April 14, 2022

Explorer recommendations were pretty flat this week but demonstrated some strength as well. JPMorgan led the banks, reporting a first quarter with a net profit of $8 billion on over $32 billion of revenue. Keep your perspective and play defense and offense. Emerging markets offer you both and we will be adding to the portfolio selectively. This week I highlight a defensive healthcare play of the highest quality.

New Recommendation

Explorer recommendations were pretty flat this week but demonstrated some strength as well. JPMorgan led the banks, reporting a first quarter with a net profit of $8 billion on over $32 billion of revenue. Keep your perspective and play defense and offense. Emerging markets offer you both, and we will be adding to the portfolio selectively. This week I highlight a defensive healthcare play of the highest quality.

From the Cruelest Tax (Inflation) to the Simple Tax
Markets are weighing the latest news that the Consumer Price Index (CPI) rose 8.5% in March compared to the same month last year. The figure marks the fastest rise since December 1981 and follows a 7.9% annual increase in February. Inflation is sometimes known as the “cruelest tax” because it hits everyone across the board.

The big question is: What we can do to unleash investment-led growth to jolt the economy and stock market while winning the U.S.-China power rivalry? I propose a significant simplification of the tax code.

As Americans struggle with completing their tax returns before this week’s filing deadline, the Internal Revenue Service (IRS) estimates that it costs about $200 billion each year to comply with an American tax code that exceeds 10 million words. This is why more than 40 countries and jurisdictions use some variation of a simple flat tax to raise required revenue without creating huge costs of compliance and the manipulation of the tax code for political ends. All this complexity leads to slower economic growth, bigger government, and the misallocation of resources.

For example, one simple idea is to have the first $100,000 of income taxed at a rate of 10%. The next $250,000 of income would be taxed at a 15% rate, and income above $400,000 would be taxed at a 20% rate. There would be a $1,000 deduction per child, spouse or dependent so that a family of four with an income of $50,000 would pay $2,000 and a family of four with an income of $100,000 would pay $7,000. Besides deducting property taxes on your first home, everything else in terms of tax credits and deductions would be thrown overboard. Of course, the political pushback would be substantial.

To encourage investment and broaden the ownership of stock, the same rates would apply to capital gains and dividends without distinction to short- and long-term capital gains. In addition, there would be no tax on savings, no deduction for paid interest, and no deduction for property taxes beyond a first home.

Keeping the tax rate for dividends equal to the capital gains rate will take away a common rationale for corporations using available cash for stock buybacks rather than investing in future growth. Overall, the vast majority of Americans would benefit from a much simpler tax code that is also more pro-investment and pro-growth.

Now let’s move to today’s new recommendation – a sterling quality, defensive healthcare idea for a volatile market.

New Explorer Recommendation
CVS Health Corporation (CVS)
While Rite Aid (RAD) is shrinking, CVS is one of the nation’s leading healthcare companies, with almost 10,000 stores. While Rite Aid stock has fallen more than 50% so far in 2022, CVS stock is in the black.

To begin, healthcare is recession-resistant. It doesn’t matter whether the economy is expanding or contracting, whether inflation is high or low, or whether interest rates are rising or falling. People who need medical attention will get it one way or another. The demand for medical services is largely steady.

Nearly 70% of Americans live within three miles of a CVS and it has more than 102 million pharmacy plan members. Costco is probably the only larger retail organization, with 115 million members – more than the number of Communist Party members in China.

CVS serves more than 38 million people with health insurance provided by government or private plans, including those offered by Aetna, which CVS bought in 2018. In addition, CVS operates more than 1,100 walk-in clinics in its stores, which are visited by more than 50 million patients – with expanded healthcare offerings, including in-house blood work.

CVS’s digital operations allow its customers to refill prescriptions through an app and pick them up at any store location. Or it delivers medications directly to patients’ homes with an electronic prescription from their doctor. Interestingly, online customers spend 2.5 times more than retail customers, and manage 1.5 times more prescriptions. And they remain loyal customers.

CVS is also a technology leader using blockchain, cloud migration and intelligent automation to improve operations and results. The company has also administered 29 million COVID-19 tests and 30 million vaccines.

The proof is in the pudding: The latest quarterly results were exceptional. Total revenues grew 11% to $73 billion and earnings of $2.42 a share were 17% ahead of consensus estimates. The company also paid down close to $8 billion of debt and paid out $650 million to shareholders through dividends. But CVS stock sells for about 15 times forward earnings – versus 25 times for the S&P 500 – with a dividend yield of 2.1%. BUY A HALF

Portfolio Changes and Updates

Model Portfolio

Portfolio Changes
None

Updates
Fisker (FSR) shares were down slightly this week amidst a volatile market for electric vehicle stocks and despite recently announcing 40,000 initial reservations for its fully electric Ocean SUV. Production is expected to begin in November and the SUV models range in price from $37,499 to $68,999. Next up after the Ocean SUV is the PEAR – a smaller vehicle than Fisker’s Ocean, with pricing starting at under $30,000. This stock will likely tread water for a while until the Ocean gets closer to production. BUY A HALF

Ford (F) shares were up marginally this week as Ford recently announced plans to produce more than 2 million EVs – about one-third of its total auto sales. By 2030, it expects half of its global sales to be fully electric vehicles and targets $50 billion in EV investment through 2026. Trading at just 3.5 times trailing earnings, a fraction of its sales, and just 7 times free cash flow, this is perhaps the best value of the leading EV makers, so I encourage you to buy if you have not already done so. BUY A FULL

Local Bounti (LOCL) shares lost half a point this week and now sit just above our entry point from a month ago. Local Bounti recently completed its acquisition of California-based Hollandia Produce Group, which operates under the name Pete’s. Local Bounti uses proprietary technology to grow leafy greens along with herbs like cilantro and basil using 90% less land and water than traditional agricultural methods – and without pesticides.

Local Bounti is one of the few startups that went public via SPAC last year that exceeded its 2021 revenue projections, with 32% gross margins. The company raised $125 million including contributions from agriculture giant Cargill, which is providing $200 million in debt financing.

The company is poised to expand distribution to major food retailers and there is also the potential opportunity to license its technology to major agriculture players since the company already has more than 50 patents. Local Bounti has tremendous potential. BUY A HALF

Marvell Technology Group (MRVL) shares were pretty firm this week and the stock remains a good recommendation. MRVL is trading at about 22 times trailing earnings compared to the average of 33 on the Nasdaq 100. Its 5G wireless-related sales are steady at about 30% growth. The average projection by Wall Street analysts is for Marvell in the current fiscal year to grow revenue by 37%, with earnings per share up 46%. I believe our patience with this stock will reap rewards. HOLD A HALF

Novonix (NVNXF, NVX) shares pulled back this week from 4.9 to 4.6. The Australian company is a strategic provider of U.S. synthetic graphite that is both higher quality and lower priced than Chinese graphite. It has a very strong partner in Phillips 66. This is a speculative idea and the company is at least a year away from reaching breakeven in terms of profitability. Novonix still seems to be undervalued and remains a buy recommendation. BUY A HALF

Oracle Corporation (ORCL) stock held firm this week in an unsteady market so it is demonstrating some relative strength. Its newly released Java 18 delivers better performance, stability, and security that will further improve developer productivity. Oracle’s co-founder Larry Ellison owns 43% of the company and that is a plus since it shows the management team is focused on the long-term success of the company. BUY A HALF

QuantumScape (QS) shares were flat this week though the stock is now up over 30% in the last month. Quantum’s technology could allow us to create electric vehicles that could last for thousands of miles without needing to be recharged. We will need to give this stock some rope to reach some more milestones but solid-state batteries could be one of the most promising breakthroughs of the EV revolution. BUY A HALF

Sea Limited (SE) shares followed a great week by pulling back five points this week. A Goldman Sachs analyst picked up the company this past week for the first time with a buy recommendation and a 196 price target (its current share price is 113). Sea’s e-commerce wing, Shopee, remains strong. This stock is still a hold for now but I may move this to a buy if it acts well in the next week or two. HOLD A HALF

StoneCo Ltd. (STNE) shares dipped from 11.2 to 10.7 but we are well in the black on this interesting Brazilian stock.

The stock is still a mile below its high of 95 posted in February 2021. Based in Sao Paulo and founded in 2000, StoneCo is a digital payments company providing financial technology solutions for merchants to conduct electronic commerce across in-store, online, and mobile channels in Brazil. Warren Buffett’s Berkshire Hathaway invested $340 million in this Brazilian fintech company. Fintechs like Stone gain market share by charging less than the big banks.

Brazil’s central bank is well ahead of the Fed as it started hiking rates in March 2021, taking the benchmark rate to 11.75%. BUY A HALF

The next Cabot Explorer issue will be published on April 28, 2022.

JUST PUBLISHED — New book from Chief Analyst Carl Delfeld