This month’s Cabot Value Model contains a diversified list of buy recommendations, with a bias toward high quality companies in the Technology and Financial sectors. These and similar companies have propelled the Cabot Value Model to gain more than the Dow Jones Industrial Average, Standard & Poor’s 500 Index and Warren Buffett’s Berkshire Hathaway.
Ben Graham Value 274
Benjamin Graham is called The Father of Value Investing. His influence has inspired many successful investors, including Warren Buffett.
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My Mini Portfolio
The stock market’s sprint higher after mid-April has given way to a slow drift lower for all the indexes except the Nasdaq Composite. The Nasdaq, led by technology stocks, has rocketed 5.1% higher since April 13.
The Nasdaq is clearly outperforming the other indexes, but will its climb last? Only time will tell, but in my opinion, technology stocks will lead the market higher, and many of the other sectors will follow during the next several weeks and months.
This month’s Cabot Value Model contains a wide variety of stocks, with a slight focus on companies in the technology and financial sectors. I’ve avoided recommending companies in the energy and automotive sectors because forecasts are turning slightly negative. I will write about the energy and automotive sectors in my Weekly Update tomorrow, May 7.
I feature five companies in the following pages, not because they are my favorites but because I haven’t featured these companies in the past several months. Together, these five—Alliance Data Systems. AT&T, Berkshire Hathaway, LyondellBassell and MSCI—could create an excellent “mini” portfolio for you!
These five mini portfolio companies offer dividend yields averaging 2.2%, sell at only 18.7 times latest 12-month earnings per share, and they’re poised for an outstanding year in 2017. Also in this month’s Cabot Value Model, I include another 10 companies plus one ETF that are ready to take off!
“The margin of safety is always dependent on the price paid. It will be large at one price, small at some higher price, nonexistent at some still higher price.” — Benjamin Graham
CABOT VALUE MODEL
The Cabot Value Model applies A-List Dividend and Modern Value Model analyses.
The stock choices using the A-List Dividend analysis meet the following criteria:
(1) Dividend increases every year for 25 years or 10% dividend increases every year for 10 years
(2) Standard & Poor’s Quality Rating of A+, A, or A-
(3) Dividend yield is 1.0% or higher
(4) Dividend payout ratio is less than 50%
The Modern Value analysis uses a system initially developed by Benjamin Graham and Dr. Wilson Payne in 1946, and later modernized and enhanced by J. Royden Ward. The analysis uncovers undervalued stocks of well-known, high-quality companies which have recorded steady earnings growth. Ward’s Modern Value analysis is similar to the approach used by Warren Buffett.
When the market is low and undervalued, the Cabot Value Model will hold 75% moderately aggressive stocks and 25% conservative, counter-cyclical stocks, bonds or ETFs. When the market is high and overvalued, the Model will hold 25% moderately aggressive stocks and 75% conservative, counter-cyclical stocks, bonds or ETFs.
Buy Recommendations
The Cabot Value Model on page 3 contains 16 securities this month with one new stock: Alliance Data Systems (ADS). One stock transitions out of the Model: Schlumberger (SLB).
Schlumberger is now listed in the table of Hold and Sell Recommendations on page 7. The page 7 table shows my Hold/Sell Opinions for these securities and for previous recommendations which have transitioned out of the Model. My Hold recommendations remain excellent investments. You should continue to hold your stocks and ETFs until your selection reaches its Min Sell Price, at which time I will issue a sell alert. I will also issue a sell alert when a disappointing performance or adverse condition affects any company or ETF.
Currently, seven stocks in the Cabot Value Model are priced slightly above their Max Buy Prices. Before buying, you should wait until the price of the stock decreases to or dips below its Max Buy Price.
Defensive Securities: This month’s allocation for my Model remains at Level 5, which calls for a mix of four stocks and 12 defensive positions. The defensive or protective portion of the Model is composed of stocks, ETFs, bonds and cash and is fulfilled by AT&T, BRKB, FDX, GOOG, ICE, LOW, LYB, NKE, SDY, SBUX, UNH and WSM.
My objective for portfolio allocation is to increase the defensive holdings in the Model when the market rises and becomes overvalued, and decrease the defensive holdings in the Model when the market declines and becomes undervalued. I believe this strategy of increasing or decreasing the number of defensive positions will help you reduce your risk and enhance your profits.
The Dow Jones Industrial Average has reached my peak Minimum Sell Price level of 21,031 indicating that the stock market is overvalued. My current allocation of four stocks and 12 defensive positions will not change if the stock market climbs higher. If the Dow falls to 19,399, my allocation mix will change to six stocks and 10 defensive positions, or Level 4.
Alliance Data Systems (ADS) Industry: Information Technology–Data Processing & Outsourced Services; Low Risk; 0.8% Yield; Modern Value Analysis
Alliance Data Systems (ADS: Current Price 255.90; Max Buy Price 255.88) is a private-label credit card processor for mid-sized specialty retail stores in the U.S. Alliance provides transaction, marketing and credit services in the U.S., Canada and other countries. Alliance uses transaction-based data to create and manage customized solutions to analyze consumer behavior. Alliance can then enhance consumer loyalty to build stronger relationships between retailers and their customers.
The company is a leader in the sector and is one of the largest third-party payment processors in the U.S. Alliance remains well-positioned to capitalize on the current trend in consumer-based businesses to shift marketing efforts toward data-driven strategies. Alliance is headquartered in Plano, Texas, and was founded in 1996.
Management will continue to focus on acquiring companies at reasonable prices to bolster future growth. Alliance will buy back shares when stock is used to facilitate acquisitions. The company also uses share repurchases as a tool to mitigate the adverse impact of foreign exchange rates.
Sales increased 13% and EPS (earnings per share) advanced 6% during the past 12 months ended March 31, 2017. Recent acquisitions and strength across all segments will propel sales 9% higher and add 17% to EPS during the next 12-month period.
Alliance Data is in the process of creating a revised Air Miles Reward Program to comply with new laws in Canada. The new program is slated to be launched in the second half of 2017.
ADS shares have advanced 11.3% in 2017 compared to an increase of 6.7% by the S&P 500 Index. The stock price is undervalued at 15.8 times latest EPS. The company’s balance sheet is strong with almost $2 billion in cash, and my risk rating for ADS is low risk. ADS will likely climb 51% and reach my 386.64 sell target within two years. Buy at 255.88 or below.
AT&T (T) Industry: Telecommunications–Integrated Telecom Services; Very Low Risk; 4.8% Yield; A-List Dividend Analysis
AT&T, Inc. (T: Current Price 38.95; Max Buy Price 41.99) is the largest telecommunications company in the U.S. and one of the largest in the world. The company’s AT&T Mobility division provides the largest wireless service in the U.S. In July 2015, AT&T purchased satellite TV operator DirecTV for $48.5 billion. DirecTV propelled AT&T to the highest position in the U.S. pay-TV market.
AT&T’s purchase of DirecTV is a game-changer. Through DirecTV’s massive customer base, AT&T is attracting many new users to its wireless business. The merger will provide $2.5 billion ($0.40 per share) of cost synergies annually starting in 2018. The company’s DirecTV-Now will launch a video streaming service over the Internet that will offer HBO, Cinemax, ESPN and other television programming. DirecTV-Now will require neither set-top boxes nor satellite dishes. The new streaming service will serve every segment of the streaming video industry and offer customers content anytime and anywhere. The service will compete with Dish Sling TV, Hulu and Playstation Vue.
AT&T’s recent $18 billion purchase in government auctions of significant radio spectrum will enable the company to pursue new business in the fast-growing Internet of Things market, where objects can be sensed and controlled remotely across existing wireless infrastructure.
AT&T boasts the fastest Internet speeds in the U.S. via its 4G network, which reaches 355 million customers. Recently, the company announced plans to expand its super-fast fiber optic broadband service, GigaPower, to 38 additional cities, tripling its city locations. The fiber optic network is becoming the most sought-after technology for secure and fast data transmission. The company also bought wireless assets in Mexico with plans to greatly expand its telecom business in Mexico and other Latin American countries.
AT&T’s proposed $85 billion acquisition of Time Warner, owner of CNN, TNT, HBO and the Warner Bros. film and TV studio, is on track to close before the end of 2017. The deal will help AT&T potentially find new areas of growth and could transform the phone company into a media giant, making it less dependent on the lagging phone business.
AT&T’s DirecTV arm lost 233,000 customers during the quarter. In addition, AT&T’s most profitable business, wireless phone services, lost 348,000 customers to rivals T-Mobile and Sprint. AT&T is responding by offering attractive discounts to win back customers.
Sales and EPS will likely advance 4% during the next 12 months ending June 30, 2017 before accelerating thereafter. The company’s balance sheet is strong, and my risk rating for AT&T is very low risk. The company, a Dividend Aristocrat, has increased its dividend for 33 consecutive years. The company’s increase at the beginning of 2017 now provides a generous 4.8% yield.
At 13.3 times current EPS and at only 5.5 times cash flow, AT&T shares are a bargain. The company’s profits could receive a boost if corporate tax rates are reduced—AT&T’s tax rate is at the 33% level.
AT&T’s stock price will likely climb 34% and reach my 52.26 sell target within 12 to 18 months. Buy at 41.99 or below.
Berkshire Hathaway (BRKB) Industry: Financial–Insurance; Very Low Risk; No Dividend; Modern Value Analysis
Berkshire Hathaway (BRKB: Current Price 165.20; Max Buy Price 165.21) is a complex holding company with renowned value investor Warren Buffett at the helm as chairman and chief executive officer. Berkshire directly owns 100% of 62 businesses. In addition, several insurance companies owned by Berkshire hold parts of 52 businesses; these businesses were attained primarily through purchases of marketable common stocks.
Any excess capital within Berkshire’s insurance companies is used to buy stocks. Berkshire’s businesses and stock investments make up a well-diversified array of investments, with a significant over-weighting in the insurance sector.
Some of the more-recognizable companies which Berkshire directly owns include Benjamin Moore & Co., Burlington Northern Santa Fe, Clayton Homes, Dairy Queen, Duracell, Fruit of the Loom, GEICO, General Re, H.H. Brown Shoe Group, Helzberg Diamonds, Johns Manville, Jordan’s Furniture, Lubrizol, NetJets, Precision Castparts, See’s Candies, Shaw Industries and The Pampered Chef. All businesses are managed on a decentralized basis with minimal involvement by Berkshire headquarters.
The 10 largest common stock holdings held by Berkshire’s insurance subsidiaries are Kraft Heinz, Wells Fargo, Apple, Coca-Cola, IBM, American Express, Phillips 66, U.S. Bancorp, Charter Communications and Moody’s. Stock holdings are managed by a team of investment professionals at Berkshire who use a buy low/hold forever approach.
Earnings per share are expected to be flat for the 2017 year due to lower earnings from the directly-owned reinsurance companies (higher catastrophe claims) and BNSF railroad (lower coal shipments). However, earnings are a poor measure of Berkshire Hathaway’s progress because of Warren Buffett’s long-term investment approach.
Book value is a better yardstick to measure the company’s growth, although according to Mr. Buffett, book value “far understates” Berkshire’s intrinsic value because many of Berkshire’s directly-owned businesses are worth much more than their carrying value. Stated book value is currently $117.40 per share, an increase of 9% from 2015. Book value is expected to rise by a similar amount in 2017 and beyond.
BRKB shares will likely rise faster than the S&P 500 Index in 2017 because of the heavy weighting in financial assets which will benefit from higher interest rates. In addition, the income tax rate for Berkshire is 30%, which could drop noticeably if tax reform is enacted.
At 1.40 times conservatively-stated book value, BRKB shares are undervalued. The company has built up a cash hoard of $71 billion, which provides flexibility to take advantage of investment opportunities quickly. I expect BRKB to climb 18% to reach my Min Sell Price of 194.24 within one year. The recent dip in the stock price presents an excellent buying opportunity.
Berkshire will release its first-quarter results on Friday, May 5, and hold its annual meeting with 40,000 Warren Buffett fans in attendance on May 6. Buy at 165.21 or below.
LyondellBasell Industries NV (LYB) Industry: Materials–Commodity & Chemicals; Low Risk; 4.1% Yield; Modern Value Analysis
LyondellBasell Industries NV (LYB: Current Price 83.54; Max Buy Price 87.43), based in Rotterdam, The Netherlands, is one of the largest plastics, chemicals and refining companies in the world. Lyondell produces and markets olefins including petroleum-based products. These include ethylene and ethylene components, which are used in the manufacture of consumer goods, packaging, housing and automotive components, and other goods. Lyondell’s refining segment is a significant producer of gasoline and diesel fuel and gasoline blending components.
Falling oil prices negatively impacted sales and earnings during the past two years. Future results will be aided by increasing global demand for petrochemicals, and more favorable raw material costs from a projected increase in U.S. natural gas supply. Lyondell’s investments in high-return projects will drive EPS growth, while cost cuts and operational improvements will provide additional gains.
First-quarter sales surged 25% but EPS sagged 16%. U.S. sales continued to improve, while global demand showed considerable improvement. Earnings were hurt by high factory maintenance costs, which will diminish during the remainder of 2017. The company completed a major expansion of its ethylene facilities in Texas and finished seven major plant maintenance upgrades.
Sales will likely increase 6% and EPS will rise 1% to $9.90 in 2017. A pickup in the U.S. economy, increased infrastructure spending and the possibility of lower corporate tax rates could enable sales and earnings to grow much more rapidly. At 8.9 times current EPS and 6.6 times cash flow, LYB shares are clearly undervalued. The company’s stout cash flow has enabled management to shape up the balance sheet after LyondellBasell’s emergence from bankruptcy in 2010.
I expect LYB to advance 35% to my Min Sell Price of 112.47 within two years. Buy at 87.43 or below.
MSCI, Inc. (MSCI) Industry: Financial–Financial Data; Low Risk; 1.2% Yield; Modern Value Analysis
MSCI, Inc. (MSCI: Current Price 101.94; Max Buy Price 99.58) provides investment decision support tools, including global equity indexes, portfolio risk and performance analytics, and corporate governance products and services to a vast array of money managers.
Several acquisitions during the past decade have bolstered sales and earnings growth. Purchases include Barra, RiskMetrics and Measurerisk. Sales growth during the past five years averaged 15%, which propelled EPS 20% higher on an annual basis. The rapid expansion of the ETF (exchange traded fund) industry has provided increased demand for MSCI’s equity indexes. The MSCI World Index and MSCI EAFE Index are used as common benchmarks for world and Europe, Australasia and Far East stock funds.
MSCI could benefit from President Trump’s plans to loosen financial regulations and reduce corporate taxes. The company currently pays more than 30% of its income to taxes. Revenue momentum could accelerate in 2017 as new products and services are introduced.
At 35.9 times current EPS, MSCI shares are a tad expensive. Sales will probably rise 8% and EPS will jump 18% to $3.25 in 2017. The company could exceed expectations if additional acquisitions are completed or the corporate tax rate is reduced. The dividend yields a respectable 1.2% and is growing rapidly. I expect MSCI to climb 22% to reach my Min Sell Price of 124.57 within one year.
MSCI will report first-quarter financial results on Thursday, May 4, and could easily beat analysts’ estimates. Buy at 99.58 or below.
Hold and Sell Recommendations
The following table includes my Hold and Sell Opinions for securities appearing in previous Cabot Value issues. These stocks have transitioned out of the Model but remain excellent investments. You should continue to hold these stocks and ETFs until your selection reaches its Min Sell Price, at which time I will issue a sell alert. I will also issue a sell alert when a disappointing performance or adverse condition affects any company or ETF. The stocks recommended to be sold in prior issues are not included in the table.
My buy recommendations (including Risk Ratings) for the May 2017 Model can be found in the table on page 3 of this issue.
Sells:
Aflac (AFL) climbed within a whisker of my Min Sell Price of 75.50 even though the company’s outlook is cloudy at best. Fourth-quarter results came in below expectations, and analysts expect the company to report lower earnings in each quarter of 2017.
Aflac was first recommended five years ago in the March 2012 Cabot Value Model using my A-List methodology. Aflac has appreciated 64.2% while the Standard & Poor’s 500 Index has risen 71.9%. Sell AFL now.
Other Changes Since Last Issue:
Alliance Data Systems (ADS) Hold to Buy.
First-quarter sales and earnings beat estimates, and management believes growth will accelerate even further in the second half of 2017.
Schlumberger (SLB) Buy to Hold.
First-quarter sales and earnings improved noticeably, but still fell short of estimates. The recent retreat in oil prices could slow SLB’s recovery further.
Model Performance
Performance calculations for the Cabot Value Model include all Buy-rated and all Hold-rated stocks.
The Cabot Value Model advanced 0.43% in April, compared to an increase of 1.34% for the Dow Jones Industrial Average. The Model gained 6.83% during the first four months of 2017 compared to an increase of 5.96% for the Dow.
The Model was first published in Cabot Benjamin Graham Value Investor 14 years ago. During the ensuing 14 years, the Model has increased 250.6% compared to increases of 135.4% for the Dow and 154.6% for the Standard & Poor’s 500 Index. All performance numbers do not include dividends.
The Cabot Value Model has also been used extensively by investment advisors since 1995 and individual subscribers since 2002, and has outperformed the Dow Jones Industrial Average by a wide margin during the past 21 years. Since inception on 12/31/95, the Cabot Value Model has provided an impressive return of 1,111.6% compared to a return of 671.9% for Warren Buffett’s Berkshire Hathaway. During the same 21-year period, the Dow has gained just 309.2%.
The Cabot Value Model performance includes the performance results of the Modern Value Model for the period from 12/31/95 to 11/30/02. Performance for the period from 11/30/02 to 3/3/14 was derived from the average monthly performance of the Classic Value Model and Modern Value Model, weighted equally.
Beginning March 3, 2014, the Cabot Value Model includes buy recommendations derived from the Modern Value and the A-List Dividend analyses. Performance calculations for the Cabot Value Model now include all Buy-rated and all Hold-rated stocks. Prior to March 3, 2014, performance calculations included only stocks contained in the Model.
Top 275 Value Stocks
Following are the highest rated Top 275 Value Stocks in the Benjamin Graham database. Use the Top 275 to look up data and ratings for stocks you already own or in which you have an interest. The table is also available on the Google cloud as an interactive, real-time worksheet. The maximum rating for Quality, Value, Growth and Technical is 5.00, which is best. The maximum Total Rating is 10.00, also the best.
Explanation of terminology for the Roy’s Opinion column:
Buy-V: Cabot Value Model stocks recommended to be purchased.
Buy-E: Cabot Enterprising Model stocks recommended to be purchased.
Potential Buy: Stocks with the possibility to be recommended. Their current prices are below their Maximum Buy Prices.
Hold-V: Cabot Value Model stocks recommended to be held until Roy issues a sell alert or the stock reaches its Minimum Sell Price.
Hold-E: Cabot Enterprising Model stocks recommended to be held until Roy issues a sell alert or the stock reaches its Minimum
Sell Price.
Sell: Stocks recommended to be sold.
Neutral: Interesting stocks in Roy’s database but not sufficiently researched to form an opinion.
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Send questions or comments to roy@cabotwealth.com.
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Cabot Benjamin Graham Value Investor is published by Cabot Wealth Network, independent publisher of investment advice since 1970. Neither Cabot Wealth Network nor our employees are compensated by the companies we recommend. Sources of information are believed to be reliable, but are in no way guaranteed to be complete or without error. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on the information assume all risks. © Cabot Wealth Network. Copying and/or electronic transmission of this report is a violation of U.S. copyright law. For the protection of our subscribers, if copyright laws are violated, the subscription will be terminated. To subscribe or for information on our privacy policy, call 978-745-5532, visit https://cabotwealth.com// or write to support@cabotwealth.com
THE NEXT CABOT BENJAMIN GRAHAM VALUE INVESTOR WILL BE PUBLISHED JUNE 8, 2017
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