Cabot Undervalued Stocks Advisor was born in October 2015, and is now past its infancy. This is a good time to review our stock selection strategy and performance.
• Thus far, 18 stocks have been sold from the portfolios.
• Of the stocks that were sold, the average total return per stock, per month, was 1.54%.
• The annualized total return per stock was 18.48% (simply calculated by taking the monthly return and multiplying by 12).
• Four of these 18 stocks were subject to buyout offers: Axiall (AXLL), Chemtura (CHMT), Harman (HAR) and Sandisk (SNDK).
• Holding periods varied dramatically, with several stocks held for less than one month, and half a dozen others held for over a year.
Previous sales of Cabot Undervalued Stocks Advisor stocks:
Now let’s talk about strategy. Contrary to what you might surmise, my stock selection strategy was not born from the perspective of seeking capital gains. It was born from the desire to minimize the risk associated with stock investing. Risk isn’t any fun, and can turn a rookie investor away from the stock market forever.
Here are the stock criteria for new additions to the CUSA portfolios:
Both current and future years’ earnings per share (EPS) growth rate plus dividend yield of 15% or more. (If EPS growth is 12% and the dividend yield is 3%, that stock could land on my buy list.) This earnings requirement eliminates companies that have stagnant earnings, falling earnings and net losses. For example, there were no energy stocks on my buy lists since the beginning of the oil price decline because their earnings outlooks were negative. Now that 2017 earnings prospects for oil & gas companies are finally looking attractive, I added four related stocks to the portfolios since November.
Price/earnings ratio (P/E) below the EPS growth rate plus dividend yield. (In the previous example, a P/E of 14 or higher would be unacceptable because the stock would theoretically be fairly valued or overvalued.) As stocks become overvalued, they morph from investments into gambles. (I live in Colorado. If I want to gamble, I can get to Las Vegas very quickly.)
Long-term debt-to-capitalization ratio below 40%. Having too much debt ties your hands, and saddles your budget with principal and interest payments. Within a business context, too much debt will hinder the company from hiring employees, building new manufacturing plants, making matching contributions to employee retirement plans or staying abreast of industry standards in technology. In a public corporation, cash flow that’s diverted toward debt service represents cash flow that’s not being used to pay dividends or repurchase stock. High debt levels can also make a company an unattractive acquisition target.
That’s it. Earnings growth (plus dividends, if they exist), price/earnings ratios and debt levels. If a stock passes those tests, then I’ll consider adding it to the portfolios, using price charts to assist with buy and sell decisions.
I’ll also be somewhat careful not to overweight the portfolios in any particular industry, although that can be tricky, because industries tend to be overvalued or undervalued as a whole. When an industry becomes undervalued and its stocks’ price charts turn bullish, there are often many good companies to choose from, as we’re seeing now in the areas of semiconductors, insurance companies and oil & gas companies.
Companies’ earnings outlooks are constantly changing. In the past, as long as the outlook continued to project earnings growth, I kept the stocks in the portfolios. Going forward, I’m going to modify that approach, with a willingness to sell a stock when earnings growth rates fall within a range of 5% to 10%. At that point, the dividend yield and P/E will contribute to my decision on whether to buy, sell or hold the stock.
If you have questions about this investment strategy, please contact me at Crista@CabotWealth.com.
Portfolio Notes
I’m going to hate doing it, but it’s possible that I will sell Amazon.com (AMZN) from the Growth Portfolio in the near future. The stock is fully valued but the price chart looks promising. My intention is to hold the stock for the next breakout and sell it after the subsequent run-up. My investment strategy does not include holding onto popular, overvalued stocks, beyond any immediately bullish profit opportunities that the price charts are presenting to us.
When that scenario takes place, I know that there will be subscribers who will want to hold AMZN. My suggestion, at that point, will be to use a stop-loss order to protect your profit. And by the way, it’s possible that we’ll see the same scenario with Adobe Systems (ADBE) in the coming months.
Sometimes a company is slated for aggressive earnings growth this year, but dramatically slower earnings growth next year. That’s the case with Applied Materials (AMAT). What we typically see in this scenario is that investors and financial media will love the stock, and drive its price up during the first half of the company’s fiscal year. But when we get to the second half of the year, the market changes its focus onto next year’s earnings growth and investor behavior changes accordingly.
If you want to see a classic example of that investor behavior, look at a three-year price chart on Apple (AAPL). Earnings per share (EPS) rose +42.9% in 2015, then fell -9.9% in 2016 (September year-end). Anyone who keeps abreast of earnings estimates—including all professional investors—knew that Apple’s earnings growth was about to come to a screeching halt. That’s why the stock fell in the second half of 2015, and did not begin to recover until the second half of 2016. With falling profits, there was no reason for institutional investors to buy the stock. But when it was time to focus on 2017 earnings growth—expected to be a slow, but acceptable 7.7%—people began buying AAPL again.
I’ve seen this pattern repeated dozens of times throughout my career. This pattern is one of the main reasons that I’ve been recommending energy, bank and insurance company stocks in recent months. Most of them are coming away from years with slow earnings growth, and commencing years of very strong projected earnings growth. Mattel (MAT) is in the same situation; the company is expected to finish 2016 with 1% earnings growth then deliver 39% earnings growth in 2017.
People keep asking me about former ExxonMobil CEO Rex Tillerson’s high profile involvement in the Trump administration, including his stances on global warming and international trade. Here’s my answer: unless I’m working on a political project that Tillerson’s directly involved in, I’m not going to waste precious time overanalyzing where he stands on various issues. Just because he has an opinion on the Trans-Pacific Partnership (TPP) trade agreement, which I lobbied against in Congress, does not mean that his opinion affects the outcome of my work. I try to stay focused on my goals, and ignore everybody who’s not blocking my path.
My recommendation of stocks like Goldman Sachs (GS) and ExxonMobil (XOM) does not represent approval of their various ex-employees who go to work in Washington D.C. I am simply focused on numbers and potential capital gains. I don’t follow the careers or political opinions of their current and ex-employees. Rex Tillerson did a great job making ExxonMobil a financially sound company. For that, I am grateful.
Best Stocks to Buy Today:
ExxonMobil (XOM)
Goldman Sachs (GS) – top pick
Mattel (MAT)
Today’s Portfolio Changes:
Goldman Sachs (GS) moves from Buy to Strong Buy.
Kraft Heinz (KHC) moves from Buy to Hold.
Last Week’s Portfolio Changes:
Amazon.com (AMZN) moved from Buy to Hold.
Boise Cascade (BCC) moved from Hold to Buy.
GameStop (GME) moved from Buy to Hold.
Goldman Sachs (GS) moved from Hold to Buy.
Updates on Growth Portfolio Stocks
ASML Holdings NV (ASML – yield 1.0%) was featured in the January issue of Cabot Undervalued Stocks Advisor. ASML is expected to report fourth-quarter EPS of $1.05 on the morning of January 18. This undervalued aggressive growth stock broke past upside resistance last week and is now actively reaching new highs. Strong Buy.
Adobe Systems (ADBE) This undervalued aggressive growth stock is rising toward short-term upside resistance at 111, which it could surpass this winter. Strong Buy.
Amazon.com (AMZN) introduced the Amazon Prime Rewards Visa Signature credit card last week. The card offers all kinds of spiffs, and in return, Amazon charges a higher interest rate on your debt than the average credit card rate. Amazon is also planning to introduce a line of workout clothing. AMZN is a fully valued aggressive growth stock, with short-term upside resistance at 840. Hold.
American International Group (AIG – yield 1.9%) This extremely undervalued, aggressive growth stock could break past 67 and begin a run-up at any time. Strong Buy.
Applied Materials (AMAT – yield 1.2%) Zacks analysts apparently love AMAT, because they featured AMAT in at least seven articles last week, including “Top Ranked Growth Stocks to Buy for January 12th”. AMAT is an undervalued aggressive growth stock with a bullish chart, and no upside resistance. I love the stock right now, and would confidently buy shares today, but earnings growth slows dramatically in 2018 (October year-end), so consider AMAT to be a shorter-term hold. Buy.
Dollar Tree (DLTR) is quite cheap and is probably sitting at the bottom of its trading range, but not yet showing readiness to rise. Patient investors should buy this undervalued, aggressive growth stock now. Buy.
Goldman Sachs Group (GS – yield 1.1%) is expected to report fourth-quarter earnings of $4.82 per share on the morning of January 18. We could easily see an upside earnings surprise, higher 2017 earnings guidance, a dividend increase and/or a new share repurchase authorization. On January 14, Barron’s published an excellent review of almost everything I’ve been saying about about GS shares.
GS is an undervalued aggressive growth stock. It’s been trading in a tight sideways range for six weeks, forming a very bullish flat base chart pattern. I think we’re about to see the stock launch upwards again. I’m moving GS from Buy to Strong Buy today, in advance of tomorrow’s earnings report. Strong Buy.
Johnson Controls (JCI – yield 2.3%) is a very undervalued growth stock. I expect JCI to retrace recent highs around 45.50 this winter. (I anticipate moving the stock to a Buy when it appears ready to rise above 36.) Hold.
Quanta Services (PWR) builds and repairs electric power, energy and telecommunications infrastructure. Read more about the company’s bullish 2017 prospects in this recent Zacks recommendation. This very undervalued, aggressive growth stock has been forming a flat base since early December. That’s a bullish sign that the stock could launch upward soon. Either buy PWR now, or buy on the day the stock breaks past 37. Strong Buy.
Vulcan Materials (VMC – yield 0.6%) This undervalued aggressive growth stock is in the midst of a temporary pullback, with price support at 123. Strong Buy.
XL Group Ltd. (XL – yield 2.1%) Last week, XL Group preannounced fourth-quarter 2016 catastrophic losses that were higher than analysts expected, mostly related to Hurricane Matthew and a New Zealand earthquake. Therefore analysts’ fourth quarter EPS estimates will be adjusted downward. The outlook for improvement in margins, expenses and buybacks remains intact. XL is an extremely undervalued aggressive growth stock. The stock could break past upside resistance at 38 this winter. Strong Buy.
Updates on Growth & Income Portfolio Stocks
BP plc (BP – yield 6.4%) Here’s a strong recommendation of BP by TheStreet, focused on the company’s improvements in operating margins, capital expenditures and development costs. I expect BP to break past 39 this winter and head toward 43. Strong Buy.
Cardinal Health (CAH – yield 2.4%) is fairly valued. The price chart is bullish, with upside resistance at 78. Hold.
D.R. Horton (DHI – yield 1.4%) Last week, Moody’s Investors Service raised its rating on D.R. Horton’s debt from Ba1 to Baa3. The price chart will turn bullish when DHI breaks past 29.50 on the upside. Buy.
Exxon Mobil (XOM – yield 3.5%) was featured in the January issue of Cabot Undervalued Stocks Advisor. XOM had a quick $10 post-election run-up, then came down to price support at 86. Take advantage of this low price before the next run-up begins. Strong Buy.
Federated Investors (FII – yield 3.6%) is currently overvalued. FII has been trading between 27 and 29.50 since its run-up during election week. Hold.
GameStop (GME – yield 6.5%) I sent out a Special Bulletin on January 13 after GME reported poor holiday same-store sales and an increase in non-physical game sales, and reiterated its full-year earnings target. Over the weekend, GameStop received customer reservations for its entire allocation of Nintendo Switch systems, which analysts had not anticipated. Corresponding games and accessories are also available for pre-order. Nintendo Switch launches on March 3, for the retail price of $299.99. Hold.
H&R Block (HRB – yield 3.7%) Here’s a January 9 interview with Block CEO Bill Cobb. HRB appears likely to break past 24 shortly, toward upside resistance at 27. Hold.
Kraft Heinz (KHC – yield 2.8%) I’m moving KHC from Buy to Hold today, due to fair valuation. Hold.
Royal Caribbean Cruises (RCL – yield 2.3%) continue to ratchet upwards towards its December 2015 high around 102. Buy.
Whirlpool (WHR – yield 2.1%) Zacks wrote extensively about Whirlpool’s undervaluation on January 10, then promptly featured the stock again in “Top Ranked Value Stocks to Buy for January 12th”. WHR is slowly rising toward price resistance at 190. Traders should exit there, and everyone else should hold the stock for additional gains this year. Hold.
Updates on Buy Low Opportunities Portfolio Stocks
Archer Daniels Midland (ADM – yield 2.7%) This is an excellent time to buy ADM, which is low within its trading range. Strong Buy.
Boise Cascade (BCC) is expected to report a fourth-quarter EPS loss of $0.05 on the morning of January 23. BCC appears ready to break past 25, and rise to short-term price resistance at 27. Buy BCC now. Buy.
BorgWarner (BWA – yield 1.4%) Here’s BWA’s presentation at last week’s Deutsche Bank Auto Industry Conference, in which the company forecasts earnings and revenues in 2017 and beyond. BWA is trading between 39 and 42. Hold.
Legg Mason Inc. (LM – yield 2.7%) is expected to grow 2018 EPS by 36.3% (March year-end), while the 2018 P/E is very low at 10.6. LM will likely trade between 31.50 and 34.50 in the coming months. Strong Buy.
Mattel (MAT – yield 5.1%) introduced a new line of WWE action figures last week, exclusively available at Wal-Mart, with broader retail penetration planned for later in the year. Wall Street expected Mattel’s 2017 EPS to grow 37.8%, while the 2017 P/E is just 16.9. MAT is low within its recent trading range of 29 to 33.50. Buy MAT now. Buy.
Molina Healthcare (MOH) was featured in the January issue of Cabot Undervalued Stocks Advisor. This undervalued aggressive growth stock rose 20% since the November elections. MOH could break past 60 soon and head toward upside resistance at 66. Buy.
Tesoro (TSO – yield 2.7%) is having a pullback. It will be important to see TSO bounce at 78 this week. Buy.
Toll Brothers (TOL) has traded between 31 and 33 since an early December run-up. Buy.
Total SA (TOT – yield 5.2%) Despite a 14% run-up since mid-November, TOT continues to show price strength. Strong Buy.
Universal Electronics (UEIC) has upside resistance at 70 and again at 78. Buy.
Vertex Pharmaceuticals (VRTX) Germany-based Merck KGaA announced last week that it has partnered with Vertex in the area of oncology treatments. Merck will pay Vertex $230 million up front, along with royalties from future net sales, in order to acquire the rights to several compounds that were developed by the Vertex R&D team.
Vertex’s full-year 2016 results will be reported on the afternoon of January 25. During the last four weeks, Wall Street’s consensus full-year EPS estimates have come up from $0.77 to $0.83, with $2.11 EPS expected in 2017.
VRTX continues to show near-term price strength. Traders should be ready for short-term upside resistance at 95. Buy.
