I asked Cabot analyst Tyler Laundon to write an introduction to this week’s update while I’m tending to my Dad in a New York hospital. Tyler very graciously and promptly responded:
“When Crista and I first spoke about having me write the intro for this week’s Cabot Undervalued Stocks Advisor update, several ideas came to mind. Unsurprisingly, they’re all related to small-cap stocks, which is my focus in Cabot Small-Cap Confidential.
“To cut right to the chase, I think all value investors should consider small-cap stocks right now given their potential to outperform large caps in 2018. I’m not going to try and talk you in to buying small caps—you know best what’s appropriate for your portfolio. But I can present some compelling data, and you can come to your own conclusions.
“Let’s start with taxes. In 2016, the median realized annual tax rate for the S&P 500 was 28%. For small caps (i.e., the Russell 2000), it was 32%. Punchline? Small caps have the most potential to benefit from Trump’s tax cut.
“Next up is relative performance. Last year, the S&P 500 was up a very impressive 19.4%. That is roughly 8% better than the 11.7% rise for the S&P 600 Small Cap Index. Advantage clearly went to large caps last year. But given that small caps tend to outperform over the long-term, and that the two asset classes have reliably traded periods of outperformance and underperformance for decades (though not exactly in-line with the calendar year!), there could be some small-cap catch-up performance in 2018.
“Let’s move on to EPS growth and valuation. Current consensus forecasts suggest S&P 500 EPS growth will be around 12.6% in 2018, versus 21.6% for the S&P 600. Advantage? Small caps.
“On valuation? Both asset classes are a little expensive. The S&P 500 trades with a forward P/E of around 18.5, and the S&P 600 has a forward P/E of 20. Small-cap valuations look much more attractive on a forward P/Sales basis however, with the S&P 600’s forward P/Sales ratio of 1.06 trending down since the end of 2013. In contrast, the S&P 500’s forward P/Sales ratio of 2.08 has been going up (from 1.6) over the last five years.
“To summarize, small caps have more to gain from Trump’s tax overhaul, are expected to grow EPS faster in 2018, trade at a similar relative valuation to large caps on a forward P/E basis but are much more attractive on a forward P/Sales basis, and their performance trailed that of large caps last year!
“I wouldn’t go so far as to say that the small-cap asset class is “undervalued” per se (small cap indexes just jumped out to all-time highs last week). But then, I don’t scour the earth for undervalued stocks like Crista does!
“If you’re at all interested in small caps, but don’t have much experience, the easiest option to go with is an ETF. My favorite for broad exposure to the value area of the asset class is the iShares S&P 600 Small Cap Value ETF (IJS). Or, if you like individual stocks, we can get you hooked up with a subscription to Cabot Small-Cap Confidential.”
Poll Results and Trading Notes
I normally send out buy and sell recommendations in the mornings. That’s because I’m usually waiting for stocks to reach specific prices, and I want to make sure stocks are going to be trading at those prices when I make the recommendations. (If I make the recommendations in the late afternoons, and then the share prices are quite different the next day, I’ve gone on record as buying or selling at very different prices than I had intended. That pretty much defeats the purpose of very carefully pinpointing good entry and exit points on stocks.)
Last week I asked subscribers their preferences on the times of day that they receive my recommendations to buy or sell stocks. The vast majority of responses indicated that you prefer to receive the notices in the mornings, so that you can assess the situations during the trading day. There were just a few people who preferred to receive the notices after the stock market closes.
I would personally find it nerve-wracking to make recommendations after the market closes, then walk on eggshells until the following morning when I ultimately learned the outcome of the trade. I can’t justify taking on that added stress.
On the bright side, most of my stock sales take place at target prices that I announce in advance, often many months prior to the actual sale. You don’t need to wait for me to pull the trigger on a stock. If I say I’m going to sell near 37, go ahead and put in a sell limit order so that you don’t have to stare at the computer when the stock approaches 37. And by the way, I try to be very specific. For me, selling near 37 does not mean trying to sell over 37. If I say near, I mean near; and if I say in the 37 to 38 area, that phrase has a different, specific meaning.
Cabot Undervalued Stocks Advisor has reached a circulation size that affects the market when we’re buying or selling small-cap stocks. If I recommend the sale of XYZ shares, you’re often going to see XYZ fall 3%-6% that day. If you missed the chance to sell before the stock fell, don’t worry too much. The stock usually rebounds in the coming days. The exception would be if I sold due to bad news, in which case the stock is not likely to rebound anytime soon. Just sell it and move on. Bad news does not disappear quickly, and in fact it often lingers many months longer than anyone initially foresees.
We’re going to move the market on small-cap stocks. Know that in advance and find a way to accept it and incorporate it into your trading strategy. Plan your sales in advance, use sell limit orders, and maybe move out of the stock slightly below my target price before the crowd enters their trades. Nimble investors could even watch the share prices carefully on those days and capitalize on the volatility.
Lastly, please be cautious with stocks that recently rose consistently without resting. Wait for pullbacks before buying them; consider using stop loss orders if you own them with a short-term investment horizon.
Send questions and comments to crista@cabotwealth.com.
Portfolio Notes
Be sure to review the Special Bulletin from January 11 in which I mentioned news, rating changes and/or price action on Baker Hughes, a GE Co. (BHGE), Blackstone Group LP (BX) and GameStop (GME).
Please note that many of our portfolio stocks’ performance numbers were reported in error in last week’s update table, and they have since been corrected online. The good news is that most of those stocks’ numbers are much higher than what was initially reported!
Buy-Rated Stocks Most Likely* to Rise More Than 5% Near-Term:
Apple (AAPL)
XL Group (XL)
*I can review price charts and make an educated determination about what’s likely to occur, but I will sometimes be wrong. I cannot control the stock market; I can only guide you through it.
Today’s Portfolio Changes:
GameStop (GME) moves from Hold to Buy.
Last Week’s Portfolio Changes:
Baker Hughes, a GE Co. (BHGE) moved from Strong Buy to Buy.
Blackstone Group LP (BX) moved from Strong Buy to Hold.
GameStop (GME) moved from Buy to Hold.
Updates on Growth Portfolio Stocks
Alphabet Cl. A (GOOGL) is the world’s largest internet company. Revenue is derived from Google’s online ads, with the balance coming from the sale of apps, digital content, services, licensing and hardware. GOOGL is a slightly undervalued, large-cap aggressive growth stock. EPS are expected to grow 28.2% in 2018, with a P/E of 27.1. Importantly, earnings estimates for 2017 through 2019 jumped again last week. While I might eventually sell GOOGL if it becomes very overvalued—which absolutely happens from time to time—longer-term investors should feel comfortable ignoring the price chart and planning to own this stock for years to come. GOOGL continues to rise. A pullback to 1,070 would be normal, and a good buying opportunity. Strong Buy.
Apple (AAPL – yield 1.4%) manufactures a wide range of popular communication and music devices. I recently wrote about a report from a major investment bank regarding Apple’s market share and revenue growth in China. Here’s a report that provides more detail on those trends: iPhone 7 Plus was second-best selling phone in China in 2017. Apple owns two of the top-10 selling phones in China, there were no other foreign brands on the list, and pricing did not emerge as the key factor in customers’ phone selection decisions.
Wall Street expects Apple’s EPS to grow by 24.3% in fiscal 2018 (September year-end), and the P/E is 15.5. I expect to keep the stock for capital gains in the first half of 2018. The price chart indicates that AAPL will likely commence a run-up this week. Buy AAPL now. Strong Buy.
Bank of America (BAC – yield 1.5%) will report fourth-quarter results on the morning of January 17. Analysts are expecting $0.44 EPS, within a range of $0.41 to $0.48. Full-year earnings estimates for 2018 and 2019 have risen in each of the last four weeks. 2018 EPS are now projected to grow 30.0%, and the P/E is 13.3. Over the course of the next several years, all the following phenomena can serve to push earnings estimates higher: lower income tax rates, higher interest rates, deregulation and a growing U.S. economy. BAC keeps climbing. A pullback could bring BAC down to 28.5. Strong Buy.
CIT Group (CIT – yield 1.2%) operates both a bank holding company and a financial holding company that provide financing, leasing and advisory services to small and middle market businesses, consumer markets, and the real estate and railroad industries. CIT is one of my two top stock picks for 2018 for the MoneyShow. Analysts’ earnings estimates continue to rise, now expecting 28.9% EPS growth, while the P/E is 14.2. The stock surpassed long-term price resistance at 50 in December, and is now reaching new all-time highs. Buy CIT now. Strong Buy.
ConocoPhillips (COP – yield 1.8%) is a global energy exploration and production company. COP was featured in the January issue of Cabot Undervalued Stocks Advisor. Oil prices are at a three-year high, global energy demand is strong and U.S. crude inventories are declining, all of which contribute to bullish price action in energy stocks. Earnings estimates for 2017 through 2019 jumped last week. The market’s expecting 235% EPS growth in 2018, and the P/E is 33.2. There’s some price resistance at 64, and additional resistance at 77.5 where COP last traded in mid-2014. Strong Buy.
KLX Inc. (KLXI) is an undervalued small-cap growth stock in the aerospace and energy services industries. KLX has been approached by several potential buyers. KLX hired Goldman Sachs in December to handle the potential M&A transaction, but there has been no recent news on the topic. Odds are strong that an offer will be made and that the KLXI share price will rise further. Hold.
Knight-Swift Transportation Holdings (KNX – yield 0.5%) is a new truckload carrier formed from the September 2017 merger between Knight Transportation and Swift Transportation Company. Both trucking supply and demand have been trending far higher than normal. KNX was featured in the January issue of Cabot Undervalued Stocks Advisor. Earnings estimates for 2018 and 2019 jumped last week. The market’s now expecting 63% EPS growth in 2018, and the P/E is 23.2. KNX rose above price resistance at 41.5 in late November, and continues to gradually rise. Strong Buy.
Martin Marietta Materials (MLM – yield 0.7%) is a supplier of crushed stone, sand, gravel, cement, concrete and asphalt, and an aggressive growth stock. MLM is fairly valued, and nearing 240 where it last traded in May 2017. I will likely sell soon. Hold.
Quanta Services (PWR) provides specialized infrastructure and network services to the electric power, oil and natural gas industries. PWR is an undervalued, mid-cap aggressive growth stock. PWR is advancing from its early December breakout above 38. Buy PWR now. Strong Buy.
Southwest Airlines (LUV – yield 0.7%) – There were big changes in analysts’ earnings estimates for LUV last week. First off, I reported several months ago that 2017 was a year of declining profits for most airlines. Seven of Southwest’s nine major peers are likely to report 2017 EPS that are lower than 2016 numbers. In that light, Southwest is currently expected to see 2017 EPS fall (-6.4%)—certainly not an alarming figure, especially compared to other airlines. But we bought LUV because of strong prospects for profit growth in 2018, and that number just jumped to 39%, while the P/E is a low 13.4. 2019 numbers also rose nicely, but it’s too early to focus on those. Besides, I’m more likely to hold LUV for less than a year than I am to hold it into 2019. Airline profits tend to bounce around from year to year, as opposed to many technology and biotech companies that experience multi-year aggressive earnings growth.
Accumulate LUV on pullbacks in the low 60s. I expect additional capital gains this year. Buy.
XL Group (XL – yield 2.5%) is an insurer and reinsurer, and an undervalued mid-cap stock. XL shares rose and then fell in 2017, giving back all their gains as the market dumped shares of property & casualty insurers in the wake of hurricanes, earthquakes and a typhoon. XL appears ready to begin its rebound. New investors could earn a 32% capital gain as XL travels back toward 47 in 2018. Buy.
Updates on Growth & Income Portfolio Stocks
BB&T Corp. (BBT – yield 2.5%) is a 145-year-old financial holding company with $220 billion in assets and 2,100 financial centers that serve businesses and individuals. Services include retail and commercial banking, investments, insurance, wealth management, asset management, mortgage, corporate banking, capital markets and specialized lending. BBT was featured in the January issue of Cabot Undervalued Stocks Advisor. 2018 and 2019 EPS estimates jumped last week. Wall Street now expects BB&T’s EPS to grow 34.3% in 2018, while the P/E is low in comparison at 14.3. The stock is performing well. Buy on pullbacks. Strong Buy.
Blackstone Group LP (BX – yield 6.5*) is an alternative asset manager. BX is rapidly approaching 37, where it last traded three years ago. I will likely sell near 37, but I want to reiterate that BX is still an undervalued growth & income stock with a fantastic dividend yield. Hold.
*The payout varies each quarter, with the total of the last four announced payouts yielding 6.50%.
Commercial Metals Company (CMC – yield 1.9%) is a recycler and manufacturer of steel and metal products, including rebar and fence posts. Earnings estimates leaped in the last three weeks. CMC is now expected to see EPS grow aggressively at 106% and 31.5% in fiscal 2018 and 2019 (August year-end), with corresponding P/Es of 17.2 and 13.1. CMC had a huge run-up since mid-November. Odds are fairly good that we could see a quick pullback to the low 20s. The general outlook for the company remains one of aggressive earnings growth. Buy.
GameStop (GME – yield 8.5%) is a retailer of games, collectibles and technology; with additional ventures in the entertainment field. I moved the stock from Buy to Hold last week, after a big short-term run-up. GME then fell 11% the next day after reporting year-over-year results for the nine-week holiday sales period ending December 30. Here are highlights from the press release:
- Total global sales rose 10.6%.
- Global same store sales rose 11.8% (13.7% in the U.S. and 7.9% internationally).
- New hardware sales rose 38.3% (Nintendo Switch and Microsoft’s Xbox One X).
- New software sales rose 7.3% (Activision’s Call of Duty: WWII and various Nintendo Switch titles).
- Pre-owned software sales declined 8.1%.
- Accessories sales rose 33.7%.
- Worldwide omnichannel sales rose 21.5%.
- Collectibles sales rose 19.4% (apparel and toys).
- Digital sales rose 36.7%.
- Technology Brands sales (not included in comparable store sales) decreased 18.6% (due to limited availability of the iPhone X and changes made by AT&T to the compensation structure in 2017.
I like these results. I’m moving GME from Hold to Buy now that the stock has pulled back from my short-term price target of 20 to 20.5. I expect additional capital gains in 2018. Buy.
The Interpublic Group of Companies (IPG – yield 3.3%) is a large conglomerate of advertising, marketing, communications and public relations companies serving all global markets. IPG is a slightly undervalued growth & income stock with an attractive rising annual dividend and a much lower P/E than the average of its peers in the media and advertising space. The stock began rising late last week. There’s 16% capital gain potential as IPG retraces its July high of 25.25. Strong Buy.
Morgan Stanley (MS – yield 1.8%) is a major U.S. investment bank and wealth manager, and an undervalued growth & income stock. The company will report fourth-quarter results on the morning of January 18. Analysts are expecting $0.77 EPS, with a range of $0.71 to $0.84. Full-year earnings estimates have risen in each of the last three weeks. Analysts now expect EPS to grow 21.4% in 2018, with a P/E of 12.8. The stock broke out of a trading range last week. There’s about 12% upside as MS travels to my price target in the low 60s. Strong Buy.
Nucor (NUE – yield 2.2%) is a low-cost producer of a diversified portfolio of iron and steel products, and an undervalued mid-cap growth stock. Earnings estimates for 2018 and 2019 jumped last week. Analysts now expect 2018 EPS to grow 33.0%, with a P/E of 14.6. NUE is reaching new all-time highs. I expect to continue profiting from both capital gains and dividends in 2018. Buy NUE on pullbacks. Buy.
Schlumberger (SLB – yield 2.5%) is a premier oilfield equipment and services company with a global footprint. Oil prices are at a three-year high, global energy demand is strong and U.S. crude inventories are declining, all of which contribute to bullish price action on energy stocks. The U.S. rig count rose by 15 last week to 939.
The company will report fourth-quarter results on the morning of January 19. Analysts are expecting $0.45 EPS, with a range of $0.42 to $0.49. Analysts expect EPS to grow 50% in 2018 (with a P/E of 35.6) and to continue growing at aggressive rates through at least 2020. There’s 10% upside plus dividends as SLB eventually retraces its December 2016 high near 86. Buy SLB on pullbacks. Strong Buy.
WestRock Company (WRK – yield 2.5%) is a major player in the global packaging and container industry, and a mid-cap growth & income stock. Earnings estimates for 2018 and 2019 rose last week. Analysts expect EPS to grow 42.4% in 2018, with a P/E of 18.6. The stock is reaching new all-time highs. Buy on pullbacks. Strong Buy.
Updates on Buy Low Opportunities Portfolio Stocks
Alexion Pharmaceuticals (ALXN) is a biopharmaceutical company that researches and manufactures treatments of severe and rare health disorders. Management continues to express more bullishness than investors do over Alexion’s value and expected successes. The stock is undervalued, and analysts project aggressive earnings growth through at least 2020. There’s a 30% capital gain opportunity as ALXN retraces its April 2016 high at 160. Buy ALXN now. Strong Buy.
Baker Hughes, a GE Co. (BHGE – yield 1.9%) offers products, services and digital solutions to the international oil and gas community. The company is 62.5%-owned by General Electric (GE), yet despite GE’s dire financial situation, Baker Hughes is thriving. Oil prices are at a three-year high, global energy demand is strong and U.S. crude inventories are declining, all of which contribute to bullish price action on energy stocks. The U.S. rig count rose by 15 last week to 939.
The company will report fourth-quarter results on the morning of January 24. Analysts are expecting $0.14 EPS, with a range of $0.10 to $0.19 per share. Earnings are expected to grow aggressively through at least 2020, and the stock is undervalued. Analysts expect 2018 EPS to grow 155% and the P/E is 34.8.
BHGE is one of my two top stock picks for 2018 for the MoneyShow. Last week, BHGE rose to 37, where it last traded in September 2017. I expect the stock to have a pullback now, then to continue rising in a few weeks or months. Traders should sell now; everybody else should hold BHGE for additional capital gains this year. Buy.
Chipotle Mexican Grill (CMG) is a growing-yet-beleaguered restaurant chain. Analysts expects 2018 EPS to grow 45.2%, and the P/E is 34. CMG is rising. There’s short-term upside price resistance at 350. Hold.
Mattel (MAT) has short-term price resistance at 18.75. January will be a decisive month for the share price, and we may even hear more about MAT being a potential buyout target. Hold.
Supernus Pharmaceuticals (SUPN) focuses on the development and commercialization of products for the treatment of central nervous system diseases and psychiatric disorders, including epilepsy and ADHD. SUPN was featured in the January issue of Cabot Undervalued Stocks Advisor. Earnings estimates for 2019 and 2020 increased substantially last week. Wall Street now expects EPS to grow 45.8%, 55.8% and 61.3% in 2018 through 2020. The 2018 P/E is just 28.3. The stock is rebounding from a fall in 2017. My first price target is 50, offering new investors a 13% potential capital gain in 2018. Strong Buy.
Universal Electronics (UEIC) is a manufacturer and cutting-edge world leader of wireless remote control products, software and audio-video accessories for the smart home, with a strong pipeline of new products. The company exhibited a strong presence in smart home technology at last week’s 2018 Consumer Electronics Show, including thermostats, motion detection, safety and security systems, smoke alarms and other devices. Universal Electronics will also present at the 20th Annual Needham Growth Conference on January 17.
Frankly, I can’t begin to understand why this gem representing the future of technology has been long-ignored by investors. I expect huge capital gains, with additional strong odds of a buyout offer. If I were a large technology company, I’d add “owning Universal Electronics” onto my A-list of things-to-do. UEIC is an undervalued micro-cap stock, forecasted to achieve aggressive 2018 EPS growth. There’s 48% upside as UEIC retraces its July high around 72. Buy UEIC now. Expect volatility. Strong Buy.
