THE SUMMER VACATION ISSUE
Today’s and next week’s issues of Cabot Undervalued Stocks Advisor are going to look a bit different. I won’t be reviewing all of our portfolio stocks today. Many Wall Street analysts are on vacation, so there will be very little in the way of changes in earnings estimates or new research reports for several weeks. That all changes after Labor Day, when analysts are back to work. They review all the companies within their research coverage, and update earnings estimates and research reports.
In addition, corporate America goes on the road, giving presentations to analysts and executives at industry conferences that are hosted by major investment firms. These conferences fuel new research reports, and often generate webcasts that are available for the general investing public. If you’re lucky, you might tune in to a webcast wherein Tesla CEO Elon Musk says something outlandish that raises the hackles of the pit bulls at the Securities and Exchange Commission.
Today, we’ll focus on stock market and economic news, investors’ inquiries, and a discussion of typical price action and opportunities with problem companies.
PROFIT OPPORTUNITIES AND PROTECTIVE STRATEGIES
WITH PROBLEM COMPANIES
There are all kinds of quirks and patterns associated with the stock market and individual stocks. One particular market phenomenon is the stock price action of companies that are immersed in problems or scandals.
When you hear about a company that’s having significant problems—not something common like tariffs on Chinese imports, but bigger, company-specific problems like repeated airplane crashes or a CEO being ousted for criminal activity—warning bells need to ring in your mind if you own those stocks.
For example, you might own shares of Boeing (BA). I’ve been warning investors about the company since their second plane crashed this year. What we’ve since witnessed are repeated delays on the “software fix” that will bring the Max 787 jets up to proper safety levels, and airlines pushing back their plans to begin flying the affected jets.
Or you might own shares of Macy’s (M), which was already projected to experience falling profits both this year and next year, and then they reported an even worse outlook last week. Their spring selling season did not go well, and the company had to slash prices to move merchandise.
You get the picture. I’m talking about big problems that tend to unfold slowly, bringing more and more bad news. What often happens to these companies is that their share prices fall, fall, and fall some more. Once we get to the second half of the year, odds are very strong that such stocks will continue falling through December. That’s because investors realize that the bad news is not going to go away quickly, as they had hoped. They sell these problem stocks and reinvest in healthier companies that have better chances to deliver capital gains. The selling ramps up in November and December as investors are taking capital losses in order to minimize their tax burdens for the year.
Take heart! There is a silver lining to this scenario. Once January rolls around, we’re past tax-loss selling season. Almost everybody who planned to sell problem stocks has already done so. All that’s left are buyers. Therefore, it’s not uncommon for these stocks to shoot upwards in January, even though the corporate problems have not been resolved. Basically, stocks rise when there are more buyers than sellers.
I want to give you a list of problem companies whose shares are trading at or near annual lows. You can protect your capital or even profit from their falling share prices by implementing any of the following strategies:
• Shareholders can use stop-loss orders.
• Shareholders can sell the stocks.
• Non-shareholders can short-sell the stocks.
• Any qualified investor can buy put options that expire in December or January.
• Any qualified investor can buy call options on the stocks in November or December.
Here’s a list of problem companies with which you can employ these protective or profitable strategies:
• Bed Bath & Beyond (BBBY)
• Boeing (BA)
• General Electric (GE)
• Kraft Heinz (KHC)
• Macy’s (M)
Please note that just because a company has big problems and a falling share price does not mean that the company is unprofitable.
INVESTOR Q & A
Question: I understand there is a correction in the markets, but I wasn’t expecting so much. Do you see this as a short term thing?
Answer: Yes, I foresee the current stock market correction as a short-term situation. The S&P 500 index is having a normal pullback, literally the same size pullback as it experienced in May, from which it recovered in June. The S&P 500 then rose to a new high in July. The strong U.S. economy has created favorable conditions for companies and their stocks, and I therefore anticipate a recovery from this current August pullback.
Question: Can an inverted yield curve cause a recession?
Answer: No, an inverted yield curve cannot cause a recession. A U.S. Treasury yield curve—no matter how bullish, bearish or unusual—cannot cause an economic recession. Only a poorly performing economy can cause an economic recession.
As you surely know, the U.S. economy is thriving, with good GDP growth, record employment, rising wages and low inflation. As recently as July, for example, U.S. retail sales rose 0.7% when economists were expecting an increase of 0.3%. June retail sales also came in more than twice as high as economists expected.
Current economic growth trends would have to come to a grinding halt AND reverse course in order for a recession to appear. It makes you wonder, then, why the media has been relentlessly using the word “recession” in news headlines. Always remember: It’s the media’s job to scare you so that you tune into their next broadcast. In short, investors are being purposely manipulated. Don’t fall for it.
Question: I have recently taken on the task of managing a family trust account. The account holds about 20 stocks. How should I go about assessing and improving the stock portfolio?
Answer: Here’s how I would handle that portfolio. First, I’d look up the earnings outlook and dividend yields on each stock, and separate the stocks into two groups: those with annually growing profits and/or stable profits with big dividend yields, and those that having falling profits. Over the long term, stocks tend to rise and fall in correlation to corporate profit trends, so I want to stick with growing companies.
Among the list of non-growing companies, here’s my thought process. Keep the stocks with bullish price charts—stocks that are rising—and use stop-loss orders. Raise the stop-loss orders as the stocks rise. Eventually, the stocks will fall and your positions will sell. You will have cash with which to buy higher-quality stocks.
Some of the stocks will be in trading ranges. If XYZ stock has been trading between 30-36 for quite a few months, put in a sell order at about 35.25. Could the stock shoot higher or lower? Sure. But odds are strong that the stock will continue this trading pattern. You can attempt to maximize your near-term profit by selling at the top of the trading range.
The stocks that have bearish price charts—stocks that are falling—are the stocks that I would promptly sell. That’s because I have no expectation that these stocks will rise in the near term. It would be more wise for me to put that same capital into a higher-quality company with a more bullish price chart, a move that can increase my chances of achieving capital gains sooner rather than later.
After removing the less attractive companies from the portfolio, I would buy a few more attractive stocks, aiming for sector diversification and relatively equal capital allocation per stock.
Question: I just recently started positions in Guess? (GES) and Designer Brands (DBI) and both are down 15%-20% already. Is this a bad time to be in consumer stocks?
Answer: I gave a presentation on retail/apparel stocks last week at the Cabot Wealth Summit. There are quite a few industries in the stock market that have performed poorly this year, and retail/apparel is one of them. Several retail/apparel companies are having financial problems, including Macy’s (M) and JCPenney (JCP). Unfortunately, profitable retail/apparel companies’ stocks are suffering too, including Guess? (GES) and Designer Brands (DBI).
Of the 10 retail/apparel stocks that I presented to the Summit audience, only three are expected to achieve two-year earnings growth (this year and next year). Guess is expected to grow profits the most at 47%. I did not include footwear stocks in the presentation, but Designer Brands is currently projected for 31% two-year profit growth. Therefore, these depressed share prices represent the classic “baby being thrown out with the bathwater.”
I am planning to hold my shares of these companies, with the expectation that the stocks will eventually perform very well, in line with corporate successes.
Question: I know you like Designer Brands (DBI), but I’m wondering if Kohl’s (KSS) is a better investment, especially given the new Amazon (AMZN) return policy through Kohl’s stores.
Answer: It certainly seems as if Kohl’s nationwide plan to accept and process Amazon returns will increase store traffic, revenue and profits. Business Insider reports, “You can simply go to your nearby Kohl’s to let an associate package and send off your returned items for free. They’ll do it for you regardless of the return season and whether the items are packaged or unpackaged.”
My problem with Kohl’s (KSS) is that the company is not projected to deliver any earnings growth at all in 2019 and 2020. Designer Brands (DBI), on the other hand, is expected to achieve 31% earnings growth in that same time frame. Kohl’s can’t easily catch up to Designer Brands’ earnings growth simply by assisting Amazon’s customers. And by the way, have you ever seen the customer service line at Kohl’s? Some people are going to think twice before accepting Kohl’s “help” with their Amazon returns.
I’ll continue to keep an eye on Kohl’s earnings projections. If the numbers improve dramatically, I’ll be happy to recommend the stock.
PORTFOLIO NOTES
TODAY’S PORTFOLIO CHANGES
Alexion Pharmaceuticals (ALXN) moves from Hold to Strong Buy.
CF Industries (CF) moves from Hold to Strong Buy.
LAST WEEK’S PORTFOLIO CHANGES
Axis Capital Holdings Ltd. (AXS) moved from Hold to Retired.
Corteva (CTVA) moved from Hold to Strong Buy.
Guess? (GES) moved from Strong Buy to Buy.
Marathon Petroleum (MPC) moved from Buy to Hold.
The Mosaic Company (MOS) moved from Buy to Hold.
*Please note that a trading range is not a price target. It’s simply the recent range of the stock’s price action. Sometimes I will specifically say that I plan to sell a stock at the top of its trading range. In most other cases, I expect the stock to eventually surpass the current trading range and begin a new run-up.
**A good stock for growth (G), growth & income (DIV) or trading (T).
UPDATES ON GROWTH PORTFOLIO STOCKS
CF Industries (CF – yield 2.5%) – Reading through last week’s Update, I see that I had meant to move CF Industries from Hold to a Strong Buy Recommendation. (I had moved the stock from Strong Buy to a Hold recommendation on August 1 after a big run-up, in anticipation of a pullback. The pullback promptly arrived, and seems to have run its course.) There’s price resistance at 52 and 55. Buy CF now. Strong Buy.
CIT Group (CIT – yield 3.3%) operates both a bank holding company with $35.3 billion in deposits and a financial holding company. CIT Group provides financing, leasing and advisory services to small and middle market businesses, consumer markets, and the real estate and railroad industries.
Last week, CIT Group announced that its subsidiary, CIT Bank, N.A., will acquire Mutual of Omaha Bank for $1 billion. The acquisition will increase CIT Group’s deposit base, including $3.9 billion of middle-market commercial loans, and the deposits from over 31,000 homeowners associations. The transaction is expected to bring the deposit base up to $42.1 billion, lower the cost of deposits, and add to EPS in 2020 and thereafter.
CIT is an undervalued stock with an attractive dividend yield. Analysts expect EPS to grow 22.3% and 6.9% in 2019 and 2020, respectively. The P/E is 8.6. Wait for the stock to stabilize from the recent pullback before buying. Hold.
UPDATES ON GROWTH & INCOME PORTFOLIO STOCKS
Corteva Inc. (CTVA – yield 1.7%) is an agricultural sciences company, providing farmers with seeds and crop protection products, enabling them to maximize yield and profitability. There’s a bullish expectation on Wall Street that corn and soybean prices will continue rising and that seed prices will also increase.
Corteva’s CFO spoke with analysts last week, raising revenue guidance for 2020 and beyond to a range of 4%-6% annual increases (an increase of one percentage point over previous guidance). Improvements in productivity and cost savings are expected to add another $700 million to profits through 2024.
The market expects EPS of $1.15 and $1.51 in 2019 and 2020, reflecting 31% growth next year. (I expect those numbers to continue improving in the coming months.) The 2020 P/E is high at 20.0, but fair in light of the EPS growth rate.
CTVA is a mid-cap growth & income stock. The company carries no long-term debt. This stock is especially appropriate for growth investors who are experienced with the volatility that can be associated with commodity stocks. This month, CTVA launched above its recent trading range to new highs, pulled back with the broader market, then jumped in response to the CFO’s bullish comments. Strong Buy.
Guess?, Inc. (GES – yield 3.2%) is a global apparel manufacturer, selling their products through wholesale, retail, ecommerce and licensing agreements. Guess will release second-quarter results on the afternoon of August 28. Analysts are expecting $0.29 EPS, within a range of $0.28-$0.30, and $672 million revenue.
Wall Street expects EPS to grow of 27.6% and 15.2% in fiscal 2020 and 2021 (January year end). The 2020 P/E is low at 11.3. GES offers the best earnings growth & value opportunity of all U.S.-based apparel retailers. The stock is suffering along with apparel stocks and the broader market. Buy.
UPDATES ON BUY LOW OPPORTUNITIES PORTFOLIO STOCKS
Abercrombie & Fitch (ANF – yield 5.1%) is a specialty retailer of Abercrombie & Fitch, abercrombie kids and Hollister brand apparel and accessories for men, women and kids. The company operates 857 stores globally. The company remains on track toward its multi-year goals of improving revenue, profits, expense-control, data analytics and global store expansion. Abercrombie will release second-quarter results on the morning of August 29. Analysts are expecting a loss of ($0.53) per share, and $851.9 million revenue. (Abercrombie is expected to earn all its fiscal year profit in the third and fourth quarters.)
ANF is an undervalued small/micro-cap stock. Abercrombie offers the best combination of earnings growth and dividend yield of all U.S.-based apparel retailers. Analysts expect EPS to fall 21% in 2019, then to rise 59% in 2020 (January year end). The stock has traded between 15-19 for 12 weeks. Buy.
Alexion Pharmaceuticals (ALXN) is a biopharmaceutical company that researches and manufactures treatments of severe and rare health disorders. Current marketable drugs include Soliris, Strensiq and Kanuma. The company is focused on the development of pipeline products that will fuel continued long-term profit and revenue growth. Wall Street expects EPS to grow 25% and 10.8% in 2019 and 2020. The 2019 P/E is 11.2, which is very low for a biopharmaceutical stock.
The European Commission will announce a decision on September 5 regarding whether Soliris can be subject to biosimilar competition in Europe. Potential drug competition is expected to take at least three years to materialize.
The stock seems ready to rise from its recent pullback. I’m moving ALXN from Hold to a Strong Buy recommendation. There’s price resistance at approximately 125 and 135. Strong Buy.
Designer Brands Inc. (DBI – yield 6.7%) operates DSW Warehouse and The Shoe Company stores with over 1,000 locations in 44 U.S. states and Canada, and Camuto Group. DSW was the #1 omnichannel retailer in the U.S. in 2017 and 2018, and has delivered 27 consecutive years of sales growth. The company will release second-quarter results on the morning of August 29. Analysts are expecting $0.48 EPS, within a range of $0.46-$0.50, and $877.5 million revenue.
DBI is an undervalued growth stock with a hefty dividend yield. Expected EPS growth rates are 15.1% and 14.1% in 2019 and 2020. The current P/E is low at 7.8. Dividend investors can buy now, while growth investors should wait for the price chart to turn bullish. Hold.
