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Value Investor
Wealth Building Opportunites for the Active Value Investor

Cabot Undervalued Stocks Advisor Weekly Update

Nobody has missed their chance to buy low and catch a long overdue run-up in some great stocks. There are lots of great opportunities listed in this week’s update.

The stock market is on the tail end of earnings season, with 69% of results showing earnings beats. Over the last five years, an average of 67% of earnings reports came in above analysts’ consensus expectations. Among the Cabot Undervalued Stocks Advisor portfolios, 15 of 19 companies (79%) recently reported earnings beats.

There will be a few more earnings reports next week, and then a smattering in September. (Not all companies operate on a December fiscal year.) Our stocks are doing well financially. Great! Let’s turn to the outlook for the overall stock market, because that’s going to be the tail that wags the dog in terms of the performance of individual stocks.

Take a look at the two-year chart of the S&P 500 index. You can see that the market rose to the 2,100-to-2,125 range over and over again during the last 18 months. The S&P’s value tripled from 2009 through 2015. It needed to rest.

Then, a few weeks ago, the S&P broke past upside resistance and began reaching new highs. I know that some of you are thinking, “Augh! I have more cash on the sidelines and I’ve missed the run-up!” The good news is that the S&P is only up about 2.7% from the July breakout. Nobody has missed their chance to buy low and catch a long overdue run-up in some great stocks. There are lots of great opportunities listed in this week’s update.

Portfolio Notes

In this issue:
• Recent earnings reports from Harman (HAR) and Kraft Heinz (KHC)

Additional news about the Anthem/Cigna merger and WellCare’s (WCG) potential as a buyout target.
• Kraft Heinz (KHC)
increased its dividend
• There are no rating changes today.

In last week’s August issue:
• Applied Materials (AMAT)
was added to the Growth & Income Portfolio

Two additional construction materials companies were featured within my research on Vulcan Materials (VMC). If you were too busy to read all of your email last week, you can go back and read about Martin Marietta Materials (MLM) and Eagle Materials (EXP).

Updates on Growth Portfolio Stocks

Adobe Systems (ADBE) is a software company. The company is in a multi-year phase of successfully shifting customers to a subscription revenue model. ADBE is an undervalued aggressive growth stock with a strong balance sheet. The stock is trading near short-term upside resistance at 100, which it will likely surpass very soon. Strong Buy. (AMZN) dominates the online retail space by offering a wide variety of merchandise at low prices to customers around the globe. As a result of Amazon’s strong second-quarter results, the full-year consensus earnings estimates now reflect 359% and 80% growth in 2016 and 2017. The company is currently opening 21 new fulfillment centers, increasing its content offerings to international Prime subscribers and entering the market in India, with the intention of dominating its e-commerce market.

AMZN is an undervalued, large-cap aggressive growth stock in the consumer discretionary sector. The stock began reaching new highs again on July 29. I expect an immediate run-up. Strong Buy.

Chemtura (CHMT) is a specialty chemical manufacturer. Wall Street expects Chemtura’s earnings per share (EPS) to grow 20.4% and 19.2% in 2016 and 2017 (December year-end). The corresponding P/Es are 16.2 and 13.6. CHMT is a very undervalued small-cap growth stock. CHMT is rising to short-term upside resistance at 29.50 and could promptly continue on to 32. Strong Buy.

D.R. Horton (DHI) is a homebuilder. Third-quarter results reflected strong increases in sales, orders, closings and backlog. DHI is an undervalued growth stock with a 1.0% dividend yield. EPS are expected to grow 18.5% and 13.1% in 2016 and 2017 (September year-end). DHI is having a small pullback during an uptrend. Strong Buy.

Delta Air Lines (DAL) is the third-largest passenger airline in the world, serving 58 countries. The company also owns an oil refinery. Delta’s new dividend yield based on the preannounced third-quarter dividend increase is 2.1%.

Delta’s earnings estimates for 2017 have come down to a no-growth expectation. In assessing DAL’s position in the growth portfolio, I need to balance the prospect of flat 2017 EPS with the reality that analysts are chronically underestimating corporate earnings this year. As DAL approaches short-term resistance at 44, I will make a Hold vs. Sell decision. Hold.

Dollar Tree (DLTR) is the nation’s leading operator of discount variety stores. Consensus EPS estimates reflect 31.9% and 22.4% growth in 2017 and 2018 (January-end). DLTR is an undervalued large-cap aggressive growth stock with a low degree of volatility. The share price has been steadily reaching new highs for two months. There’s price support at 90. Buy.

E*Trade (ETFC) offers financial brokerage and banking products and services. After E*Trade’s second-quarter earnings blowout, analysts raised their EPS estimates to reflect 44.4% and 3.0% growth in 2016 and 2017 (December year-end). ETFC could rise to upside resistance at 28 quite soon, with good price support at 24.5. Hold.

Royal Caribbean Cruises (RCL) is a global cruise vacation company. Last week, CEO Richard Fain commented that the Brexit event has had no impact on cruise bookings and that there’s been very little impact from the Zika virus so far. The company also reported that the CEO purchased 29,190 shares of stock. EPS are currently expected to grow 27.3% and 14.1% in 2016 and 2017, with corresponding P/Es of 12.1 and 10.6. RCL offers a 2.0% dividend yield, big dividend increases and share repurchases. The price chart formed a shakeout pattern last week—a bullish sign for near-term upside in the stock. RCL could reach 84 in the next few months. Buy.

Vulcan Materials (VMC) is the nation’s largest producer of construction aggregates. The company was featured in the August issue of Cabot Undervalued Stocks Advisor. EPS are expected to continue growing aggressively at rates of 56.6% and 37.0% in 2016 and 2017, with corresponding P/Es of 34.7 and 25.3 (December year-end). VMC has a nominal 0.7% dividend yield. Last week, VMC pulled back from recent highs. Price charts are bullish throughout the construction materials sector. Buy VMC now for both near-term and long-term capital gains. Strong Buy.

WellCare Health Plans (WCG) is an undervalued aggressive growth stock in the managed healthcare sector. The company is also a potential takeover target by Cigna (CI), if the Anthem-Cigna merger fails. Cigna’s management affirmed that if the merger with Anthem fails, Cigna will seek to deploy cash through strategic M&A opportunities.

The U.S. Department of Justice (DOJ) sued to block the Anthem-Cigna merger due to antitrust issues. Last week, the lawsuit was reassigned to a different judge, who seems to be aiming for trial in December or January. Those dates conflict with the merger’s timeline because Cigna will not agree to an extension past December 31.

Consensus EPS estimates increased after WellCare’s strong second-quarter report to reflect growth of 45.3% and 18.0% in 2016 and 2017 (December year-end). WCG broke out of a trading range last week. Strong Buy.

Updates on Growth & Income Portfolio Stocks

Applied Materials (AMAT) is a worldwide leader in the manufacture of capital equipment in the semiconductor industry. The company was featured in the August issue of Cabot Undervalued Stocks Advisor. The company is expected to report third-quarter EPS of 48 cents on August 18. Earnings per share (EPS) are expected to grow by 28.6% and 22.9% in 2016 and 2017 (October year-end). The corresponding P/Es are 17.5 and 14.3. AMAT has a dividend yield of 1.5%.

AMAT is a volatile, large-cap aggressive growth stock; but it’s also a seriously undervalued stock with an attractive dividend yield and a strong balance sheet. AMAT broke through medium-term upside resistance at 25 in July and has lots of room to climb in the coming year. Strong Buy.

Big Lots (BIG) is an American discount retailer. The company is expected to report second-quarter EPS of 46 cents on August 22. BIG is a mid-cap growth & income stock with a strong balance sheet. The dividend yield is 1.6%. The share price briefly touched new all-time highs in late July. I expect BIG to launch upwards any time now. Strong Buy.

Cardinal Health (CAH) is one of the largest U.S. distributors of healthcare products and services. Cardinal finished 2016 with EPS growing 19.6% (June year-end), but lowered its 2017 profit forecast. Full-year EPS are expected to grow 7.6% and 11.7% in 2017 and 2018 (June year-end). CAH has a dividend yield of 2.1%. CAH is rising toward 87, with additional resistance at 91. Buy.

Carnival (CCL) is a cruise vacation company, and the largest leisure travel company in the world. Wall Street is expecting earnings to grow 23.3% and 15.6% in 2016 and 2017 (November year-end). The corresponding P/Es are 14.0 and 12.2. CCL is extremely undervalued, with a current dividend yield of 3.0%. CCL is climbing toward 49, and could even reach 52 this month. Buy.

Federated Investors (FII) is a global investment management company. Federated is having a great year, but earnings growth is expected to be moderate in 2017. Consensus estimates show Federated’s EPS growing 22.2% and 5.6% in 2016 and 2017 (December year-end). The dividend yield is 3.1%. FII is rising toward medium-term upside resistance at 33.50, where it will most likely hit a ceiling and trade sideways. Hold.

GameStop (GME) is a video game & consumer electronics retailer. The company just acquired 507 AT&T Mobility stores, in keeping with its diversification into non-video game technology brand stores. Here’s a late July CNBC interview with CEO J. Paul Raines, in which Mr. Raines discusses how GameStop is benefiting from the Pokeman GO craze.

GME will likely climb to upside price resistance at 33, then rest. Please note that analysts expect GameStop to report second-quarter EPS of 28 cents on August 25. Quarterly revenue and profits will invariably surpass earnings estimates, which means that if the share price does not jump in the coming weeks, it will likely jump upon the earnings release. The stock is undervalued with a huge 4.9% dividend yield. Buy.

General Motors (GM) is an American auto manufacturer. Analysts increased their 2016 EPS growth estimate to 16.7% in the wake of GM’s recent blowout second-quarter report. However, analysts now expect a year of flat earnings in 2017 (December year-end). GM has a large 4.9% dividend yield. I expect the stock to trade in the low 30s for a short while, then climb to 35. Hold.

Goldman Sachs Group (GS) is a global investment banker, serving consumer, institutional and government clients. The company reported a strong earnings beat in late July and repurchased $1.75 billion of stock during the quarter. Goldman plans to increase both its dividend and its share repurchase authorization, but has not yet announced the dollar amounts. I’ve been recommending financial stocks all year. Tune in to this CNBC discussion, “Banks: the next great trade?”, to hear more about the undervaluation of the banking sector.

Wall Street now expects Goldman’s EPS to grow aggressively at 17.2% and 20.0% in 2016 and 2017 (December year-end). The corresponding P/Es are 11.4 and 9.5, indicating that the stock is significantly undervalued. GS has a current dividend yield of 1.6%. The stock is rising toward upside resistance at 167, where it will likely rest briefly. Strong Buy.

H&R Block (HRB) is a leader in tax preparation services. HRB is a slightly undervalued growth & income stock with a 3.7% dividend yield. The share price has been trading in a narrow sideways range for six weeks. Its next likely move will be a push past 24 toward upside resistance at 28. Buy.

Kraft Heinz (KHC) is a global food and beverage producer. Last week, the company reported second-quarter adjusted EPS of 85 cents vs. the consensus estimate of 72 cents and increased the quarterly dividend from 57.5 cents to 60 cents. Kraft Heinz is in the early stages of revenue management initiatives in the wake of the 2015 merger between Kraft Foods Group (KRFT) and privately owned H.J. Heinz. (Read more about KHC’s outlook in this Barron’s article.)

KHC is an undervalued aggressive growth and income stock, with a 2.6% dividend yield. Full-year EPS are expected to grow 41.1% and 24.6% in 2016 and 2017 (December year-end). The strong earnings beat sent the stock soaring toward short-term upside resistance at 90, which it could surpass quite soon. Strong Buy.

Whirlpool (WHR) is the world’s largest appliance manufacturer. Wall Street expects EPS to grow 18.6% and 17.6% in 2016 and 2017 (December year-end), with corresponding P/Es of 12.9 and 11.0. WHR is an extremely undervalued growth stock with a 2.1% dividend yield. The stock just surpassed price resistance at 188, with additional resistance at 200. I’ve seen WHR rise 50% or more three times during the last three years! The stock is so cheap that it could rise 50% from today’s price and still be undervalued. 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. Consensus EPS estimates have increased dramatically since Boise’s recent second-quarter report. Wall Street now expects to grow 10.5% and 38.8% in 2016 and 2017 (December year-end). The 2016 and 2017 P/Es are 19.0 and 13.7. BCC is quite undervalued based on strong projected 2017 earnings growth. The share price has paused in an uptrend. I expect BCC to rise to upside resistance at 32 during the next few months. Buy.

BorgWarner (BWA) is a maker of engineered automotive systems and components for power train applications. EPS are currently expected to grow 7.6% and 9.2% in 2016 and 2017. The stock is fairly valued based on 2016 numbers; however, with a 2017 P/E of 9.4 and a 1.5% dividend yield, the stock is undervalued based on 2017 numbers. BWA has price support at 32, with short-term upside price resistance at 35 and again at 40. I expect BWA to reach both of those price targets this year. Buy.

FedEx (FDX) is an international package delivery company. The company completed its acquisition of Europe’s TNT Express, which is expected to be accretive to earnings in fiscal 2018 (May year-end). FedEx is a growth & income stock, undervalued based upon 2018 earnings expectations. The current yield is 1.0%. FDX has been trading sideways since mid-March, with upside resistance at 168, and again at 180. Given a neutral-to-bullish stock market, I think FDX could break past 168 in the coming weeks. 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. Last week, the company reported fourth-quarter EPS of $1.57 vs. the consensus estimate of $1.52 (June year-end). Revenue beat analysts’ estimates in all business segments, and backlog grew 4.7% to $24.1 billion. Earnings and revenue projections for 2017 through 2019 were also higher than analysts had expected. Harman finished its 2016 fiscal year with earnings up 9.3%. Analysts expect the next two years’ EPS to grow 10.4% and 9.7%.

HAR is an undervalued growth & income stock with a 1.6% dividend yield. Last week I wrote, “HAR is rising toward upside resistance at 88. Buy HAR now.” The stock then shot up to 88 on news of the strong earnings report. It will probably rest briefly near 90, before rising toward medium-term resistance at 110. Buy.

Johnson Controls (JCI) operates in the areas of energy management and auto batteries. Media stock guru Jim Cramer commented on JCI last week, “That’s a very undervalued situation.”

Due to the company’s third-quarter earnings beat, combined with bullish statements from management, analysts increased EPS estimates to reflect 15.8% and 9.1% growth in 2016 and 2017 (September year-end). The corresponding P/Es are 11.5 and 10.5, and the dividend yield is 2.5%. (The dividend is expected to remain fully intact throughout the spin-off and merger processes.)

Here’s a recap of 2016 M&A activity:
• The company plans to spin off Adient (ADNT), its automotive seating and interiors business, on October 31, 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.
• Johnson Controls bought a 56% stake in security systems company Tyco International PLC (TYC) in a transaction that closes on September 2. 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. On July 15, Jim Cramer commented, “I love that merger.”

JCI recently broke past 45, and will likely rise to 50-51. Buy JCI now. Buy.

Robert Half International (RHI) is a staffing and consulting company. RHI offers investors moderate earnings growth, a very strong balance sheet and a 2.4% dividend yield. The share price appears quite capable of rising to upside price resistance at 41–42 in the short-term. Hold.

Toll Brothers (TOL) is the leading U.S. luxury homebuilder. The company was featured in the August issue of Cabot Undervalued Stocks Advisor. Toll Brothers is expected to report third-quarter EPS of 61 cents on August 23. EPS are expected to grow 31.5% and 15.4% in 2016 and 2017 (October year-end). The corresponding P/Es are low in comparison to Toll Brothers’ earnings growth rates, at 10.7 and 9.3. TOL is a greatly undervalued, mid-cap growth stock. There’s upside price resistance at 30 and again at 35. Any price below 30 is a bargain. Buy.

Vertex Pharmaceuticals (VRTX) is a biotech company that develops breakthrough drugs and carries them through to the manufacturing process. Vertex is a clear leader in the treatment of cystic fibrosis.

VRTX is a vastly undervalued, aggressive growth stock. Despite only one barely-profitable year between 2006 and 2015, Vertex is expected to earn $1.02 per share in 2016, $3.11 in 2017 (December year-end)—reflecting 205% earnings growth in 2017—and to surpass $11.00 EPS by the year 2020. VRTX is climbing, with short-term resistance at 110, and much stronger price resistance in the low 130s. Buy.