Cabot Stock of the Week Issue: April 17, 2023

The market reaction to last week’s headline-heavy week was pretty muted, as stocks have scarcely budged since the latest CPI print (which came in lower than expectations, at 5%), PPI number (also encouraging), and the start of earnings season, which went well for several big banks on Friday. Ordinarily, the combination of a cooler-than-anticipated inflation number and some high-profile earnings surprises might have sent shares skyward, at least temporarily. The fact that both were greeted with a relative shrug suggests that the market might be a tad overbought, at least in the short term. After all, the S&P is up 7.5% year to date, while the Nasdaq is up more than 15%. So, if we get a few earnings disappointments in the back half of April, the next big move may be down. That’s why we’re adding another dividend stock to the portfolio today.

It’s a new pick from Cabot Dividend Investor Chief Analyst Tom Hutchinson. The yield is modest, but the stock has been outperforming the market for years. And as one of the largest health insurance companies in the world, it’s not going anywhere, dovetailing perfectly with America’s rapidly aging population, and thus qualifies as a nice “safe” pick in case the market does turn sour again.

Here are Tom’s latest thoughts on it.

UnitedHealth Group Inc. (UNH)

UnitedHealth Group (UNH) is a Dow Jones component that is America’s largest insurer and one of the world’s largest private health insurers. It’s a goliath with $324 billion in annual revenues that serves 149 million members in all 50 states and 33 countries. That’s a lot of monthly insurance premiums!

The company operates in two primary groups, UnitedHealthcare and its Optum franchises. UnitedHealthcare provides health insurance and benefits to a wide range including large national employers, public sector employers, mid-sized employers, and small businesses and individuals. It also provides health insurance for Medicare and supplements as well as employers globally.

The Optum franchise provides direct healthcare, technology services, and prescription drug solutions. The direct healthcare includes an alliance with 70,000 physicians in local medical groups as well as ambulatory care systems and other chronic treatments. The technology provides data and analytics to manage complex administrative and regulatory issues with hospitals and physicians. It also provides a full spectrum of pharmacy care services.

The group provides services at just about every facet of the healthcare process and the full-scale operation provides a powerful alignment of incentives that helps clients control costs better than competitors, which is a massive issue in the industry.

It’s also a huge company and operation. Scale is hugely important in this industry. It enables UnitedHealth Group to keep costs down by virtue of volume, have cash for acquisitions, and wield significant power to adjust rates as prices increase. That’s a huge benefit during inflation.

But talk is cheap. How has this massive and comprehensive operation reflected in stock performance? Here’s a look at various returns over the past 10 years (as of April 11) compared to the market, as measured by the S&P 500.

Although UNH is large in scale, the stock has managed to blow away the returns of the overall market, with roughly twice the return over the past three- and five-year periods and quadruple the return over the last 10 years. UNH has also done this with considerably less volatility than the market, with a beta of just 0.69.

Sure, UnitedHealth has the huge tailwind of the aging population. But so do many other stocks in the healthcare sector. I chose UNH because it has also been a consistently strong performer. It has significantly outdone its peers as well as most large healthcare stocks of any stripe.

UNH currently pays a quarterly dividend of $1.65 per share, or $6.60 annualized, which translates to 1.3% yield at the current price. While that’s a subpar yield, the payout is well supported with just a 30% payout ratio and the dividend is likely to grow. In fact, the quarterly payout has grown 120% over the past five years, from $0.75 in 2018 to the current $1.65. Companies that grow their dividend tend to be the best market performers as a group over time.

Health care is a highly recession-resistant business as people tend not to postpone health issues in any economy. UnitedHealth Group is a large, safe business that provides stability in uncertain markets. Aside from that, it has the massive tailwind of the aging population and an ever-increasing number of customers.

Enrollments were up 1.2 million last year and are forecast to grow by a million again this year. Because of a solid balance sheet, reliable revenues, and deep pockets, the company is able to grow through acquisitions. It recently acquired a cutting-edge software company that should give it a further advantage in streamlining processes and saving costs.

Last year was a bear market and the S&P 500 was down 19.4% for 2022. UNH was up over 5% for that year and earnings per share (EPS) grew 18.3% for the calendar year versus 2021. It is a great safe haven, and the company forecasts mid-teens EPS growth for at least the next several years while average S&P 500 earnings are forecast to shrink for the second quarter in a row.

UNH is never going to be your biggest winner, unless you hold it forever. But it will be a safe port in an impending storm. It will increase earnings during an earnings recession for the overall market. It will provide defense and growth at the same time while never providing a high level of risk. It’s a great pick for the current times.

Current Recommendations

Changes Since Last Week: None

No changes this week, as market volatility is at its lowest point – at least as measured by the VIX – since January 2022. Of course, we know what happened after that, which is why it’s worth taking a cautious stance and building slowly with your positions. It’s also why we added a mega-cap health insurance company that pays a dividend. The addition of UNH brings our portfolio to 19 stocks, one shy of our cap. So pretty soon, some stocks will have to go. Let’s hope it’s a hard decision and not an obvious one on the heels of an earnings blowup.

For now, all is well, and two of our stocks are at all-time highs. One has risen so fast, in fact, that it might be worth booking profits on a few shares.

Here’s what’s happening with all our stocks.

Updates

Cisco Systems (CSCO), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, has been in a range between 50 and 52 for the past three weeks. In his latest update, Bruce wrote, “Cisco Systems (CSCO) is facing revenue pressure as customers migrate to the cloud and thus need less of Cisco’s equipment and one-stop-shop services. Cisco’s prospects are starting to improve under a relatively new CEO, who is shifting Cisco toward a software and subscription model and is rolling out new products, helped by its strong reputation and entrenched position within its customers’ infrastructure. The company is highly profitable, generates vast cash flow (which it returns to shareholders through dividends and buybacks) and has a very strong balance sheet.

“There was no significant company-specific news in the past week.

“CSCO shares slipped 2% in the week and have 31% upside to our 66 price target. The valuation is attractive at 9.5x EV/EBITDA and 13.4x earnings per share. The 3.1% dividend yield adds to the appeal of this stock.” BUY

Comcast Corporation (CMCSA), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, continues to hold in the 37-38 range. Shares have 10% upside to Bruce’s 42 price target. Earnings are due out on April 27. BUY

Eli Lilly and Company (LLY), originally recommended by Tom Hutchinson in the Dividend Growth Tier of his Cabot Dividend Investor advisory, just keeps rising, up 20% in the last six weeks, touching new 52-week highs last week before pulling back slightly this morning. In his latest update, Tom wrote, “LLY was upgraded to a BUY last month and has since moved sharply higher and may be approaching a new high. After a stellar 2022 where it returned 34% in a bear market, LLY pulled back early this year. But it was unlikely to stay down for long. Lilly grew earnings 12.7% in 2022 and is expected to grow earnings by an average of 22% per year over the next five years. It also has two drugs that could be mega-blockbusters in the pipeline that could be approved in the next year. The longer-term trajectory is strong and it made sense to buy the dip, especially ahead of a possible recession.” BUY

Gates Industrial Corp. (GTES), originally recommended by Bruce Kaser in the Buy Low Opportunities Portfolio of his Cabot Undervalued Stocks Advisor, has been holding firm at 13. In his latest update, Bruce wrote, “Gates is a specialized producer of industrial drive belts and tubing. While this niche might sound unimpressive, Gates has become a leading global manufacturer by producing premium and innovative products. Its customers depend on heavy-duty vehicles, robots, production and warehouse machines and other equipment to operate without fail, so the belts and hydraulic tubing that power these must be exceptionally reliable. Few buyers would balk at a reasonable price premium on a small-priced part from Gates if it means their million-dollar equipment keeps running. Even in automobiles, which comprise roughly 43% of its revenues, Gates’ belts are nearly industry-standard for their reliability and value. Helping provide revenue stability, over 60% of its sales are for replacements. Gates is well-positioned to prosper in an electric vehicle world, as its average content per EV, which require water pumps and other thermal management components for the battery and inverters, is likely to be considerably higher than its average content per gas-powered vehicle.

“The company produces wide EBITDA margins, has a reasonable debt balance and generates considerable free cash flow. The management is high quality. In 2014, private equity firm Blackstone acquired Gates and significantly improved its product line-up and quality, operating efficiency, culture and financial performance. Gates completed its IPO in 2018, with Blackstone retaining a 63% stake today.

“There was no significant company-specific news in the past week.

“GTES shares rose 4% in the past week and have 20% upside to our 16 price target.” BUY

Kimberly-Clark de México (KCDMY), originally recommended by Carl Delfeld in his Cabot Explorer advisory, is up slightly since we added it three weeks ago. The Mexican subsidiary of Kimberly Clark is a play on Mexico’s manufacturing costs now being about 25% lower than China’s, making its companies more appealing to global shoppers. BUY

Las Vegas Sands (LVS), originally recommended by Mike Cintolo in Cabot Top Ten Trader, got back the point it lost the week before but is bumping up against resistance at 58. A push to 59 for the first time since early March would be bullish. First-quarter earnings for this Macau-centric gaming company – due out this Wednesday, April 19 after the market close – will be very pivotal, as this is the first full quarter since China lifted its zero-Covid policies. BUY

Microsoft (MSFT), originally recommended by Tyler Laundon in Cabot Early Opportunities, held mostly firm this week, and has been in an increasingly tightening range this month. Earnings are due out next week, April 25, so chances are the stock won’t move much prior to that. Expectations are modest: Analysts anticipate 3.4% revenue growth and flat EPS; if the actual numbers clear that low bar, perhaps it will spark the next leg up in a stock that’s already up 20% year to date. BUY

Novo Nordisk (NVO), originally recommended by Carl Delfeld in his Cabot Explorer advisory, exploded to new all-time highs after upping its sales guidance for 2023. The company raised revenue guidance to a range of 28-34% from a mere 13-19% previously, with higher sales expectations from Wegovy, its obesity drug, and Ozempic, its diabetes medicine, the driving factors. Also, as Carl noted, Novo inked a “nearly $2.7 billion deal with privately held Aspect Biosystems that boosts its efforts in diabetes and obesity treatment. Its popular drug Ozempic is approved for Type 2 diabetes, but people have been taking the drug for losing weight because of its effectiveness.” We now have a 28% gain on NVO in less than four months. BUY

Realty Income (O), originally recommended by Tom Hutchinson in Cabot Dividend Investor, dipped from 62 to 61 this past week on no news. However, the stock remains comfortably above its March lows at 59. In his latest update, Tom wrote, “In a highly uncertain environment like this, where the narrative can change on a dime, income is king. And this legendary income REIT is the king of income stocks. It has paid 632 consecutive monthly dividends and increased the dividend payment 119 times since its IPO in the 1990s. And the REIT has been growing stronger through acquisitions of late. Realty should be solid in the event of recession. Despite being a retail REIT, the portfolio is largely staple properties like drug stores and supermarkets that are resilient in a slower economy.” HOLD

Sensata Technologies (ST), originally recommended by Bruce Kaser in the Buy Low Opportunities portfolio of his Cabot Undervalued Stocks Advisor, was up to 47 from 46 in its debut week in the portfolio. In his latest update, Bruce wrote, “Sensata Technologies (ST) is a $3.8 billion (revenues) producer of nearly 47,000 highly engineered sensors used by automotive (60% of revenues), heavy vehicle, industrial and aerospace customers. About two-thirds of its revenues are generated outside of the United States, with China producing about 21%. Investors undervalue Sensata’s durable franchise. Its sensors are typically critical components that generally produce high profit margins. As the sensors’ reliability is vital to safety and performance, customers are reluctant to switch to another supplier that may have lower prices but also lower or unproven quality. Sensata has an arguably under-leveraged balance sheet and generates healthy free cash flow. The relatively new CEO will likely continue to expand the company’s growth potential through acquisitions. Electric vehicles are an opportunity as they expand Sensata’s reachable market.

“There was no significant company-specific news in the past week.

“ST shares rose 3% in the past week and have 58% upside to our 75 price target. Our price target looks optimistic in light of the broad market sell-off and worries over a possible recession (which would slow demand in its automotive and other end-markets), but we will keep it for now, even as it may take longer for the shares to reach it.” BUY

SiTime (SITM), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, is off to quite the inauspicious start in its first two weeks in the portfolio. Shares have fallen 10% on no news, other than the recent retreat in semiconductor stocks. We’ll keep it at Buy for now, as SITM is still up 23% year to date and is thus far holding above 121 support. A decisive dip below that level could have us moving to Hold next week. SiTime is a fabless semiconductor company that provides MEMS (micro-electro-mechanical systems) and silicon-based timing systems. Apple is a major customer at 20% of revenue. BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, didn’t budge ahead of its Q1 earnings report this Wednesday after the market close. Analysts estimate 24.4% revenue growth but a 20% dip in EPS. This is the first quarter since the company started slashing prices on some of its Models – the S, the X and the Y – so this will be a window into whether the strategy is working. With first-quarter deliveries coming in shy of estimates (despite hitting new record highs), and Tesla announcing another round of price cuts earlier this month, chances are the early returns on the change in strategy aren’t great. But all that will matter this week is whether those returns are “less bad” than analysts are anticipating. HOLD

Uber (UBER), originally recommended by Mike Cintolo in Cabot Growth Investor, has been stuck in a range between 30 and 32 for more than a month. This seems like a very normal holding period after shares of the ride-sharing giant had broken out in January and early February – the stock is still up 29% year to date and trades comfortably above its 200-day line (29). BUY

Ulta Beauty (ULTA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, was up 1% this past week, regaining some of its modest losses from the first week of April. Shares of the beauty retailer are now up 13.6% year to date and now up 40% since it was added to the portfolio 11 months ago. BUY

Visa Inc. (V), originally recommended by Tom Hutchinson in Cabot Dividend Investor, was up 2% this past week, likely moving in tandem with the market. The company reports earnings next week, April 25. In his latest update, Tom wrote, “V is tied to the fortunes of the more cyclical stocks in the near term. But it tends to outperform that group. It held up nicely in a very tough 2022 with a -3.4% return for the year, it’s up over 30% since the September low, and it has a better than 11% return YTD. Of course, it could be under pressure if the economic situation deteriorates. But the stock is still relatively cheap, and it should fly when the market eventually senses the end of this cycle and the next recovery.” BUY

Wingstop (WING), originally recommended by Mike Cintolo in Cabot Growth Investor, has been in a range between 176 and 187 for most of the past month. In his latest update, Mike wrote, “Wingstop got hit a bit early last week, but overall, it’s hovering in a relatively tight range above its 50-day line and just a few percent below all-time highs. Nothing has changed here—odds favor higher prices, but given the market and WING’s own choppiness, we’ll stick with a Hold rating here.” Because we got in later than Mike, we’ve had WING at Buy and will keep it right there. BUY

WisdomTree Emerging Markets High Dividend Fund (DEM), originally recommended by Carl Delfeld in his Cabot Explorer advisory, is a rock. It keeps holding in the 37 to 39 range, unaffected by all the volatility and turbulence virtually everywhere else in the market. Our lone ETF offers a high dividend yield and some of the highest-quality emerging market stocks. The fund gives broad exposure with an emphasis on income and value. BUY

Xponential Fitness (XPOF), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, crept up to new all-time highs above 32 this week! The only real news was that the company rolled out its new digital platform, Xponential+, for LG Smart TVs, making its brands such as Pilates, Pure Barre and Yoga Six, among many others, available to people who buy those TVs. The stock is up a whopping 40% year to date and more than 75% since we added it to the Stock of the Week portfolio less than seven months ago. Simply put, it’s our biggest winner. If you bought early, or even prior to 2023, you would be wise to sell a few shares – anywhere from a quarter to a half position, perhaps – and let the rest ride. If you’re late to the party, it’s still a Buy. BUY

The next Cabot Stock of the Week issue will be published on April 24, 2023.