Cabot Explorer Issue: October 27, 2022

The Point of “Maximum Pessimism”?

Ford (F) reported a down third quarter, but Explorer stocks had a good week with all positions in the black. MP Materials (MP) and Oracle (ORCL) were up 11%, and SQM rose 8%.

The headline of today’s GDP report will likely be more upbeat than the two previous negative growth numbers, instead showing that third-quarter GDP grew at about a 2% annualized pace.

But beneath these numbers, investor sentiment, economic trends, and geopolitical risks are not all that encouraging.

How should investors take all this in and execute a strategy to exploit the situation?

Sir John Templeton, an extraordinary and legendary global and value fund manager, delivered great returns for his clients by acting on what he referred to as “points of maximum pessimism.”

One example was buying stocks during World War II and after the war, scooping up Japanese stocks as the country launched its economic miracle in the wake of a shattered economy.

Could we be near one of these “action points” now? It helps to have some perspective. History shows that the average U.S. bear market takes stocks down 26% from the peak and lasts about nine months.

The S&P 500 is down about 20% from its high a little over nine months ago.

Yes, the selling pressure could last a bit longer, but the worst of this decline is most likely behind us.

China is perhaps a different situation but remember that markets look forward and often move up when economic conditions seem poor. For example, global capital is fleeing China as Xi Jinping was appointed for a third five-year term and packed China’s cabinet and Politburo with “yes men.”

I can use the term “yes men” because not one woman is in either group.

A sharp selloff is hitting Chinese markets, as capital moves out of Chinese stocks and probably out of the country. Hong Kong’s Hang Seng index had its worst daily drop since the 2008 financial crisis. And China’s currency hit its weakest level against the U.S. dollar in more than 14 years.

Meanwhile, Goldman Sachs’ index of Chinese ADRs – U.S.-listed securities tied to shares of some of the largest Chinese companies – collapsed by 15% on Monday.

Why? In addition to slower economic growth, U.S. and EU restrictions on tech trade, the China-Russia partnership, and threats regarding Taiwan – Xi Jinping not only won a historic third five-year term but removed the few remaining market-friendly technocrats that served on the powerful seven-man Standing Committee of the Politburo.

Still, don’t underestimate the possibility that stocks will snap back at some point.

Yesterday, we saw just that as Chinese stocks broadly rebounded.

Stay optimistic but be careful. Be selective and buy and keep quality stocks that are making profits.

New Explorer Recommendation: Marvell Technology, Inc. (MRVL)

Semiconductors are perhaps the most crucial and strategically important technology because they are the materials and circuitry needed to produce microchips that are at the heart of everything from smartphones to advanced satellites. You might think of these microchips as the brains inside all advanced technology. One trillion chips a year are made, and an electric vehicle has about 3,000 microchips.

Semiconductor producers stand to benefit from Biden’s $2.3 trillion infrastructure package that goes beyond fixing roads and bridges to expanding broadband internet access and boosting the expansion of 5G. This is important because China already has about a million 5G cell towers and is hard at work on 6G.

The best play on 5G may be smart devices – what is known as the “Internet of Things.” This is the name for all the web-enabled devices that collect, send and act on data using sensors, processors and other hardware to talk to each other.

5G is much more than just a faster internet; it will have a major impact on many industries and services from robotics to artificial intelligence, self-driving cars and, of course, smartphones.

The 5G launch is off and running with AT&T, Verizon, Sprint and T-Mobile leading international carriers all moving forward. Many investors still don’t appreciate just how revolutionary 5G will be. Because its bandwidth has a much higher capacity, network data speeds will be 10 times faster than under the current 4G standard. Mobile data speeds could be up to 100 times faster.

My recommendation on all these developments is Marvell Technology, Inc. (MRVL). Marvell is headquartered in Bermuda with operations in the U.S., China, Taiwan, Japan, India, South Korea, Vietnam and several other countries.

Marvell designs, develops and sells a wide variety of semiconductor products that are at the core of 5G-capable networks, processors and devices as they partner with and transition from 4G to 5G. The company’s embedded processors and products are cutting-edge and already generate $3 billion in annual sales.

New markets are emerging in which Marvell has a first-mover advantage such as virtual reality, drones, data integration and consumer and industrial robotics. These are all huge markets giving Marvell a long runway of growth as the company expects double-digit growth in both sales and net profit for 2022.

The company is helping telecom carriers such as Samsung and Nokia set up 5G networks across the world. The Samsung partnership gives Marvell a ticket to attack this huge market as the Korean company has won deals to deploy 5G networks in the U.S. and Japan and is now conducting trials with telecom carriers in Europe.

Marvell is also growing through acquisitions and has more than 10,000 global patents.

I expect Marvell to maintain this impressive growth, so I suggest we take advantage of the overall pullback in tech stocks to begin with a half position.

Marvell, whose share price has been cut in half this year, is one of those companies that has seen its share price hit hard even though management has done everything shareholders could have reasonably expected.

The fundamentals here are largely unchanged and the company has beaten Wall Street’s consensus earnings estimates in each of the last four quarters.

Here are a few highlights from the most recent quarterly report:

• Sales reached a record $1.5 billion, up 41% over the year-ago period.
• Earnings per share increased 68% year over year.
• Operating margin reached a record 36.5%.
• The company returned $101 million to shareholders through cash dividends and share repurchases.

In a conference call after the latest earnings release, CEO Matt Murphy stated that product demand remains strong, and he sees a path to sustained, long-term growth.

Unfortunately, all this good news gets overlooked or ignored when tech markets pull back.

But this pessimism and lack of conviction about companies like Marvell create opportunities.

Looking ahead, I expect earnings at Marvell could reach more than $3 next year. The company is one of the world’s fastest-growing chipmakers and I expect its share price to recover its momentum.

BUY A HALF POSITION

Model Portfolio

Portfolio Changes

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Updates

Centrus Energy (LEU) shares continued to rebound, jumping from 40 to 44. This nuclear fuel supplier for utilities in U.S. and abroad has net income margins are above 50% so far this year with new nuclear fuel sales contracts and commitments worth an estimated value of $270 million.

Nuclear power provides 20% of the power for our electricity grid and more than 50% of U.S. emission-free energy, according to the Department of Energy. Centrus stock is still trading way off its 52-week high and at less than four times earnings so LEU remains a strong buy. BUY A HALF

Ford (F) shares picked up a point this week but futures were down more than 2% after the close yesterday when the company reported that it lost money in the third quarter as rising costs took a toll as did a write-down of an investment in a self-driving technology business.

The automaker said it lost $827 million, compared with a profit of $1.8 billion in the third quarter of 2021. Ford shipped 1.1 million cars and light trucks in the quarter, compared with just over one million in the same period last year.

Ford said it still expected 2022 adjusted earnings before interest and taxes of $11.5 billion.

Ford has a forward price to earnings ratio of just over 6 with a dividend yield of 4.7%. It continues to see rising demand for its electric vehicles and Ford stock will benefit from $7,500 EV subsidies.

Therefore, Ford remains my favorite conservative stock despite a challenging market and economy. BUY A HALF

Infineon Technologies (IFNNY) shares followed up last week’s double-digit gains by adding two points this week to get to 26.

Infineon has an advantage on many other semiconductor stocks in that it is focused on auto and industrial markets where shortages and high demand persists, allowing it to raise prices.

Infineon has dodged the semiconductor stock meltdown by designing and manufacturing chips used in autos, industrial machines, and consumer electronics. What sets the company apart is its exposure to autos, accounting for about 50% of revenue, and especially electric vehicles (EVs). This means that Infineon is less exposed to the falling demand for consumer electronics, which has hit other sector heavyweights such as Advanced Micro Devices (AMD).

This stock seems undervalued to me, with a forward price-to-earnings ratio of 13 while the company’s earnings per share are expected to grow 38% this year and cash flow growth is strong. This is still a buy on dips in the market. BUY A HALF

Kraken Robotics (KRKNF) shares were up marginally this week two weeks removed from Kraken’s COO making this statement at an investment conference:

“Over the past few months, Kraken has seen continued momentum in orders across all its product and service offerings including a $9 million mine hunting contract from a NATO navy; $6 million of synthetic aperture sonar sensor orders; more than $3 million for sub bottom cable imaging; and a $1 million follow on subsea battery order.”

In addition, Sophic Capital has come out with a research report that says,

“Geopolitical events have accelerated unmanned underwater vehicle (UUV) adoption by several navies (including adversaries), and several companies continue to evolve their products and services to meet growing demand. The underwater drones market size is significant, estimated at about US$4.5 billion in 2021 and forecasted to reach approximately US$12.5 billion by 2030.”

This is probably the most speculative of Explorer stocks, with a market cap of a mere $68 million, but micro-caps are outperforming their big brothers. Based in Newfoundland, Kraken Robotics is a marine technology company providing ultra-high resolution, software-centric sensors and underwater robotic systems. Though a micro-cap stock, Kraken is a well-run company and a prime takeover candidate in the growth defense sector with a strong management team. BUY A HALF

MP Materials (MP) shares gained 11% this week and announced that it will report its third-quarter earnings on November 3. This stock is an effective way to play clean tech, defense, semiconductors, and other advanced and emerging technologies. Based on its valuation, MP is moving closer to being rated a buy and at a current price of 31 is down sharply from the 58 it traded at in early April of this year.

MP is America’s only active rare earth mining and processing site, producing approximately 15% of the rare earth content consumed in the global market in 2021. HOLD A HALF

Oracle (ORCL) shares were up 12% this week to reach 75, driven by growth in cloud computing. Its recent earnings were strong with cloud infrastructure revenue increasing 58% year over year. Oracle may be offering a better product than Amazon’s cloud product and one advantage for Oracle is that its cost structure is fixed, so each additional dollar of revenue earns more profit than the last. Despite all these positives, Oracle’s shares are still a hold until tech market sentiment improves. HOLD A HALF

Sociedad Química y Minera de Chile S.A. (SQM) shares were up 8% this past week as the stock approaches 100. Lithium prices are quite high and demand is also strong, but I would put in place a stop-loss around 80 to be on the safe side. SQM offers us a dividend yielding 11% and an impressive 12% five-year annualized dividend growth rate. In addition, SQM is also one of the largest producers of potassium nitrate used for fertilizer, so the stock has two drivers of revenue and profits. This stock has a reasonable valuation based on earnings with an incredible 25% return on assets and 60% return on equity so I’m keeping this a hold and encouraging you to take some profits off the table. HOLD A HALF

Toyota Motors (TM) shares were up five points in their second week as an Explorer recommendation.

Toyota’s hybrid EV sales jumped 73% last year, according to research firm Motor Intelligence. Toyota pioneered hybrid cars in the late 1990s with the Prius, which quickly became a strong seller allowing auto makers to meet tightening regulations on emissions in the U.S. and abroad. Hybrids, including plug-in cars, accounted for around 20% of Toyota’s U.S. sales in September.

Toyota remains the No. 1 hybrid seller in America, led by a gas-electric version of the RAV4 sport-utility vehicle, the nation’s top-selling hybrid. Toyota leader Akio Toyoda recently told reporters the company could make eight plug-in hybrids with the same number of batteries in a single 320-mile-range EV.

High-quality Toyota trades at just 10 times earnings at about 138 – down from a 52-week high of 213. BUY A HALF

Explorer ETF/Fund Update

WisdomTree Emerging Markets High Dividend Fund (DEM) was flat this week. With a 10% dividend yield, this ETF covers 17 different emerging markets and gives broad exposure to large caps, mid-caps and small caps in these countries with an emphasis on income and value. The stocks in its basket tend to be conservative, defensive companies with low valuations and high dividends. In addition, it holds some of the cheapest quality stocks in the world with an average price-to-earnings ratio of just 5. BUY A HALF

The next Cabot Explorer issue will be published on November 10, 2022.

JUST PUBLISHED — New book from Chief Analyst Carl Delfeld