As we move into a new year, the market shrugs off the chaos engulfing Capitol Hill and the GOP losing its majority in the U.S. Senate. Expect higher federal spending and debt in the next couple years, though it should be mentioned that we have already added $8 trillion to the national debt over the past four years. There were a few bright spots but Explorer stocks in general drifted a bit lower over the last week.
Today we have a new recommendation of a company of at the forefront of the technology revolution.
Cabot Global Stocks Explorer 726
The Upheaval of Technology and Finance
I normally read non-fiction, especially history and foreign affairs books, but received a fiction spy thriller for Christmas, Quantum Spy by David Ignatius. As you might guess, it is about the U.S.-China rivalry in super-fast quantum computing, with both sides trying to get the upper hand.
This China and technology theme underlines just how the American economy has changed over the last few decades in what I call the “upheaval in finance and technology.” It also reflects what types of companies and stocks have soared and what sort of companies have been left behind.
Going back even further, the shift in power, wealth and influence over the past century has been unmistakable. From agriculture and land to industrial production and now to information, data, technology and finance, intellectual intangible assets are now more important than physical assets and even cold hard cash.
The most important catalyst for America’s political upheaval as well as the prime generator of wealth over the last three decades has been the inexorable rise of finance and technology and the relative decline in terms of jobs, growth and profits from manufacturing and industry. Finance and technology have become the key drivers of the American and global economy and stock market, as capital now effortlessly moves around the world like a ravenous animal seeking the highest short-term returns.
This two-decade shift from capital and labor-intensive investment in manufacturing is evident in the number of American firms that have either exited manufacturing or have contracted out manufacturing. For example, most tech companies are completely out of manufacturing, which closely correlates to the movement of S&P 500 companies since the 1970s as you can see from the below table.
It is important to recognize a key impact from the rise of technology and finance, which puts a premium on intellectual capital and requires little real capital. This is a trend that has been unmistakable since the 1990s when a major theme was that we were entering the “information age.” Just consider the share of tangible assets such as buildings and equipment and intangible assets such as software and patents of all S&P 500 companies. As you can see by the above graph based on a study by Ocean Tomo, the proportion of intangible assets to total assets for S&P 500 companies as a group has gone from 32% in 1985 to 90% in 2020.
That brings me to today’s new recommendation, a company that is at the heart of our transformation to an information technology economy.
New Explorer Recommendation
International Business Machines (IBM)
A Quantum Blue Chip On Sale
IBM is now primarily an information technology consulting and research organization with clients in businesses and government in 170 countries. In short, the company helps clients ensure that their technology systems are not only faster and more efficient but also far more secure.
And it is the world leader in artificial intelligence (AI). AI enables computers, robots and other connected devices to mimic the perception, learning, problem solving and decision-making of the human mind. AI progress is dependent on computing power and data with applications ranging from speech recognition, language processing, virus and spam prevention, autopilot technology, and image recognition. This is where quantum computing comes into the picture.
While you won’t find them in any Best Buy, IBM still produces and sells computer hardware, middleware and software, and provides hosting and consulting services in areas ranging from mainframe computers to nanotechnology. It is also a major research organization, as of 2020 holding the record for most American patents generated by a business for 27 consecutive years.
IBM has also invested billions of dollars to accelerate the commercialization of IBM Watson, a cognitive technology that processes information more like a human being than a computer. The company has also invested billions to create IBM Bluemix, its cloud platform for software developers. That means businesses can develop and consume cloud services anywhere and from any cloud, public or private.
Big Blue has also been busy on the acquisition front.
In 2019, IBM acquired Red Hat, the world’s leading provider of enterprise open-source solutions, for $34 billion. This was IBM’s largest cloud-based acquisition, and now more than 2,600 clients are using Red Hat and IBM’s hybrid cloud platform.
IBM also recently announced the takeover of Finland-based, cloud-focused start-up Nordcloud, which will help the company expand its stake in the cloud professional services.
Just what is “cloud computing”? It is on-demand access to computing resources – applications, services, data storage, networking capabilities and more – hosted at a remote data center managed by a cloud services provider like IBM. It allows businesses and other organizations to “plug into” IT infrastructure rather than installing and maintaining it on-premises. This lowers costs, saves time, and allows businesses and other organizations to scale up more quickly.
All this sounds good … but what about IBM’s stock? Surprisingly, the stock is no higher than it was in October 2009, while the S&P 500 index has gained more than 250% over that 11-year period. More than a few information technology service stocks are up more than that just since the March 2019 pandemic meltdown.
The reason is that IBM has been posting some mediocre growth numbers.
While it delivers giant annual revenue of more than $75 billion, profits at IBM are up just 2% year over year, while sales are actually down slightly. IBM’s operating and profit margins are decent, reaching double digits, but in general this has been a sleepy stock.
What changes could deliver higher sales growth, expanding margins and a much higher stock price?
First, IBM has a new CEO who is taking the company in a new, exciting, high-growth direction. His name is Arvind Krishna, and he has shifted the company’s focus to revenue, hybrid cloud technology and AI since taking over as CEO in April 2019. The company sees the hybrid cloud as a $1 trillion opportunity. Even before the COVID-19 crisis, enterprises were rapidly shifting their workloads to the cloud. The spending on cloud services, globally, is projected to witness a compound annual growth rate (CAGR) of 15.7% between 2020 and 2024 and surpass $1 trillion, per an IDC report.
Further, according to a report from Mordor Intelligence, the hybrid cloud market is forecast to witness a CAGR of 19% between 2020 and 2025, to hit $128 billion. The company’s new focus on cloud computing, analytics and cybersecurity could lead to sales reaching $77 billion in 2021, and earnings could grow by more than 50%.
Another plus sign for IBM is that, just this week, Gary Cohn, the heavy hitter and former president of Goldman Sachs, joined the company as vice chairman.
This is a conservative growth and value play to begin 2021. IBM stock is trading at just over 10 times projected earnings, which is less than half the average for the S&P 500 index. This is highlighted by a bump in insiders accumulating shares. IBM director Sidney Taurel, former CEO of Eli Lilly, recently bought 5,000 shares at a cost of more than $550,000. He now owns 28,798 shares. Director Bill McNabb III – retired chairman and CEO of Vanguard Group – paid just under $1 million for 9,250 shares.
This is a solid, conservative growth play to begin 2021 and on top of all this, IBM offers a 5.3% dividend yield. BUY A HALF
|Hold a Half
|Cloudflare, Inc. (NET)
|Hold a Half
|Buy a Half
|International Business Machines (IBM)
|Buy a Half
|Buy a Half
|MP Materials (MP)
|Hold a Half
|NeoGenomics, Inc (NEO)
|Buy a Half
|NovoCure, Ltd. (NVCR)
|Sea Limited (SE)
|Hold a Half
|Taiwan Semiconductor (TSM)
|Buy a Half
|Virgin Galactic (SPCE)
Afterpay (APT.AX) from Buy a Half to Hold a Half
Afterpay (APT.AX) shares retraced from 120 to 113 this past week despite releasing positive consumer shopping trends for the Holiday fourth-quarter 2020 shopping season. Based on this data, consumers expanded their gift giving lists and shopped for more items compared to last year. The average basket size for Afterpay users increased 30% relative to the 2019 Holiday shopping season. Traffic to Afterpay’s brand partners was also strong, as the company saw a 145% year-over-year increase in referrals to global merchants from its Shop Directory.
Afterpay has proven to help customer conversion rates increase by more than 20% and average order values to increase by more than 25% compared to all other payment methods. I suggest we take partial profits here as I’m moving this stock from a buy to a hold. MOVE FROM BUY A HALF TO HOLD A HALF
Cloudflare (NET) shares drifted lower again this week, falling from 76 to 73, after a huge run in 2020, up 360%. As companies continue to allow their employees to work from home, Cloudflare benefits. Identity and security needs continue to make this a viable and even preferred cloud play. Think of it as an internet infrastructure play that helps deliver and secure the data and services traveling across the internet.
Another positive for this company is its diversified client base. In the third quarter alone, the number of businesses spending more than $100,000 annually on Cloudflare’s offerings grew by 99. The company also inked a deal with its first-ever $10 million-a-year customer. No single customer accounts for more than 5% of Cloudflare’s revenue, and the top 20 customers account for less than 20% of revenue.
I will keep NET a hold at these levels and again advise you to sell some shares to lock in some profits. HOLD A HALF
Companhia de Saneamento Basico do Estado de Sao Paulo: SABESP (SBS) shares lost some ground this week going from 8.5 to 8.0.
SABESP is a conservative water play in Brazil that provides water and sewage services to over 26 million people in 365 of the 645 municipalities in the State of Sao Paulo. I like SABESP because the company has plenty of room to grow in its monopoly territory of Sao Paulo with 18 million not yet connected to its services. In addition, the company is expanding to other regions in Brazil, and even in neighboring countries. It is trading at about 12 times projected earnings, quite a bit off its 52-week high. SBS is an excellent water play in a country with a stock market in a strong uptrend. BUY A HALF
ElectraMeccanica (SOLO) shares were flat the first week of 2021 after surging 179% in the fourth quarter of 2021. The stock has been treading water recently. This is understandable given a run that was way ahead of sales, which are just getting going on the West coast. A month ago, I advised to sell half of the shares you purchased and this seems to have been a wise move. This is a speculative idea that will attract some serious media attention into 2021 and has a chance to scale up in America and beyond. If you have not yet bought shares, let’s hold off for now. HOLD A QUARTER
LogiQ (LGIQ) shares have been volatile over the last three weeks closing yesterday at 8.25, down from 12.75. I recently recommended to lock in some profits as we head into 2021. LogiQ is a New York-based leading global provider of e-commerce, mobile commerce, and fintech business enablement solutions for three big markets: Southeast Asia, Europe and the United States. LogiQ’s stock is an aggressive idea that is trading at just over three times 2020-projected revenue. I would be a buyer here but only incrementally. BUY A HALF
MP Materials (MP) shares came back a couple of points to close yesterday at 29. It had reached a high of 39 in late 2020 on the back of higher rare earths that are critical to electric vehicle (EV) motors. MP Materials is the only major rare earths resource in the Western Hemisphere. Its primary rare earth products are key ingredients in permanent magnets that power the traction motors of EVs, robotics, wind turbines, drones and many other technologies. This is a speculative idea so feel free to take some profits. I’m keeping this stock a hold until it comes back a bit more. HOLD A HALF
NeoGenomics (NEO) shares held up nicely until yesterday’s tech selloff as the stock went from 55 to 51. NeoGenomics operates a network of cancer-focused testing laboratories in the United States, Switzerland, and Singapore. It is the world’s leading oncology testing company for doctors, pathologists and hospitals serving more than a half a million patients each year. Revenue should accelerate in 2021 as the pandemic recedes and pent-up demand drives catch-up in-person testing. This is an aggressive play in a critical, high-growth market. You can still buy shares here if you have not yet done so. BUY A HALF
NovoCure (NVCR) shares this week retraced their movement over the past three weeks, pulling back from 172 to 157. This firm is now an international oncology leader with nearly 800 employees, operations in the U.S., Europe and Asia, and $450 million in annual sales. Yet this is still a relatively small company. In 2011, the company launched Optune – its Tumor Treating Fields delivery system – for glioblastoma, the most common primary brain cancer. Studies are underway with other brain cancers as well as pancreatic, ovarian, liver and lung cancers, with key results due over the next few months. And its technology has succeeded in every clinical test. I rate this stock a buy for long-term investors that have not yet purchased shares. BUY A FULL
Sea Limited (SE) shares rallied this week to breach 200, and then settled yesterday at 194. Not much news here except that the company recently announced it has been granted a license to operate a full-service digital bank by the Monetary Authority of Singapore. This is a big deal but I would again recommend that investors take some profits here. This story will likely continue into 2021 since Sea is Southeast Asia’s biggest gaming, e-commerce and payments firm with more 40 million daily active users in a region populated by 655 million tech-savvy consumers. HOLD A HALF
Taiwan Semiconductor (TSM) shares are receiving a lot of media attention and added seven points to reach from 109 to 116 over the past week. Taiwan Semiconductor dominates global chip making with a market share better than 50%. It also benefits from secular trends of advanced computing and 5G going into next year and beyond. The chip-making business is both capital and brain intensive with half the company’s workforce having postgraduate degrees. The company delivered an impressive return on equity of 31% with operating margins in excess of 40% in its most recent quarter. I maintain a buy rating on the stock. BUY A HALF
Virgin Galactic (SPCE) shares held firm this week at 24.
Virgin Galactic CEO Michael Colglazier recently outlined how from just a single operational VSS Unity spaceplane today, flying out of Spaceport America in New Mexico, Virgin Galactic plans to build entire fleets of spaceplanes and fly them out of multiple spaceports around the world with the goal of bringing in annual revenue of $1 billion. This is welcome ambition but it will require eight crafts each flying 50 flights per year as well as a higher price per ticket relative to the $250,000 set for the first 600 passengers. Given all the uncertainty regarding the timing of tests and then the launch of the spaceplanes, I recently moved this stock to a hold. HOLD A FULL
The next Cabot Global Stocks Explorer issue will be published on January 21, 2021.
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