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Value Investor
Wealth Building Opportunites for the Active Value Investor

Cabot Undervalued Stocks Advisor Weekly Update

The S&P 500 index is having an orderly pullback, after rising for three weeks. In that light, we’re not likely to see a lot of portfolio action this week. Looking out over the next four weeks or so, these buy-rated portfolio stocks appear best-positioned to rise 5% or more.

When Is A Dividend At Risk?

When a stock’s share price falls, its dividend yield rises—the equation works like a seesaw. It’s a common worry among individual investors (as opposed to institutional investors) that when the dividend yield rises, it might be a warning that the dividend is at risk of being cut. Let’s take the worry out of the equation by focusing on a few key balance sheet items that will help you know whether a big dividend is a red flag—or a gift.

Is the company producing rising profits or taking annual losses? A company that’s losing money is going to have to cut back on its spending, which might result in job layoffs or a dividend cut. It would be highly unusual that a company with rising annual profits would encounter a cash flow problem that would cause it to cut its dividend.

Does the company have high debt levels? Large debt and interest payments can really strangle cash flow in a corporation, just like they can in your personal budget. If a company has high debt levels, it’s going to be cash-strapped more quickly when profits fall. Such a company can remain profitable but still be forced to cut its dividend if it’s earning a lot less money than it used to.

Has the company recently increased its dividend or repurchased outstanding shares? Large American companies are run by some of the smartest business people in the world. These folks plan their finances years in advance, and are well aware of their financial flexibility when it comes to allocating cash toward normal business operations and growth, vs. additionally allocating cash toward dividends and share buybacks. They’re not going to increase a dividend if they don’t see the dividend as sustainable.

A weak stock market does not put dividends in jeopardy. Companies continue to execute their business plans regardless of share prices. Poor company finances put dividends in jeopardy.

Example #1: An investor asked me if H&R Block’s (HRB) dividend was in jeopardy. HRB earned less money in its fourth quarter than it had expected. But HRB is a solidly profitable company. The company also announced a $3.5 billion share repurchase authorization in September 2015, and the company has low debt levels.

H&R Block had in fact insinuated to Wall Street analysts that it could possibly increase its dividend. That’s how I knew that the dividend would potentially increase last week.

Example #2: What about GameStop (GME)? It’s dividend yield is 5.6%. Is the company in trouble?

  • GameStop increased its dividend in February 2016.
  • GameStop is actively repurchasing stock.
  • The company is earning record annual profits.
  • The company repurchased 26% of its outstanding shares in the five years ending January 2016.
  • The long-term debt-to-capitalization ratio is very low at 14%.

There are no red flags in the GameStop scenario.

Example #3:
General Motors (GM) has a 5.2% dividend yield. The company increased its dividend and repurchase authorizations in 2016. Profits are projected to continue rising through fiscal 2017. Debt levels are normal—not high and not low. Again, no red flags.

You are most likely to hear about dividend cuts among energy industry stocks. That’s because most of those companies have seen their profits plummet, which often leads to several years of net losses. It’s relatively obvious that a company that’s losing money is cash-strapped and destined to cut or cancel its dividend payments.

You can avoid that scenario by investing in companies with rising profits and moderate debt levels. Those are exactly the kinds of companies that I recommend in Cabot Undervalued Stocks Advisor.

Portfolio Notes

Here are some portfolio highlights in today’s update:

• I issued a Special Bulletin on June 7, in which I sold Priceline (PCLN) from the Growth Portfolio. I also told day traders to sell H&R Block (HRB) because it rose to short-term upside price resistance at 24 to 25. Medium- and longer-term investors should hold HRB for future capital gains.
FedEx (FDX) and H&R Block (HRB) each announced quarterly dividend increases last week.
H&R Block (HRB) reported quarterly and full-year results last week.

The S&P 500 index is having an orderly pullback, after rising for three weeks. In that light, we’re not likely to see a lot of portfolio action this week. Looking out over the next four weeks or so, these buy-rated portfolio stocks appear best-positioned to rise 5% or more:

• Growth Portfolio: Adobe Systems (ADBE), Chemtura (CHMT) and D.R. Horton (DHI)
• Growth & Income Portfolio: General Motors (GM) and H&R Block (HRB)
• Buy Low Opportunities Portfolio: Whirlpool (WHR)

Updates on Growth Portfolio Stocks

Adobe Systems (ADBE) is a software company. ADBE is an undervalued aggressive growth stock with a strong balance sheet. The stock began reaching new all-time highs in late May. Buy ADBE now. Strong Buy.

Chemtura (CHMT) is a specialty chemical manufacturer. CHMT is an undervalued, small-cap growth stock. EPS are expected to grow 21.8% and 16.8% in 2016 and 2017 (December year-end), with corresponding P/Es of 15.8 and 13.5.

The stock rose 6% last week, and barely paused as the S&P declined. Please note: CHMT could easily surpass 29.50 on its next run-up, which could happen this month. There’s additional upside resistance around 32. Strong Buy.

D.R. Horton (DHI) is a homebuilder. DHI is slightly undervalued growth stock with a 1% dividend yield. The share price rose to minor upside resistance last week, then pulled back. The chart remains bullish. The next run-up could reach 33. Buy.

Delta Air Lines (DAL) is a global passenger and cargo air transportation company. Delta is the third-largest passenger airline in the world, serving 58 countries, and also owns an oil refinery. The stock was featured in the June 7 issue of Cabot Undervalued Stocks Advisor.

Delta’s EPS are expected to grow 40.3% and 7.4% in 2016 and 2017 (December year-end). (The 2016 estimate has been consistently inching downward since February, while the 2017 estimate has been rising.) The corresponding P/Es are 6.5 and 6.0. The current yield is 1.3%, and based on the preannounced third-quarter dividend increase, the yield is 1.9%. Despite the much-slower 2017 earnings growth, DAL remains undervalued.

Airline stocks have been weak since late April. DAL has strong price support at 41, with upside resistance at 46 to 52 this year. Buy DAL now. Buy.

Dollar Tree (DLTR) is the nation’s leading operator of discount variety stores. DLTR is an undervalued, large-cap aggressive growth stock with a low degree of volatility. (Caveat: Dollar Tree’s long-term debt-to-capitalization ratio is higher than I would prefer, at 62%.)

Importantly, the share price did not pull back after its recent run-up. If the market brings DLTR down to 85, buy. Strong Buy.

E*Trade (ETFC) offers financial brokerage and banking products and services. E*Trade launched a new robo-advisor service in June, called Adaptive Portfolio. The service will help investors assess their investment goals and risk tolerance, and assemble a portfolio of ETFs and mutual funds.

The stock is having a normal pullback with the financial sector. When ETFC reaches upside resistance at 31, I will consider selling the stock, depending upon 2017 EPS projections. (Traders take note: there’s strong price support at 25 and room for a 10%+ capital gain within ETFC’s trading range). Hold.

Royal Caribbean Cruises (RCL) is a global cruise vacation company. RCL offers investors strong earnings growth, a low P/E, a 2% dividend yield, big dividend increases and share repurchases. The stock is significantly undervalued. Earnings estimates increased a bit last week.

Despite their extreme undervaluation, cruise company stocks are lagging the market. Your best-case scenario in the coming months is for RCL to return to December’s all-time high of 103.40. And by the way, at 103.40, the stock would still be undervalued based on both 2016 and 2017 earnings expectations. Patient investors could buy now, if you’re willing to wait for a share price recovery, which might take several months to commence. There’s strong price support at 72.50. 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. UEIC is a volatile small-cap growth stock. The stock is fairly valued based on 2016 EPS estimates, and overvalued based on 2017 EPS estimates.

UEIC rose 52% from its January lows to its April all-time high, then corrected alongside the broader market. The share price is trading between 61 and 69. If earnings estimates don’t increase in the coming weeks, I will likely advise shareholders to sell near 69. Hold.

Vulcan Materials (VMC) produces construction aggregates. VMC is a very undervalued aggressive growth stock with a small 0.7% dividend yield. The chart remains bullish. VMC rose as high as 120 in late May. Buy on dips to 114. Strong Buy.

WellCare Health Plans (WCG) is an undervalued aggressive growth stock in the managed healthcare sector. WellCare just completed the acquisition of Advicare’s Medicare Business, a 30,000-member (39%)increase in its South Carolina enrollment. The stock is resting after its big run-up in late May. The chart remains bullish. Buy on dips to 100. Strong Buy.

Updates on Growth & Income Portfolio Stocks

Big Lots (BIG) is an American discount retailer. BIG is a slightly undervalued growth & income stock with a strong balance sheet and a 1.6% dividend yield. The stock had a big run-up in late May. Patient investors will probably get a chance to buy BIG below 49, before it rises again. Strong Buy.

Cardinal Health (CAH) is one of the largest U.S. distributors of healthcare products and services. Cardinal increased the quarterly dividend to 44.89 cents in May, giving the stock a current yield of 2.3%. The company also announced a new $1 billion share repurchase plan. The stock’s trading range is solid: CAH could easily rebound to 87. Hold.

Carnival (CCL) is a cruise vacation company, and the largest leisure travel company in the world. CCL is extremely undervalued, with a current dividend yield of 3.0%. The price charts of cruise company stocks have been weak, but their earnings growth is strong. Patient investors could buy now, if you’re willing to wait for a share price recovery that might take several months to commence. Buy.

Federated Investors (FII) is a global investment management company. Federated benefits from interest rate increases, which allow the company to earn more fees from money market funds, a dominant part of its product mix.

New rules governing money market funds, which take effect in October, will also work in Federated Investors’ favor. Institutional investors are expected to move approximately $400 billion from prime funds to government money funds. That’s because prime funds, which invest in corporate debt securities, will be potentially less liquid, and their net asset values (NAV) will be more likely to fluctuate from the common one dollar per share.

FII pays a 3.2% dividend yield. The stock’s been trading sideways, between 30 and 34. Traders could make 10% in the near-term. Hold.

GameStop (GME) is a video game and consumer electronics retailer. Cricket Wireless announced that GameStop will be its largest retail distributor, expanding its presence to 3,400 U.S. GameStop locations. Each participating store will have a trained Dedicated Cricket Consultant.

GameStop’s earnings growth is slow, but Wall Street’s consensus estimates show the company achieving record profits in 2017 and 2018 (January year-end). The company has very low debt levels and the dividend yield is ridiculously high, at 5.6%.

The stock is not ready to rise yet. The only people who should buy today are patient investors who calmly understand that nothing’s wrong with the company, that the stock is currently out of favor, and that an opportunity to lock in a 5.6% dividend yield is a rare gift. Buy.

General Motors (GM) is an American auto manufacturer. A June 3 report showed that GM’s May vehicle sales in China leapt 16.9% vs. a year ago, and its year-to-date sales in China rose 4.3% to a record 1.54 million vehicles.

The market is expecting GM’s EPS to grow 13.1% this year. While earnings growth is expected to slow dramatically in 2017, the stock remains incredibly undervalued, especially in light of the big 5.2% dividend yield. The share price is in a trading range between 29.50 and 32.50. Buy.

Goldman Sachs Group (GS) is a global investment banker, serving consumers, institutions and government clients. Goldman was featured in the June issue of Cabot Undervalued Stocks Advisor. GS offers investors strong earnings growth, a very low P/E and a 1.7% dividend yield. The share price has repeatedly bounced at 150 since January. Investors who buy now will be getting quite a bargain. There’s upside price resistance at 166 and again at 175. Strong Buy.

H&R Block (HRB) is a leader in tax preparation services. Last week, the company reported fourth-quarter results that met analysts’ expectations, and increased its quarterly dividend by 10% from 20 cents to 22 cents per share. Full-year 2016 EPS fell 9.1%. The market breathed a great sigh of relief that Block’s poor 2016 tax season is behind them. The stock rose 12% on Friday.

The 2017 outlook is very attractive, offering 19.5% EPS growth, a low 12.5 P/E and a 3.7% dividend yield (April year-end). The stock remains undervalued.

It’s a very bullish sign that HRB did not give back any substantial amount of its gains from Friday’s price surge. The best-case scenario for the share price through the summer is for HRB to rise to 28. Buy HRB now. Buy.

Kraft Heinz (KHC) is a global food and beverage producer. KHC is an undervalued aggressive growth & income stock with a 2.7% dividend yield. The share price is trading sideways after a big run-up in early May. KHC is likely to bounce at 83 again before beginning its next run-up to new highs. Strong Buy.

Updates on Buy Low Opportunities Portfolio Stocks

Boise Cascade Company (BCC) is a leading U.S. wholesaler of wood products and building materials. Revenue is benefiting from a strong home-building market, but profits are suffering due to weak plywood pricing, which resulted from increased foreign and domestic competition and a strong dollar. The company is currently slated for 4.5% and 41.7% EPS growth in 2016 and 2017 (December year-end). The stock is quite undervalued based on 2017 earnings estimates.

The share price has advanced at a slow pace since winter. There’s upside resistance at 25. Buy.

BorgWarner (BWA) is a maker of engineered automotive systems for power train applications. BWA is fairly valued based on moderate 2016 earnings, and quite undervalued based on stronger 2017 earnings. The dividend yield is 1.5%.

BWA has a wide trading range, with upside resistance at 40. The stock is currently priced low within its range, so now is a great time for both traders and longer-term investors to buy BWA. Buy.

FedEx (FDX) is an international package delivery company. The company closed on its purchase of TNT Express in late May.

I previously advised investors that the company’s next dividend announcement would reflect a substantial percentage increase. Last week, FedEx increased its quarterly dividend by 60%, from 25 cents to 40 cents per share. The current yield is 1.0%.

The company’s June 21 full-year 2016 earnings announcement will likely trigger a move in the share price. The consensus EPS estimate for the fourth quarter is $3.29. Expect FedEx’ 2017 fiscal year to be characterized by frequent changes in earnings estimates, as analysts begin to get a handle on the company’s post-merger revenues, margins and net income.

FDX is slightly undervalued based on the fiscal 2017 consensus EPS estimate (May year-end), and distinctly undervalued vs. competitor United Parcel Service’s (UPS) stock valuation. The stock has traded sideways since mid-March after a big run-up. FDX has upside resistance at 168, and again at 180. Buy.

Harman International Industries (HAR) is the premiere connected technologies company for automotive, consumer and enterprise markets, best known for its JBL and Harman Kardon audio systems. The company is about to begin its 2017 fiscal year (June year-end). Analysts expect 13.2% EPS growth with a P/E of 10.9.

HAR is an undervalued growth & income stock with a 1.8% dividend yield. There’s short-term upside price resistance at 89. Traders and growth stock investors should buy now. Buy.

Johnson Controls (JCI) operates in the areas of energy management and auto batteries. JCI is a large-cap growth & income stock with a 2.6% dividend yield. (The dividend is expected to remain fully intact through the spin-off and merger processes.)

Here’s a recap of upcoming Johnson Controls M&A activity:

• The company plans to spin off Adient (ADNT), its automotive seating and interiors business, on October 3, 2016. Adient’s margins are expected to rise from 5.8% to about 6.9%, post-spin-off. JCI shareholders will receive one share of ADNT—valued somewhere near $8 per share—for every 10 shares of JCI that they own. The ADNT spin-off is expected to be a taxable event.
• This week, Johnson Controls bought a 56% stake in security systems company Tyco International PLC (TYC). The combined company will offer electrical systems and security systems to the building industry. Tyco brings strength in Europe to the new venture, while Johnson Controls is strong in the Americas and Asia. The combined company will domicile in Ireland to take advantage of lower income tax rates.

I mentioned in a Special Bulletin last week that JCI rose to medium-term upside price resistance at 45, where it will likely get stuck for a little while. Try to buy on pullbacks to 42. Hold.

Robert Half International (RHI) is a staffing and consulting company. RHI is a growth & income stock with a strong balance sheet and a 2.2% dividend yield. The best-case scenario for this year’s share price is probably 47. Buy.

Toll Brothers (TOL) is the leading U.S. luxury homebuilder. TOL is a greatly undervalued, mid-cap growth stock. I expect TOL to deliver lots more capital gains to shareholders this year. Buy now. Any price below 30 is a bargain. Buy.

Whirlpool (WHR) is the world’s largest appliance manufacturer. Whirlpool was featured in the June issue of Cabot Undervalued Stocks Advisor. WHR is a very undervalued growth stock with a 2.2% dividend yield.

The share price peaked in April, pulled back, and is now rebounding toward 190. When WHR reaches its all-time closing high of 213 from February 2015, today’s investors will have a 20% capital gain, plus dividends, and the stock will still be vastly undervalued. Buy WHR now. Strong Buy.