The market is enjoying a big bounce today, but that’s not unexpected given last week’s washout; the main trend is still down.

And that means continued caution is the prescription, which is filled this week with an old-school vehicle parts company that pays a solid dividend and has a nearly bulletproof business.

As for the current portfolio, which is 25% in cash, there’s one Sell and a couple of downgrades to Hold.

Details in the issue.

Cabot Stock of the Week Issue: June 21, 2022

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Stocks bounced back on big volume this morning, following the market’s worst week since 2020, so there’s a decent possibility that last week marked the bottom of this bear market; the bad news is highly visible, and expectations are very low. However, until we can actually identify a new uptrend, we have to admit that the main trend is still down, and thus continued caution is the wisest course, which means favoring low-risk stocks and cash. Today’s recommendation is an undervalued stock that pays a solid dividend. It was originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, and here are Bruce’s latest thoughts.

Allison Transmission (ALSN)
Allison Transmission Holdings is a midcap ($3.7 billion market cap) manufacturer of vehicle transmissions with about $2.7 billion in revenues. About 76% of sales are produced in North America. The Indianapolis-based company has its roots in the 1915 founding of the Speedway Team Company that helped support James Allison’s efforts related to the Indianapolis 500 race. The company joined General Motors in 1929. In 2007, the business was acquired from General Motors by a consortium of high-quality private equity investors which helped scrub away any lingering GM-related problems. Allison returned to public ownership through an IPO in 2012.

Many investors reflexively dismiss this company, viewing it as a low-margin producer of car and light truck transmissions that is destined for obscurity in an electric vehicle world. However, this view would be incorrect. Allison produces no car and light truck transmissions; instead, it focuses on the school bus, metro bus and Class 6-8 heavy-duty truck categories, where it holds an impressive 80% market share. The company avoids the commoditized Class 8 long-haul semi-tractor truck category and instead focuses on special duty vehicles like those used in mining, construction and other attractive niches. Parts, support equipment and related products, with stable demand and generous margins, contribute 22% of revenues.

The company emphasizes proprietary, patented technologies that have allowed it to develop and maintain a reputation for high quality and reliability. As the world gradually transitions to electric vehicles, Allison is well-positioned, as it already is a leading producer and innovator in electric axles, which all electric trucks will require. Another indicator of its advanced capabilities: Allison was selected to help design the U.S. Army’s next-generation electric-powered vehicle.

From a financial perspective, Allison’s technology edge and efficient manufacturing capabilities help it produce a 47% gross margin – comparable to tech companies like Microsoft and Oracle, while its 35% EBITDA (cash operating profit) margin is sharply higher than its competitors and on par with many specialty manufacturers.

Behind its impressive operating and financial results is a capable and shareholder-friendly management team. Allison generates considerable free cash flow – in a typical year it equals 20% or more of its revenues – which the management allocates toward improving Allison’s core business rather than diversifying into other categories. A top priority is returning cash to shareholders. Over the past five years, the company has repurchased nearly 40% of its outstanding shares (an impressive 2% was repurchased in the most recent quarter) while at the same time it has kept debt to a very reasonable 2.5x EBITDA level. Allison recently raised its share buyback authorization by $1 billion. Its dividend, raised by 11% in May, offers a respectable 2.2% yield.

Recent results were encouraging despite the difficult operating environment. First-quarter revenues rose 15% and earnings rose 21%, with both beating consensus estimates. The company maintained its full-year revenue, profit and cash flow outlook, which calls for 12% sales growth, 9% EBITDA growth and flat free cash flow. Like most companies, Allison is working to overcome higher input, labor and transportation costs. The company has been successful in raising its prices to offset most of these headwinds. If a sharp recession strikes the economy, however, Allison’s revenues, profits and cash flow would be weakened.

The shares trade at an attractive valuation of 6.3x estimated 2022 EBITDA. This multiple is below the company’s historical average and undervalues its franchise and financial strength. We have a 48 price target on ALSN shares. Despite the stock market’s slide this year, ALSN shares have generally held their value, reflecting the enduring merits of its underlying business. From a tactical perspective, investors may want to establish a starter position here, then add if the shares exhibit significant weakness.

Current Recommendations

The addition of ALSN to the portfolio brings it up to 16 stocks (of a maximum of 20), while the sale of Bristol Myers Squibb (BMY) (see below) takes it back to 15, and I’m comfortable with that in this market, particularly because so many of these stocks are lower risk and/or have great upside potential. Details below.

Allbirds (BIRD), originally recommended by Tyler Laundon in Cabot Early Opportunities, makes footwear from sustainable natural materials and is growing at a good pace. But as with any low-priced stock, its percentage moves can be big, in either direction. Since bottoming at 3.71 in early May, the stock has been working its way higher, and is now trading at its 25- and 50-day moving averages, which are poised to turn up. HOLD

Bristol Myers Squibb (BMY), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor for his Growth/Income Portfolio, has been sold by Bruce, for a nice profit. But Mike Cintolo recently recommended it in Cabot Top Ten Trader for its strong chart and that’s why we’ve held longer than Bruce. However, Mike had a suggested stop on the stock of 73.5 and that line was crossed last week as the market fell apart—and thus I will rate the stock sell today. However, if you didn’t sell (sometimes not being too close to the market is a good thing), and you still own it, you could still hold, as the stock has bounced strongly today and is once again above all its moving averages. SELL

Broadcom (AVGO), originally recommended by Tom Hutchinson in Cabot Dividend Investor for his Dividend Growth Tier, is a lower-risk technology stock that has become a good value. In his latest update, Tom wrote, “It’s been another ugly week for technology stocks and this time the selloff took AVGO down with it. The stock fell over 9% in just the last week. Although that is actually less than the sector’s decline, it usually holds up better. I still stand by last week’s claim that AVGO has gotten oversold and will likely be a lot higher priced in six months to a year from now. The selling may not be over, but the eventual payoff should make the short-term pain worth it.” HOLD

Brookfield Infrastructure Partners (BIP), originally recommended by Tom Hutchinson in Cabot Dividend Investor for his Dividend Growth Tier, is the only stock in the portfolio that wasn’t up this morning, but history says it will rebound soon. In his update last week, Tom wrote, “The weird low price is not your imagination. And no, the stock didn’t crash. Shares underwent a 3:2 stock split on June 13^th. That means shares priced at 60 per share before the split were price at 40 immediately afterwards, but you have 50% more shares. If you had 500 shares before the split, you now have 750 shares. A lower price per share can make the stock attractive to more investors. The stock fell over the last week, albeit far less that the overall market. But business is solid. And BIP is ideally suited for this market. It’s a safe dividend payer with built in inflation protections. Just hold on and collect the dividend. It should serve you well over time. (This security generates a K1 form at tax time).” HOLD

Chevron (CVX), originally recommended by Tom Hutchinson in Cabot Dividend Investor for his Dividend Growth Tier, hit a new high two weeks ago, but was pulled down by the market last week. In his update then, Tom wrote, “Even CVX sold off this week, because it’s a stock. But the story that recently drove the stock to new highs is still very much intact. Energy prices are likely to move higher over the course of the summer for a host of good reasons. Of course, a recession would knock prices down, but that really isn’t in the cards quite yet. Chevron is the most levered to oil prices of all the energy majors and will benefit from this inflation. Despite returning over 45% YTD, CVX still sells at a price/earnings ratio well below the overall market as well as its five-year average. The company expects to grow earnings by 100% this year and is well on track to do so.” Tom is now rating the stock Hold, so I’ll follow suit. HOLD

Cisco Systems (CSCO), originally recommended by Bruce Kaser in the Growth/Income Portfolio of Cabot Undervalued Stocks Advisor, remains above its mid-May low, ready to climb back up. In his update last week, Bruce wrote, “Cisco’s CEO recently waded into the debate on gun laws during an all-employee meeting. Our concern is not which side of the debate he is taking, but rather the fact that he is taking any side at all. The gun law issue is highly charged and unrelated to Cisco’s core business or strategy, particularly since Cisco sells almost exclusively to other businesses and not to consumers (where personal stances by CEOs may have some relevance). His stance-taking is already creating infighting which could easily degenerate into distracting the company’s employees from their jobs of improving Cisco’s business performance.

The valuation is attractive at 8.8x EV/EBITDA and 12.9x earnings, the shares pay a sustainable 3.5% dividend yield, the balance sheet is very strong, and Cisco holds a key role in the basic plumbing of technology systems even if its growth rate is only modest. We are keeping our Buy rating. CSCO shares have 52% upside to our 66 price target.” HOLD

CVS Health (CVS), originally recommended by Carl Delfeld in Cabot Explorer, fell through its 200-day moving average five weeks ago, then rallied back above it, but fell to new lows last week as the market collapsed. Still, Carl is sticking with it, and last week wrote, “This is an excellent stock for this sort of market because its first-quarter revenue was up over 11% year over year and it has a decent dividend and represents great value, trading at just over 11 times forward earnings. CVS Health is one of the nation’s leading healthcare companies with 300,000 employees including more than 40,000 physicians, pharmacists, nurses, and nurse practitioners. It has almost 10,000 stores and is viewed in a different category than retail companies such as Target. Nearly 70% of Americans live within three miles of a CVS. CVS stock is still a buy, and my price target is 100.” BUY

Fanuc (FANUY), originally recommended by Carl Delfeld in Cabot Explorer, is the world’s leading manufacturer of computerized numerical control (CNC) devices that are used in machine tools and serve as the “brains” of industrial robots. But the young stock is not heavily supported by institutions yet, so trading is loose. In his update last week, Carl wrote, “Shares were off about a point this week despite the fact that since exports represent about 90% of sales, it should get a big boost from the Japanese yen trading at a 24-year low against the U.S. dollar. Fanuc’s stock offers investors a great balance sheet, zero debt and $7 billion in cash. Fanuc is a high-quality, profitable play on a clear growth trend and my six-month price target for this conservative stock remains 25.” BUY

Nio, Inc. (NIO), originally recommended by Carl Delfeld in Cabot Explorer, and featured here last week, is one of the top five Chinese EV makers, and the stock is off to a great start for us. In his update last week, Carl wrote, “Shares were on a bit of a rollercoaster this week but managed to finish up after the company announced an upgrade to existing models with an advanced in-vehicle intelligence digital system called Alder. This includes a digital cockpit controller and better sensing capabilities and hardware. It also unveiled this week the ES7, a five-seater electric SUV based on an updated, highly autonomous driving platform. Nio expects to start deliveries in late August and the ES7 will compete against Tesla’s Model Y and BMW’s X5 L SUV in China. Nio’s ET7 and ET5 models offer battery upgrades with ranges of 621 miles on a single charge – better than Tesla’s Model 3 and Model S. Furthermore, Nio offers consumers its battery-as-a-subscription service, whereby buyers can swap batteries rather than wait for recharging. Nio is one of the top premium EV makers with massive growth potential and my target is for this stock to go from its current 20 per share to 40 over the next year.” BUY

ON Semiconductor (ON), originally recommended by Mike Cintolo in Cabot Growth Investor and featured here two weeks ago, is a Phoenix-based manufacturer of semiconductors, focusing on intelligent power modules, power management chips and sensing semiconductors, which are perfectly suited for high-growth markets like electric and hybrid vehicles. But the stock is barely bouncing in today’s strong up market, and because it now sits just above support between 50 and 51 — support that risks being broken — I’ll now downgrade it to Hold. HOLD

Organon (OGN), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor for his Buy Low Opportunities Portfolio, nearly touched its old high four weeks ago but the market has pulled it back down and it’s now fallen below its 200-day moving average. In his update last week, Bruce wrote, “Organon was recently spun off from Merck. It specializes in patented women’s healthcare products and biosimilars, and also has a portfolio of mostly off-patent treatments. Organon will produce better internal growth with some boost through smart yet modest-sized acquisitions. It may eventually divest its Established Brands segment. The management and board appear capable, the company produces robust free cash flow, has modestly elevated debt and will pay a reasonable dividend. Investors have ignored the company, but we believe that Organon will produce at least stable and large free cash flows with a reasonable potential for growth. At our initial recommendation, the stock traded at a highly attractive 4x earnings. OGN shares have about 39% upside to our 46 price target. The shares continue to trade at a remarkably low valuation while offering an attractive 3.4% dividend yield.” BUY

Pfizer (PFE), originally recommended by Tyler Laundon in Cabot Early Opportunities, is coming out of a growth trough (due to the 2019 patent expiration of Lyrica) and re-igniting its growth engines courtesy of Covid-related products and transformative M&A. The stock has fallen below its 200-day moving average, but remains in an uptrend, and above its May low—and it yields 3.0%! BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, lost half its value as it fell from last November’s high to its low of four weeks ago, but in last week’s market collapse, the stock stayed above that low—so odds are very good the bottom has passed. TSLA is a very visible stock, and a big company, too; first-quarter revenues were $18.8 billion, while at Nio, recommended last week, they were just $1.6 billion, so I don’t think the stock deserves a buy here. But I do think it’s worthy of a strong hold, given the great growth possibilities for the company in the energy sector, where demand is growing for relief from high oil prices. HOLD

Ulta Beauty (ULTA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, gapped up on big volume four weeks ago after reporting a great first quarter (unlike so many retail stocks), and as I write, it’s trading above all its moving averages, which is very impressive. HOLD

Visa (V), originally recommended by Tom Hutchinson in Cabot Dividend Investor for his Dividend Growth Tier, has been building a base at 190 for nearly six months now, but it hasn’t been able to develop an uptrend yet. In his update last week, Tom wrote, “V is the poster child for a stock whose fortunes look bad now but great later. Everything related to global growth is getting clobbered. And the beatings probably aren’t over. But the company itself is killing it. The tremendous earnings boost it gets globally from the removal of covid restrictions easily outweighs slower global growth or geopolitical uncertainty apart from a global recession. Visa’s earnings blew away expectations with YOY revenue growth of 25% and 30% earnings growth. This stock should be one of the first to reverse course and move higher when the market stabilizes.” HOLD

The next Cabot Stock of the Week issue will be published on June 27, 2022.

Analyst Bio

Timothy Lutts

Timothy Lutts is Chairman and Chief Investment Strategist of Cabot Wealth Network, leading a dedicated team of professionals who serve individual investors with high-quality investment advice based on time-tested Cabot systems.

Timothy is also the chief analyst for Cabot Stock of the Week and chief analyst of Cabot Marijuana Investor.

Under his leadership, Cabot advisories have been honored numerous times by Hulbert Financial Digest, Dow Jones MarketWatch and Timer Digest as the top investment newsletters in the industry.

After working in this business for more than 33 years, Timothy says, “There are 8 things I know.

1. The business of investing can provide great rewards to those who work at it and are willing to learn. Those who refuse to learn will lose money.
2. To succeed as an investor in growth stocks, it’s best to buy when upside potential dwarfs downside potential, to cut losses short, and to let winners run.
3. To succeed as an investor in value stocks, it’s best to buy low and hold patiently, until the stock is fully valued.
4. Your greatest enemies are your own emotions and the daily news (generally bad) which distracts you from a long-term focus. Try to ignore them both.
5. On the other hand, use your imagination to consider how great companies might evolve, remembering the power of the unforeseeable and the incalculable. When it began renting DVDs by mail, did anyone imagine Netflix could become a leading producer of content? When it began selling books, did anyone imagine Amazon would eventually sell almost everything?
6. For over two centuries, the long trend of the markets has been up, reflecting the growth of asset values, and I recommend that you invest in synch with that trend. Your greatest ally is time.
7. However, there will always be bull markets and bear markets, and you can use these to your advantage, particularly if you pay close attention to both chart patterns and investor sentiment.
8. Lastly, have faith in the ability of intelligent, innovative men and women to adapt, as they always have, and to solve the problems of the future in ways that are unimaginable to people of today. Invest in these people when you can.

Timothy has appeared on numerous podiums as an investing expert, including Bloomberg TV and the World Money Show, led Investor’s Business Daily discussion groups and been interviewed by Dow Jones MarketWatch,TopStockAnalysts.com, VoiceAmerica.com, AOL Finance and numerous other business news organizations.