Stocks produced one of their strongest quarters in living memory, with the S&P 500 returning 20.5% in the period ending June 30. The index has nearly fully regained its previously-lost value, declining only 6% for the first half of the year. Investors frequently ask how the S&P 500 can be down only modestly given the Depression-like broad economic statistics.
The answer is the buoyant effect of mega-cap stocks like Amazon (+49% year-to-date), Microsoft (+29%) and Apple (+24%), which benefit from the pandemic environment. Facebook and Alphabet/Google, also beneficiaries, have produced gains this year, as well. These five companies hold the top five largest market capitalizations in the S&P, comprising a combined 22% weighting, so their effect is huge. For comparison, if all of that index’s stocks had the same weighting, the S&P500 would have been down 10.8% in the first half.
Likewise, Growth stocks, which include the tech giants, have gained 9.8% through June 30, far ahead of the dismal 16.3% loss for Value stocks. Similarly, small-cap stocks have produced a 13.0% loss. The international picture is little different: developed country stocks have fallen 12.6%, while emerging market stocks have declined 10.7%, helped by modest gains in Chinese stocks.
The “beneficiaries” have continued to surge, with Amazon up another 13% and Alphabet/Google gaining 10% since June 30. Also, the roster is expanding, with riskier but at-least-momentarily well-positioned companies like payments processor Square (SQ) surging 21% since the start of July. In the first 3½ trading days of July, the S&P 500 has already beaten the equal-weighted S&P 500 Index by over one percentage point.
What does an investor do in this two-tier market? First, simply being aware of this distortion is valuable. When thinking about a stock, asking “which bucket does it fall into… the beneficiary bucket or the all-others bucket” can be illuminating. Riding a beneficiary can work exceptionally well. Avoiding stocks in the all-others bucket can, too. However, trends don’t continue forever, and the momentum will change, perhaps abruptly. So, check to see how much you have in each bucket – are you too concentrated in one (either one) and too light in the other? Think today about what would push you to shift your positions, when “enough is enough.”
Also, there are many other forms of diversification to keep in mind, including sectors, size, quality and stocks vs bonds vs other vs cash. And, remember, no one gets any of this exactly right. Close enough is broadly defined and is usually, well, close enough.
Send questions and comments to Bruce@CabotWealth.com.
TODAY’S PORTFOLIO CHANGES
Relocating Marathon Petroleum (MPC) to the Special Situations and Movie Star Portfolio
VanEck Vectors Oil Refiners ETF (CRAK) moves from Buy to Hold.
LAST WEEK’S PORTFOLIO CHANGES (July 1-6)
Columbia Sportswear (COLM) new Buy.
Quanta Services (PWR) moves to Buy from Hold.
Marathon Petroleum (MPC) moves to Hold from Buy.
GROWTH PORTFOLIO
MKS Instruments (MKSI – yield 0.7%) generates about 49% of its revenues from critical components that become part of equipment used to make semiconductors. MKS’ products are generally in the stronger segments of this currently healthy industry. While MKSI shares rather closely track the broad semiconductor indices, the expansion of its Advanced Markets segment, including its 2016 acquisition of Newport Corporation, as well as its 2019 acquisition of semiconductor-related Electro Scientific Industries, may allow its shares to break out. The company recently elevated 13-year company veteran Dr. John T.C. Lee to CEO. MKS Instruments was featured in the February 19 issue of Cabot Undervalued Stocks Advisor.
MKSI is an undervalued, small-cap growth stock, making it a good choice for growth investors and traders. Analysts’ consensus estimates continue to point toward EPS growth of 12% and 37% in 2020 and 2021, respectively. MKSI shares continue their upward move, somewhat following the broad semiconductor indices. Traders should consider exiting near 120 where there is resistance. Buy-and-hold growth investors should be comfortable holding the stock longer term and accumulating shares near 100 if the opportunity presents itself. Hold.
Quanta Services (PWR – yield 0.5%) is a leading specialty infrastructure solutions provider serving the utility, energy and communication industries. Their infrastructure projects have meaningful exposure to highly predictable, largely non-discretionary spending across multiple end-markets, with 65% of revenues coming from regulated electric, gas and other utility companies. Quanta achieved record annual revenues, operating income and backlog in 2019, and is pursuing a multi-year goal of increasing margins. Dividend payouts and share repurchase activity have continued uninterrupted during the pandemic.
We view this company as high-quality, well-run and resilient. The market views PWR as a safe haven in an unpredictable market and economy, helping the shares to fully recover from their March 2020 lows. The new 15-year contract to operate and modernize Puerto Rico’s energy grid is an encouraging positive as the company is seeking to shift toward a capital-light, recurring profit model. Quanta Services was featured in the July monthly issue of Cabot Undervalued Stocks Advisor.
PWR is an undervalued, mid-cap growth stock. Analysts estimate that Quanta’s earnings per share will dip about 6% in 2020 to $3.15, due to disruption costs related to the pandemic, then rebound over 22% to $3.82 in 2021. On 2021 estimated earnings, the P/E is a reasonable 10.2x. The shares have mostly recovered from their March lows, yet are essentially unchanged compared to three years ago. Traders may consider exiting near $43. For long-term holders, Quanta stock looks well-positioned to continue to prosper. New investors should establish a starter position now and look to add on weakness. Buy.
Tyson Foods (TSN – yield 2.8%) is one of the world’s largest food companies, with over $42 billion in revenues last year. Beef products generate about 36% of total revenues, while chicken (31%), pork (10%) and prepared/other contribute the remaining revenues. It has the #1 domestic position in beef and chicken with roughly 21% market share in each. Its well-known brands include Tyson, Jimmy Dean, Hillshire Farms, Ball Park, Wright and Aidells. As only 13% of its sales come from outside the United States, Tyson’s long-term growth strategy is to participate in the growing global demand for protein. Tyson Foods was featured in the June issue of Cabot Undervalued Stocks Advisor.
Unlike many of its food company peers whose shares have fully recovered this year, or more, Tyson’s shares remain 36% below their year-end price and seemingly stuck in a 58-65 range, although they briefly broke out to over 68 before falling back. Much of this is due to absentee issues surrounding its processing facilities (there is no evidence that the virus is transmissible to meat products), oversupply conditions in the poultry industry and import restrictions by China. Also, Tyson is more of a commodity company than a diversified branded food company, so its exposure to weaker commodity prices and its lower profit margins make it a less-defensive stock than its peers.
Tyson’s profits are expected to fall 19% in 2020 due to pandemic business disruptions, then rise 32% in 2021. The 2020 P/E is 13.1x. The shares produce a 2.8% dividend yield. The company’s business is starting to improve, particularly from its food service segment that suffered from stay-at-home restrictions, as well as from its emerging and higher-margin prepared foods business. The shares are touching a near-term technical low in the 58-65 range. Buy.
Universal Electronics (UEIC) is a dominant producer of universal remote controls that subscription broadcasters (cable and satellite), TV/set top box/audio manufacturers and others provide to their customers. The company pioneered the “universal” remote, named the All For One, which was quickly adopted by consumers after its launch in 1986. Since then, the company has expanded into a range of remote control devices for smart homes, safety and security and other residential and commercial applications, driven by its extensive and valuable proprietary technology. Clients include every major cable and satellite company: AT&T, Cox, Dish, Comcast, Samsung, LG, Sony, Liberty, Daikin, Sky and more. Universal Electronics was featured in the February monthly issue of Cabot Undervalued Stocks Advisor.
Strong and steady revenue and earnings growth drove the shares to over 80 by mid-2016, from only about 12 in mid-2012. However, the shares have stumbled and remain down about 45% from their peak. UEIC is a volatile, undervalued, micro-cap growth stock, appropriate for risk-tolerant investors and traders. Over the short-term, its shares generally correlate with overall market and economic re-opening sentiment. Attractive buying opportunities are appearing as the shares remain near the midpoint of their recent range. Strong Buy.
Voya Financial (VOYA – yield 1.3%) is a U.S. retirement, investment and insurance company serving 13.8 million individual and institutional customers. Voya has $603 billion in total assets under management and administration. The company previously was the U.S. arm of Dutch financial conglomerate ING Group, from which it was spun off in 2013. Voya has several appealing traits. Even though it is well-capitalized, it is migrating toward a capital-light model, taking a major step in this direction by selling its life insurance business, which should close in the third quarter. Some of the released capital could be used to repurchase shares. Also, it won’t pay cash taxes for as many as five years due to its deferred tax assets. Voya is generating considerable free cash flow, and its diversified and highly-regarded product base offers steady long-term revenue strength.
VOYA shares trade at an attractive 7.9x estimated 2021 earnings and 0.8x book value. Per share earnings in 2021 are expected to jump 41% compared to 2020. VOYA is a mid-cap stock, appropriate for growth and value investors and traders. The shares’ daily trading range appears to be ticking slightly upward. Strong Buy.
GROWTH & INCOME PORTFOLIO
Bristol-Myers Squibb Company (BMY – yield 3.0%) is a global biopharmaceutical company. Following its controversial acquisition of Celgene for $74 billion in November 2019, the merged company markets a long list of pharmaceuticals, including Revlimid, Eliquis and Opdivo, which treat cardiovascular, oncology and immunological diseases. The company expects revenue and profit growth to come from four areas: sales volume increases from current products, development and launch of new medicines, life cycle management and synergies from the Celgene acquisition. Investors will want to be aware that the Celgene deal raised Bristol-Myers’ debt to over $46 billion – a manageable sum yet elevated compared to peers. Bristol-Myers was featured in the April issue of Cabot Undervalued Stocks Advisor.
The company is expected to increase its EPS by 32% and 20% in 2020 and 2021, respectively, in large part due to the benefits from the Celgene deal. Its 2020 P/E is a modest 9.7x. Bristol-Myers’ financial priorities include debt repayment, investment in innovation, share repurchases and annual dividend increases.
BMY is appropriate for growth and income investors as well as traders. The shares have price and valuation support at around 55-56, and offer defensive traits during “risk-off” trading days, as well as the potential to ride some sentiment tailwinds surrounding the pharmaceutical sector in general. Strong Buy.
Broadcom (AVGO – yield 4.1%) is a global technology leader that designs, develops and supplies semiconductor and infrastructure software solutions that serve the world’s most successful companies. CFO Tom Krause expects to continue paying the dividend and paying down debt in 2020 (none of which is maturing this year), even under poor economic conditions. Share buybacks and M&A activity are on the back burner for now. Broadcom was featured in the December 17 and January issues of Cabot Undervalued Stocks Advisor.
AVGO is an undervalued growth and income stock as well as a useful trading stock. Despite shares losing half their value in the market sell-off, Broadcom’s stock price has fully recovered. Other than the sell-down, the stock has remained in a range of roughly 270-320 for over a year, and is just below its all-time high of 331. Full-year profits are expected to grow 1% and 12% in 2020 and 2021, respectively, and the 2020 P/E is 14.7x. Hold.
Dow Inc. (DOW – yield 6.7%) is a commodity chemicals company with manufacturing facilities in 31 countries. In 2017, Dow merged with DuPont to temporarily create DowDuPont, then split into three entities in 2019 based on the newly-combined product lines. Today, Dow is the world’s largest producer of ethylene/polyethylene, which are the world’s most widely-used plastics. Dow is primarily a cash-flow story driven by petrochemical prices, which often are correlated with oil prices and global growth, along with competitors’ production volumes. Dow was featured in our July edition of the Cabot Undervalued Stocks Advisor.
Dow announced on July 6th that it is selling railroad infrastructure assets for $310 million. Proceeds will go toward debt reduction. This transaction is part of its strategy to sell assets not directly related to producing its products.
Analysts expect full-year EPS of $1.14 and $2.32 in 2020 and 2021, respectively. The high dividend yield is particularly appealing to income-oriented investors. Management makes a convincing case that the dividend will be sustained. After a healthy surge from the market’s lows in March, Dow shares reached 44.40 in early June on optimism about the economic re-opening. Since then, they have pulled back on rising Covid-19 cases, which suggest a slower re-opening and thus slower demand for plastic-based products. We like its low valuation and appealing yield. Buy.
Total S.A. (TOT – yield 7.5%) based in France, is among the world’s largest integrated energy companies, with a global oil and natural gas production business, one of Europe’s largest oil refining/petrochemical operations and a sizeable gasoline retail presence. The company is also expanding somewhat aggressively into renewable and power generation business lines, which may either be highly profitable or value destructive. While low energy prices have hurt Total like all integrated producers, the company’s low production costs (below $30/barrel), efficient operations and sturdy balance sheet position it well relative to its peers. Also, the company’s production growth profile may still be among the best in the industry despite sharp capital spending reductions.
Total remains attractive to income investors with its high dividend yield that is likely to be sustained. Management has chosen to maintain their quarterly dividend of 66 euros, even if they need to raise debt or trim assets to do so. Total SA was featured in the May issue of Cabot Undervalued Stocks Advisor.
The most recent consensus estimates indicate full-year EPS of $1.28 and $2.76 in 2020 and 2021, respectively. The P/E multiple of 11.4x estimated 2021 earnings reflects only partial recovery toward normalized earnings of around $4.00. The shares remain rangebound. Growth and income investors should add to positions below 38. Hold.
BUY LOW OPPORTUNITIES PORTFOLIO
Columbia Sportswear (COLM) produces the highly recognizable Columbia brand outdoor and active lifestyle apparel and accessories, as well as SOREL, Mountain Hardware and prAna products. For decades, the company was successfully led by the one-of-a-kind Gert Boyle, who passed away late last year. The Boyle family retains a 36% ownership stake and Gert’s son Timothy Boyle remains at the helm. First-quarter sales fell 13% from a year ago, as 64% of sales are produced in the U.S., where its reliance on wholesale distribution, and the longer lockdown periods relative to other countries, hurt results. However, the company is rapidly improving its online operations, both through its own websites and through third-party online retailers, which combined generate over 20% of sales. Columbia’s balance sheet remains solid, with $707 million in cash and only $174 million in debt. The company is likely to remain healthy as consumers seek its highly relevant products.
Columbia’s shares have declined 22% this year, and trade at the same price as they did in early 2018. Analysts’ earnings per share consensus estimates are $2.23 and $4.04 for 2020 and 2021, respectively. For comparison, the company earned $4.83/share in 2019. On next year’s estimates, the shares trade at a P/E of 19.2x. The stock has appeal for value investors and for growth investors with patience for what might be a slower recovery than other growth stocks. Traders will find COLM shares appealing given their sensitivity to consumer and economic re-opening trends. Buy.
General Motors (GM), under CEO Mary Barra (since 2014), has transformed from a lumbering giant to a well-run and (almost) respected auto maker. The company has smartly exited many chronically unprofitable geographies (notably Europe) and trimmed its passenger car roster while boosting its North American market share with increasingly competitive vehicles, particularly light trucks. We consider its electric and autonomous vehicle efforts to be near industry-leading. GM’s much-improved North America cost structure allow it to remain profitable at perhaps an 11 million vehicle industry volume. Its GM Credit operations are well-capitalized but will likely be tested in the pandemic. The shares will remain volatile based on the pace of the economic re-opening, U.S.-China relations and customer credit quality. GM was featured in the December 31, 2019 issue and the February issue of Cabot Undervalued Stocks Advisor.
GM’s second quarter vehicle sales fell 34% from a year ago, but showed improving results as the quarter progressed. The company said that demand surpassed supply later in the quarter. Full-sized pickup truck sales were particularly sturdy. Sales in China fell a more modest 5% in the quarter. Nearly all of its U.S. plants, including all of its truck and SUV facilities, will continue to operate during the traditional two-week summer shutdown.
Wall Street is projecting EPS of $1.07 and $4.00 in 2020 and 2021, respectively. The 18% share price decline since June 8 has made GM stock more attractive for investors and traders. Strong Buy.
SPECIAL SITUATION AND MOVIE STAR PORTFOLIO
Adobe Systems (ADBE) dominates the content creation software industry. Much of its financial success (beyond its powerful product successes) was produced by its adoption of bundling and subscription-based revenue models, partly guided by respected activist investor Value Act. With operating profit margins of 40% and minimal debt, the company generates prodigious amounts of free cash flow. The shares have appreciated 14x since the start of 2012, making it one of the strongest stocks in the market during that period.
Analysts expect full-year EPS to increase by 44% and 14% in 2020 and 2021, respectively. The 2021 P/E is 41x, reflecting Adobe’s immense profits and cash flow as well as its dominant position in a growing industry. ADBE stock now trades at essentially all-time highs. Traders may want to take some profits, while longer-term investors should hold their shares but be prepared to exit upon weakness. Hold.
Amazon.com (AMZN) remains nearly perfectly positioned for a pandemic world. Its to-your-doorstep shopping marketplace allows consumers to safely shop for just about anything without leaving their homes. As the world accelerates its transition to the digital world, the Amazon Web Services (AWS) cloud business will continue to produce vast and growing profits ($20 billion in operating profits next year, up 20% from the prior year and comprising nearly 65% of total company operating profits). Also, Amazon’s innovations and forays into new industries are disrupting established global businesses, including freight companies, retailers, entertainment and technology companies. Amazon.com was featured in the April issue of Cabot Undervalued Stocks Advisor.
Analysts expect per-share earnings to fall from $23.01 in 2019 to $20.03 in 2020, then rise 92% to $38.55 in 2021. The decline in 2020 profits results from Amazon’s plans to spend much of its profits (essentially all of its second-quarter profits) on Covid-related expenses, including new hires and wage increases. AMZN shares surged past $3,000 and have gained 65% this year. This stock is clearly the iconic stock of its era. How long this will last is hard to say. Hold.
Equitable Holdings (EQH – yield 3.5%) owns two principal franchises: Equitable Financial Life Insurance Co. and a majority stake in AllianceBernstein Holdings L.P. (AB), a highly respected investment management and research firm. Equitable, with a 161-year history, was acquired by French insurer AXA in 1992. Starting in 2018, AXA began to spin off Equitable with an initial public offering of part of its ownership. Part of the motivation behind the spin-off was to fund AXA’s $15 billion acquisition of insurer XL Group Ltd. Through subsequent stock sales, AXA currently owns less than 10% of Equitable. With its new-found independence, Equitable may be considering strategic changes for its 65% ownership in AllianceBernstein.
Equitable Holdings is well-capitalized and has significant liquidity. Its diverse, high-quality investment portfolio is hedged against adverse changes in interest rates and equity markets. AllianceBernstein’s assets under management as of May was $596 billion. Equitable expects to continue delivering a 50% to 60% payout ratio via dividends and share repurchases. The stock was featured in the July issue of Cabot Undervalued Stocks Advisor.
Profits are expected to fall 13% in 2020, then rise 19% in 2021. Equitable shares are undervalued, with a 2020 P/E of 4.5x. Like many insurance companies, investors also value Equitable on a book value basis. With its $37.78 in per-share book value, EQH trades at 0.50x P/BV, which is a significant discount. This low valuation may be prompting management to consider reducing or exiting its AllianceBernstein stake.
At 19, EQH shares trade below their 20 IPO price, which was then a disappointment relative to the 24-27 price range that bankers had targeted. Since then Equitable has arguably become a better company and any sale of AllianceBernstein is likely to unlock further value. EQH shares are appropriate for dividend investors, growth investors and traders. While the shares may trade in sync with the overall stock market, given its investment-driven operations, we see more upside than downside. Strong Buy.
Netflix (NFLX) is the world’s leading streaming entertainment service with more than 183 million paid subscribers in over 190 countries. Viewers can enjoy unlimited access to TV series, documentaries and feature films across a wide variety of genres and languages, all without commercial interruptions. The company is experiencing rapid international subscription growth and creating original foreign language content for international markets. Netflix was featured in the January 22 issue of Cabot Undervalued Stocks Advisor.
Netflix is a widely popular, aggressive growth/momentum stock. Its shares have surged to nearly 45x their year-end 2011 price – producing a 52% annualized rate of return – a stunning rate that reflects the power of an innovative idea launched at the right time. The stock has surged 9% in July already, past its former all-time high of 468. Its 57.3x P/E on estimated 2021 earnings, as well as its 8.0x multiple of revenues, implies that it is only in the early stages of its profit growth – a view we don’t entirely agree with. And, earnings estimates suggest that its growth will decelerate as the company is facing increased streaming competition from a wide array of well-financed competitors including Disney. Its growth isn’t likely to continue forever, nor is its ability to fund its growing cash flow deficit. For now, we’re keeping NFLX as a Hold, respectful of its upward momentum but also suggesting a stop-loss order to protect the downside. Hold.
NVIDIA (NVDA – yield 0.2%) is the pioneer and leading designer of graphics processing unit (GPU) chips, which initially were built into computers to improve video gaming quality. However, they were discovered to be nearly ideal for other uses that required immense and accelerated processing power, including data centers and artificial intelligence applications such as professional visualization, robotics and self-driving cars. In April, NVIDIA completed the $6.9 billion acquisition of Mellanox Technologies, an innovator in high-performance interconnect technology routinely used in supercomputers and hyperscale data centers. NVIDIA’s data center business now represents about 50% of total revenues. NVIDIA was featured in the March and May issues of Cabot Undervalued Stocks Advisor.
NVDA is a high-P/E, aggressive growth/momentum stock. Its shares have increased 17x since the start of 2015 and now have surged past their former all-time high of 385. Yet, part of the reason behind the gains is that cloud-based computing is the biggest secular trend in technology, and the most powerful. No one knows how large the industry will ultimately become, but “larger than it is today” seems like the correct answer for many days and years into the future. Until this open-ended growth appears to peak, it would be difficult to bet against it. The only question for momentum investors is when to stop betting on it. The valuation of 34.3x estimated fiscal year 2022 earnings is high but not astronomical.
Wall Street now expects EPS to grow 21% in fiscal 2022 (January year-end) compared to fiscal 2021. For now, we’re staying with our Strong Buy recommendation.
Marathon Petroleum (MPC – yield 6.5%) is a leading integrated downstream energy company and the nation’s largest energy refiner, with 16 refineries, a majority interest in midstream company MPLX LP, 10,000 miles of oil pipelines, and product sales in 11,700 retail stores.
We are moving MPC to the Special Situations/Movie Star portfolio, as it no longer fits the more growthier profiles and low debt metrics of the other portfolios.
As noted last week, Marathon may sell its Speedway retail gas station chain. Thus, the market is increasingly valuing Marathon’s shares as if this deal will be completed. Since neither a deal nor a price is a guaranteed outcome, the shares will sell at a discount to this value but higher than if there was no chance of a deal.
Using very rough numbers, we think the Speedway business might be worth $24/share and the rest of Marathon worth perhaps $17/share, for a total value to MPC shareholders of perhaps $41/share. There are many assumptions that could change these numbers. With MPC shares trading at about $35, this implies 17% upside. While interesting and appealing, it is not enough to warrant a return to a Buy rating. Meanwhile, Marathon produces a reasonably sustainable 6.5% dividend yield.
Shares have weakened this past week on concerns about a slowed re-opening of the economy, and the possible effects this would have on overall oil prices and the currently wide refiner margins. We are watching these effects in MPC as well as in our now-HOLD-rated shares of the VanEck Vectors Oil Refiners ETF (CRAK).
Wall Street analysts are forecasting a 2020 full-year loss of ($1.98) per share, a slight deterioration from a week ago. Estimates for 2021 earnings also weakened modestly to $2.28/share. The company will report second-quarter results on the morning of August 3.
Like most energy stocks, MPC offers a useful vehicle for traders: its economics are closely tied to oil prices yet the company has a more stable business, with its refining, MPLX midstream, and retail operations that dampen its volatility and provide more downside protection relative to pure exploration or energy service companies. Hold.
VanEck Vectors Oil Refiners ETF (CRAK) seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the MVIS Global Oil Refiners Index (MVCRAKTR). This index includes refiners from around the world, not just in the United States, so it may trade out of sync with major domestic refiner stocks from time to time. While the global mandate (IMO 2020) for ocean-bound ships and tankers to use scrubbers or low-sulfur diesel fuel should be providing a tailwind for refiners, it has been more than offset near-term by sharply reduced demand for gasoline and aviation fuel due to the pandemic. Incrementally, our concerns are increasing that the global demand for oil and refined products may not be quite as strong as we had previously expected, nor might the currently wide refining margins last quite so long. We are moving shares of the VanEck Vectors Oil Refiners ETF (CRAK) to a Hold.
