an important similarity to individual stocks. You need to know what you’re buying.

My #1 ETF rule is to look under the hood on an ETF … before you invest.

New Recommendation

PayPal (PYPL)

While every situation is different, a pretty good rule of thumb for investors is to look for stocks of well-run companies with solid fundamentals in a sector that has been out of favor. Then check that the stock is in an uptrend with clear catalysts that support a further rise in its stock price.

This is the situation with PayPal (PYPL). The stock is down over the last year but since this past fall is in an uptrend. It is at the center of payments and fintech. The stock is trading at a relatively low valuation despite a return of equity near 20%.

Around January 25, a partnership with the payments company Venmo will be announced and Alex Chriss, PayPal CEO, previewed the new initiative:

“Twenty-five years ago, at the dawn of the internet, PayPal was created, and e-commerce was born and now PayPal is leading the way to provide safe, secure experiences to customers around the world. I invite you to join us … to hear about the next chapter of PayPal and how we’re going to revolutionize commerce again through AI-driven personalization for both consumers and merchants.”

There are several other indications that PayPal may be undervalued with catalysts that could support a continued uptrend.

First, PayPal remains a digital payment giant. With 430 million active accounts generating over $1.5 trillion in payment volume annually, PayPal retains a strong leadership position in the e-commerce payment ecosystem.

Second, PayPal has been cutting costs and expanding margins and earnings growth. The goal is to reduce expenses by $900 million and this will directly boost profitability in 2024 and beyond. Third, PayPal’s new CEO is spearheading an innovation drive. Instead of playing defense, PayPal is doubling down on growth efforts under former CEO Bill Ready such as boosting crypto capabilities and developing a super app ecosystem.

We can capitalize on this blend of fintech value and innovation by buying PayPal shares while they remain on sale.

BUY A HALF

Explorer Weekly Stock Commentary

Below is a brief update on each Explorer stock. Any changes in ratings will be highlighted. This section is all you need to read each week.

Explorer Trading Recommendations – need to watch more closely

The tech selloff led to the aggressive ideas of 10x Genomics (TXG)-BUY and Exscientia (EXAI)-BUY having a subpar week on no news of importance. 10x is a leader in the emerging field of “spatial biology” which is a cutting-edge life science for making new discoveries about human health and disease. EXAI has a potent AI drug development platform as well as its drug candidates and partnerships.

Novo Nordisk (NVO)-HOLD shares stood firmly with little change this past week as it carves out a share of a huge market for diabetes and obesity which Goldman Sachs estimates could become a $100 billion market by 2030. SK Telecom (SKM)-BUY shares were up a bit as the company aims to triple the proportion of its AI-related investments in the next few years. The stock is trading at below book value and has a 6.8% dividend yield.

The world’s second-largest lithium producer, Sociedad Química y Minera de Chile S.A. (SQM)-HOLD shares seem to have reached an area of support around 50 and sport about a 10% dividend yield. Super Micro Computer (SMCI)-BUY shares gave back much of last week’s 23% gain even after recently reporting a surge in demand for its Nvidia, AMD, and Intel AI platforms. Management increased its revenue guidance from $10 billion to $10.5 billion for the year ahead.

Explorer Dominator Blue-Chip Recommendations – More Buy and Hold

ConocoPhillips (COP)-HOLD shares were off 2% this week along with most oil stocks. The company will report its next earnings on February 8. With oil priced in dollars, lower interest rates should lead to higher crude prices. International Business Machines (IBM)-BUY shares were up six points to 166 this week and its next earnings report is expected on January 24. IBM has $11 billion of cash and generated $10.3 billion of free cash flow over the last four quarters.

Visa (V)-BUY shares were up again this week and, since the company’s 2008 IPO, Visa shares have booked compound annual growth rate (CAGR) of 21%.

Watch List – BYD (BYDDY): Shares of the Chinese electric vehicles were down another 7% in the last week despite the company unveiling plans for a new driver-assist system and hosting its 2024 BYD Dream Day event. Nothing is wrong with the company, which surpassed Tesla in total electric vehicle sales in the third quarter, but the stock remains a casualty of all the negative press China’s economy has been getting. So, I downgraded it to the Watch List earlier this month. I’ll keep an eye on it in case of a bounce-back.

Explorer ETF/Fund Positions

Global X Lithium & Battery Tech ETF (LIT) offers solid exposure to other beaten-down lithium names at a low cost. With an expense ratio of 0.75%, some of its top holdings include Albemarle (ALB), Tesla (TSLA), BYD (BYDDY), Panasonic Holdings (PCRFY), and Livent (LTHM) to name a few of the fund’s 46 holdings. Buy a Half.

JPMorgan Equity Premium Income ETF (JEPI) offers double-digit yield coming from both option premiums and dividends using a value focused strategy. Current yield is about 8%. Buy a Full.

WisdomTree Emerging Markets High Dividend Fund (DEM) offers a high dividend yield and some of the highest quality emerging market stocks. Buy a Half.

WisdomTree China ex-State-Owned Enterprises Fund (CXSE) is a way to gain China exposure without any state-owned enterprises (SOEs). Buy a Half.

Model Portfolio

Explorer Stocks Summary

Brief company summaries that will not change week to week.

Watch List: BYD (BYDDY) switched to producing only all-electric battery vehicles (BEVs) and plug-in hybrid electric vehicles (PHEVs). The company also manufactures and supplies EV batteries, including to Tesla, and makes its own chips. This is vertical integration that would make Henry Ford proud. BYD is in a strong position to be one of, if not the leader of the EV revolution in terms of size, scale, and growth.

ConocoPhillips (COP) is a global energy industry giant and one of the largest independent exploration and production (E&P) companies in the world, as measured by production levels and proved reserves. The company, founded in 1917 and based in Houston, has operations in 13 countries, although almost half the company’s production is derived from U.S. sources.

Exscientia (EXAI) was founded in 2012 and based in Oxford, England, Exscientia is using AI to develop new medicines and is attracting high quality partners. Exscientia (EXAI) stock is trading way off its high in an uptrend at 6.22. It went public at 22 a share so the company has about $500 million in cash on the books – a big number for a company with a market capitalization of just $777 million. Finally, keep in mind that this is an attractive speculative stock which may have a bumpy ride. It is a young company that is not and will not be profitable next year.

10x Genomics (TXG) is a leader in the emerging field of “spatial biology,” a cutting-edge life science for making new discoveries about human health and disease. Founded in 2012 and based in Pleasanton, California, 10x builds tools for scientific research to advance human health. Its instruments, reagents and software allow researchers to examine cells and molecules at a resolution and scale never imagined or experienced before. 10x helps researchers look at the roots of biology.

International Business Machines (IBM) is a blue-chip artificial intelligence (AI) and India play with a nice dividend yield. Known as “Big Blue,” IBM now primarily helps businesses and governments manage their information technology in the cloud era. The stock sells at a discount to the S&P 500 multiple and the information technology sector’s forward earnings multiple. IBM has paid a dividend every quarter since 1916 and has had 28 consecutive years of dividend increases.

Novo Nordisk (NVO) specializes in treatments for diabetes, hemophilia, and obesity. The company supplies half of the world’s insulin, and its diabetes care products are used by over 34 million people today. Novo highlights that more than 750 million people are currently living with obesity and that this is up a multiple of 3X since 1975. In summary, based on sizable and growing demand for this weight-loss drug, this well managed, highly profitable company with an excellent growth profile and potential to develop new products has limited risk.

SK Telecom (SKM) is one of the largest telecommunications companies in South Korea and is placing AI at the core of its business. SK Telecom is rapidly transforming into an artificial intelligence (AI) company.

Its affiliate, SK Hynix, is already the world’s second largest memory chipmaker. SK Telecom’s stock was flat in 2023 but importantly, it is the parent of Sapeon, an artificial intelligence (AI) chip startup. Backed by South Korea’s telecom-to-chip conglomerate SK Group, it has launched its latest chip for data centers, joining the global race to develop AI chips with bigger rivals like Nvidia (NVDA).

Sociedad Química y Minera de Chile S.A. (SQM) produces specialty plant nutrients, iodine, lithium, potassium chloride and potassium sulfate, industrial chemicals, and other commodity fertilizers which together account for about 30% of SQM’s annual revenue. SQM is generally considered the world’s second-largest lithium producer, behind U.S.-based Albemarle (ALB), and in recent years, demand for the “white gold” has been strong. Demand for lithium is strong due to electric vehicle growth and lithium contributes about 40% of the company’s gross profits. Fertilizer ingredients supply another 40%, and iodine contributes the rest.

Super Micro Computer (SMCI), commonly known as supermicro, manufactures enterprise computer server hardware for cloud computing, artificial intelligence, data storage and telecommunications. Super Micro stock looks relatively inexpensive right now for the growth that it has been delivering. The company trades at just two times sales. Super Micro has two larger rivals, Dell (DELL) and Hewlett Packard (HPE), but it is forecast to grow five to 10 times faster. Furthermore, both Dell and HPE have relatively high debt whereas Super Micro has a net positive cash position. This is an aggressive pick in a sector experiencing extraordinary growth.

Visa (V) doesn’t extend credit but provides the plumbing for financial payments and communications throughout the world. Visa has the largest card network in the U.S., processing $14.8 trillion of payment volume in the last 12 months. Visa’s financial infrastructure also underpins much of the world’s commerce. The duopoly between Visa and Mastercard is often referred to as one of the best businesses in the world, with insurmountable moats, low operating costs, and plenty of opportunities for unlocking additional value. Visa currently trades at a discount to its archrival MasterCard. This leaves it much better poised to outperform the latter going forward.

The next Cabot Explorer issue will be published on February 1, 2024.