It was an encouraging bounce-back week for the market, with the S&P 500 up more than 2% since we last wrote while the Nasdaq rebounded 3%. The Fed, more rate hikes, persistent inflation, a potential recession, war in Ukraine – all that stuff is still lurking. But for the time being, those ongoing worries aren’t having the same kind of suffocating effect on the market that they did in 2022. So our portfolio remains near capacity, even with another sell today.
One thing we don’t have much of are blue-chip tech stocks, aside from portfolio mainstay Tesla (TSLA). A year or so ago, that would have been unthinkable. But last year’s bear market put a major dent in some of the bluest of blue-chip technology stocks on the market, particularly the FAANGs (Facebook, Amazon, Apple, Netflix, Google). Today, we’re adding the largest tech stock that’s not a FAANG – a household name that has long been a favorite of Cabot Early Opportunities Chief Analyst Tyler Laundon. Tyler recently recommended the stock again to his readers, and here are his latest thoughts on it.
In November 2014, I was running a growth newsletter covering companies across the full market cap spectrum. I saw an opportunity in a very large company that seemed so obvious many investors didn’t see it.
That company was Microsoft (MSFT).
Microsoft released Azure, its cloud computing platform, in 2008. Over the following years, the company laid the groundwork for a cloud-centric business.
In 2014, it was gaining momentum with Office 365, the cloud-based subscription version of the popular application suite. Office 365 would help pull back a massive user base that had drifted from Microsoft while also becoming a more profitable version of the perpetual license platform that users downloaded about every six years.
Since November 2014, MSFT stock had delivered an average annual return of about 26% and a total return of over 530%.
The big buzz today is around Microsoft’s investment in artificial intelligence (AI), specifically ChatGPT.
ChatGPT is a natural language processing tool developed by OpenAI. The language model can answer questions and help people complete tasks such as writing a letter, crafting a poem, writing an essay and writing code.
It is not perfect. But it is quite good. And the implications for efficiency gains for coders, content creators, etc., are massive.
That’s why ChatGPT is the fastest-growing app in history. Reports suggest it gained more than 100 million active users in just two months. It took TikTok nine months to cross that threshold.
Microsoft is currently integrating the tech into many of its cloud-based tools, including its Bing search engine and Edge browser.
I’m not an AI revolutionary that thinks the technology will turn the world upside down. But it’s pretty easy to see how Microsoft’s already sizeable user base will embrace the technology across multiple products AND be willing to pay more for it.
In other words, this feels like another “Office 365 moment.”
Stepping back, Microsoft is a massive company providing software, cloud computing infrastructure, consumer electronics and personal computers to consumers and businesses around the world.
In 2022, revenue grew by 18% to $198.3 billion while EPS grew by 16% to $9.21. In 2023, analysts see revenue up 5%, then up 11% in 2024.
Microsoft has been laying the groundwork in AI for years. It invested in OpenAI in July 2019 and has been investing in AI within Azure, GitHub Co-pilot and Microsoft Designer, among other solutions, since.
Management says Search is the largest software category in the world and that the digital ad market is worth roughly $500 billion and growing at about 18% a year.
It only holds about 3% market share. That translated into just $18 billion in 2022 ad revenue (9% of total revenue).
The number is so small because the big tree in this market is Google (GOOG), which holds roughly 85% market share.
That said, Microsoft has been gaining share for seven consecutive quarters. And each percentage point of share gain equates to about $2 billion of Bing revenue. If the company captured an additional 10% market share that’s $20 billion in revenue, enough to add roughly 10% to 2022 revenue.
Beyond Bing, Microsoft is also bringing ChatGPT/AI technology to other solutions. It recently announced premium editions of its Teams solution for $10 per user per month. The new technology will help with note-taking and meeting scheduling.
Rough math suggests the cost to run all Bing search queries through ChatGPT technology will be about $600 million to $1 billion per year, assuming no major changes to market share. That works out to about 0.4% of estimated 2023 revenue, which seems reasonable given the monetization opportunities of better-targeted ads and new subscription tiers across other products.
MSFT peaked at 349 in November 2021 then did poorly in 2022, ending the year down 28% from where it started.
Over the first two months of 2023, MSFT appears to be shaping up and is trying to stay above its 200-day moving average line. Trading near 255, now the next zone of resistance is 276, which is where MSFT was in early February.
|MSFT||Revenue and Earnings|
|Forward P/E: 26.7||Qtrly Rev||Qtrly Rev Growth||Qtrly EPS||Qtrly EPS Growth|
|Trailing P/E: 27.7||(bil)||(vs yr-ago-qtr)||($)||(vs yr-ago-qtr)|
|Profit Margin (latest qtr) 33.1%||Latest quarter||52.7||2%||2.32||-6%|
|Debt Ratio: 193%||One quarter ago||50.1||11%||2.35||4%|
|Dividend: $2.72||Two quarters ago||51.9||12%||2.23||3%|
|Dividend Yield: 1.10%||Three quarters ago||49.4||18%||2.22||14%|Current Recommendations
Price on 3/6/23
Arcos Dorados (ARCO)
BioMarin Pharmaceutical Inc. (BMRN)
Centrus Energy Corp. (LEU)
Cisco Systems Inc. (CSCO)
Comcast Corporation (CMCSA)
Gates Industrial Corporation plc (GTES)
Las Vegas Sands (LVS)
Medical Properties Trust, Inc. (MPW)
Novo Nordisk (NVO)
Uber Technologies, Inc. (UBER)
Ulta Beauty (ULTA)
WisdomTree Emerging Markets High Dividend Fund (DEM)
Xponential Fitness, Inc. (XPOF)
Changes Since Last Week: BioMarin Pharmaceutical Inc. (BMRN) Moves from HOLD TO SELL
One more sell today, as BioMarin Pharmaceutical (BMRN) has fallen apart after missing earnings estimates. So that keeps our portfolio at 17 stocks, with today’s addition of Microsoft. Two of those stocks are at new all-time highs as I write this, while another is hitting 52-week highs. Plus, new addition Visa (V) had a very good debut week.
There’s a lot to like in our current portfolio, BMRN’s meltdown aside. Let’s dive right in.
Arcos Dorados (ARCO), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, remains in the 8-9 range. Nothing new here. Earnings are due out March 15. BUY
BioMarin Pharmaceutical Inc. (BMRN), originally recommended by Mike Cintolo in Cabot Top Ten Trader, was already backsliding heading into last week’s Q4 earnings report. It’s fallen another 6.5% since. Earnings per share lagged estimates by 7.7% while revenue was basically in line. The stock is still above its 200-day moving average, but we are now at roughly a 10% loss since adding it to the portfolio in mid-December. With BMRN losing momentum fast (down 6.8% year to date) let’s go ahead and sell to make room for a more promising growth opportunity down the road. MOVE FROM HOLD TO SELL
Centrus Energy (LEU), originally recommended by Carl Delfeld in Cabot Explorer, had a rough week, dipping from 46 to 42. In fact, the stock has been backsliding for two straight weeks since peaking at 50 after a stellar fourth-quarter earnings report in which the company reported 41.8% revenue growth and beat EPS estimates. Nothing to worry about here – just some normal consolidation after a big run-up, which is why we recommended booking profits on a few shares in each of the last two issues. This nuclear energy stock remains one of the best performers in our portfolio and is still up 30% year to date. If you have not yet bought it, the recent dip looks like a buying opportunity. BUY
Chewy (CHWY), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, has held firm around 40 after a big gap down two weeks ago. The 200-day moving average line (38) appears to be acting as support. The online pet supplies retailer will report earnings on March 22. BUY
Cisco Systems (CSCO), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, was up a point, to 49 from 48, this past week on no news. In his latest update, Bruce wrote, “On February 15, Cisco reported impressive fiscal second-quarter results that were ahead of consensus estimate and raised its full-year revenue and earnings guidance by about 6%. The company raised its dividend by 1 cent per quarter, to $0.39/share. Overall, the company is maintaining its position as a critical provider of a broad array of tech gear and software even as other mega-cap tech companies that focus on only one or two niches are having to retrench. The company’s cash flow machine is running at full tilt, with operating cash flow of $4.7 billion nearly doubling the year-ago pace. Cisco’s balance sheet strengthened despite the $2.8 billion in year-to-date share buybacks and dividends. Cash in excess of debt rose by $3.4 billion, to a total of $13.2 billion. However, we are wary of the ongoing gross margin slippage and the sharp decline in new orders. For now, we will keep our Buy rating.
“There was no significant company-specific news in the past week.
“CSCO shares … have 35% upside to our 66 price target. The valuation is attractive at 9.1x EV/EBITDA and 13.0x earnings per share. The 3.2% dividend yield adds to the appeal of this stock.” BUY
Citigroup (C), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, is threatening to break above six-month resistance (52). In his latest update, Bruce wrote, “This past week, the yield spread between the 90-day T-bill and the 10-year Treasury bond, which approximates the drivers behind Citi’s net interest margin, was unchanged at negative 90 basis points (100 basis points in one percentage point).
“Until inflation relents to a 2% pace for perhaps six months, we see little chance for the Fed to declare ‘mission accomplished.’ The recent CPI and other reports suggest that the 6-month clock hasn’t yet started.
“Sentiment is shifting toward higher-for-longer interest rates, as inflationary pressures seem to be abating more slowly than most investors had hoped for. Some commentators are calling for the Fed Funds rate to approach 6%. Such a rate may not fully relieve inflation pressures but would clearly be a depressant for stock prices.
“Citi estimated that its wind-down of operations in Russia would cost about $190 million. This equates to about $0.10/share, pre-tax.
“Citi shares trade at 62% of tangible book value and 8.6x estimated 2023 earnings. The remarkably low valuations assume an unrealistically dim future for Citi.
“Citi shares … have 63% upside to our 85 price target. Citigroup investors enjoy a 4.0% dividend yield.
“When comparing Citi shares with a U.S. 10-year Treasury bond, Citi offers a higher yield (4.0% vs. 3.9%) and considerably more upside potential (about 70% according to our work vs. 0% for the Treasury bond). Clearly, the Citi share price and dividend payout carry considerably more risk than the Treasury bond, but at the current valuation, Citi shares would seem to have a remarkably better risk/return trade-off.” BUY
Comcast Corporation (CMCSA), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, barely budged this past week. Bruce says shares of the media giant have 12% upside to his 42 price target. The 3.2% dividend yield also holds appeal. BUY
Gates Industrial Corp. (GTES), originally recommended by Bruce Kaser in the Buy Low Opportunities Portfolio of his Cabot Undervalued Stocks Advisor, is hitting its highest point in nearly a year. The stock has been on a steady rise since a mid-October bottom at 9.7 a share, advancing to 14.5 as of this writing – its highest point since early April 2022. In his latest update, Bruce explained the reasons behind the company’s momentum: “On February 9, Gates reported an encouraging fourth quarter and provided reasonably strong guidance for 2023 that implied steady-to-rising revenues and profits rather than a recessionary decline. Fourth quarter free cash flow rose 55% as profits rose and inventory was sold down. Total debt fell about 3%. Leverage remains reasonable at 2.8x EBITDA, although it ticked up due to lower EBITDA. Gates continues to follow a common strategy of companies owned/controlled by reputable private equity firms: generating wide profit margins and high free cash flow conversion (free cash flow relative to adjusted net income). We strongly agree with this strategy.
“There was no significant company-specific news in the past week.
“GTES shares … have 10% upside to our new 16 price target. We recently raised our price target from 14 to 16 due to the company’s capable management, strong franchise within its market, still-improving fundamentals and reasonable valuation.” BUY
Las Vegas Sands (LVS), originally recommended by Mike Cintolo in Cabot Top Ten Trader, just broke above 60 – a new 52-week high! In his latest update, Mike wrote, “Las Vegas Sands (LVS) has perked up, as more and more signs point toward China’s economy picking up steam in a big way (some surveys this week were the latest to support that thesis). We obviously like the action, and as we wrote last week, we’d like to fill out our position in LVS, but given the market, we’ll again hold off, as the chances of some more shaking and baking (the 50-day line is just above 54 and rising) is still real given the market.” BUY
Novo Nordisk (NVO), originally recommended by Carl Delfeld in his Cabot Explorer advisory, is also at 52-week highs! In fact, it’s at new all-time highs, breaking above 143 resistance last week. The catalyst still appears to be the company’s Q4 earnings report, though as Carl pointed out in his latest update, Novo’s obesity drugs were the subject of a recent “60 Minutes” segment, which may have given NVO shares an extra nudge. Novo plans to increase production of Wegovy, its weight loss drug, due to high demand in the U.S. There’s a lot to like here, and last week’s breakthrough provides even more of a tailwind for the stock. BUY
Polestar (PSNY), originally recommended by Carl Delfeld in his Cabot Explorer advisory, is down slightly in the past week, with most of the losses coming this morning. The stock actually got a nice initial boost after reporting Q4 earnings last Thursday. Revenues improved 84% year over year, while losses narrowed. Better yet, the electric vehicle maker exceeded its 50,000-car annual production forecast, prompting CEO Thomas Ingenlath to breathlessly refer to Polestar as “the EV startup that delivers on the targets and fulfills what we promised to do.” Given all the good earnings and production news, I’m not concerned about the lack of momentum in the share price – yet. The stock is still above its late-December lows around 4.7. A dip below that might change my tune. But for now, buy. BUY
Realty Income (O), originally recommended by Tom Hutchinson in Cabot Dividend Investor, was up and down this past week, with no net change. Investors appear to still be processing the company’s recent earnings report. Here’s what Tom had to say about it in his latest update: “The legendary income REIT delivered solid earnings with 6.4% growth for the quarter and 9.2% for the full year. But it has moved lower since the announcement due to the recently indiscriminate market. O has still been trending slowly higher since the middle of October. The REIT sector is having a much better year so far. O has delivered a positive return over the last year while the overall market is down.” BUY
Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, finally dipped back below 200 a share, but only just. The stock is still up 59% year to date. The stock didn’t respond well to last Wednesday’s annual Investor Day, where Elon Musk’s so-called “Master Plan 3” underwhelmed. Namely, Musk didn’t provide many details on the company’s oft-teased next-generation platform, didn’t have an update on Tesla’s long-promised “very affordable car,” and failed to supply a delivery date for the years-in-the-making Cybertruck – among other shortcomings. Still, there was enough for investors to latch on to – like confirmation of the company’s new factory in Monterrey, Mexico, its largest production facility to date – that shares haven’t totally tanked. Keeping at hold, but this wouldn’t be a bad entry point given the recent dip. HOLD
Uber (UBER), originally recommended by Mike Cintolo in Cabot Growth Investor, was up to 34 from 33 last week, though it remains in its monthlong 33-36 range. In his latest update, Mike wrote, “Uber (UBER) has done the drip-drip-drip pattern with the market, with the fear obviously being that the Fed will go too far and in turn nail the economy, which will slow the firm’s rides and delivery business. Really, though, we think the weakness is simply about the market itself, as Uber’s cash flow is ramping and, barring a complete implosion, there shouldn’t be much standing in the way of continued bookings growth. A drop all the way toward 30 would be abnormal, but right here, we’re sticking with a Buy rating, thinking picking up shares is a good risk/reward situation if you’re not yet in.” BUY
Ulta Beauty (ULTA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, was up a bit ahead of this Thursday’s (March 9) earnings. The last time the company reported earnings, in early December, it spring-boarded shares to a 12% gain in three months. This week, analysts are anticipating 18% revenue growth and 3.7% EPS growth. The beauty retailer has handily beaten earnings estimates the last four quarters. Another beat could send shares even higher. We’ll see what happens. BUY
Visa Inc. (V), originally recommended by Tom Hutchinson in Cabot Dividend Investor, had a very good first week in its grand return to the portfolio, with shares rising to 226 from 220. In his latest update, Tom wrote, “The payments processing company stock has been thriving. After an impressive -3.4% return in last year’s bear market, V is up over 6% YTD. Even if the recent cyclical reversal continues, V should continue to hold up relatively well and it is giving a preview of how well it will react when the market finally turns for good. It’s well worth holding through the uncertainty into the next recovery.” BUY
WisdomTree Emerging Markets High Dividend Fund (DEM), originally recommended by Carl Delfeld in his Cabot Explorer advisory, keeps holding in the 37 to 39 range. 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, got a major boost from last Thursday’s earnings report, gapping up from 25 to 29 on Friday. That’s a new all-time high! What did Wall Street like so much about the fitness studio/product chain’s earnings? For starters, the company’s EPS of 11 cents more than tripled 3-cents-per-share estimates. Revenues ($71.3 million) beat estimates by 6%, and more importantly were 44% higher than the company’s Q4 sales a year ago. According to CEO Anthony Geisler, the company is taking advantage of people’s return to gyms in a post-Covid world plus the fact that there’s less competition, with many smaller gyms closing during the pandemic. As long as the anticipated recession is mild, as expected, there’s no reason to expect a slowdown in Xponential’s resurgence. Up more than 60%, XPOF is perhaps our top recent performer. If you bought shortly after our late-September recommendation, now might be a good time to sell a few shares – perhaps a quarter of your original position. For everyone else, it’s still a Buy. BUY
The next Cabot Stock of the Week issue will be published on March 13, 2023.