IS THIS A NORMAL STOCK MARKET CORRECTION – OR A BEAR MARKET?
U.S. stock markets continue to work their way through the 2018 stock market correction. It’s not a bear market—it’s just a correction. And fortunately, the correction did not arrive due to a bearish economic situation, war or a California earthquake. The market simply rose too far, too fast without resting in 2017. As such, most stocks are down from very recent highs while the market digests that gourmet dinner.
Not convinced that this is just a normal correction? I’ll give you two clues that should shore up your confidence. Visit stockcharts.com or your favorite chart service. Key in the S&P 500 ($SPX) index. First, look at a six-month chart. You can see that the SPX bounced at the same price twice during this market correction. That’s a good sign! What you don’t want to see is an erratic pattern, in which the market keeps hitting new lows every few weeks.
Next, change the time frame on the chart to three years. You will see that the pattern on the price chart for the current market correction is roughly the same pattern as the two corrections that took place in late 2015 and early 2016. When there’s a repetitive pattern, that means there’s predictability, and not chaos! As a person who stares at price charts every single day, I’ll tell you that there’s nothing about the current SPX price chart that alarms me right now, and therefore I’m very comfortable buying many stocks while they’re “on sale”.
It’s not any fun to see your account value decline, but on the bright side, investors who have cash available with which to buy stocks can find some excellent opportunities. Discovery Communications (DISCA), Thor Industries (THO) and Toll Brothers (TOL) each offer capital gains of 20% or more, simply in the course of rebounding to their January highs. If you’re patient enough to let the market finish bouncing around, and then recover, you’ll probably be counting your capital gains and patting yourself on the back within 3-6 months.
Please send questions and comments to Crista@cabotwealth.com.
Portfolio Stocks
Alphabet Cl. C (GOOG) 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. At last week’s Shoptalk conference, the future of voice-activated hardware got a perception boost when Google reported that a majority of consumers who use voice-activated speakers indicated a willingness to make retail purchases via voice activation in the coming months. In addition, French retailer Carrefour (the largest retailer in Europe) announced a partnership with Google aimed at competing aggressively with Amazon’s Alexa, with a new online voice assistant name Lea.
I will consider GOOG to be fairly valued when it retraces its January high near 1180, at which point I might sell so as to make room for a more undervalued stock recommendation. There’s room within the current trading range for short-term traders to make 16% profit. For those of you who want to own GOOG long term, it’s a high quality aggressive growth stock, and will probably deliver attractive capital gains for years to come. Sell near 1180.
Apple (AAPL – yield 1.5%) manufactures a wide range of popular communication and music devices. Longer smartphone replacement cycles have caused industry-wide smartphone shipments to decline at an accelerating pace. The maturing smartphone market is leading to a shift in market share toward the bigger players, including Apple, leaving many other tech companies vulnerable to Wall Street downgrades in revenue, earnings estimate and price targets. Yet not only has Apple’s 2018 consensus earnings estimate remained unchanged since its last big boost after reporting fourth quarter 2017 results last November, but the 2019 and 2020 consensus estimates have risen consistently and significantly since that time. The reason is accelerating revenue growth coming from Apple Services (Apple Music, Apple Pay and iCloud). Read more in this March 22 Barron’s article.
I’ve frequently described the correlation between Apple’s share price performance and its inconsistent profit trend. The profit trend provides seemingly-foolproof clues as to whether investors will achieve capital gains in the coming months. Read more in my updated article, Making Money in AAPL Stock is Much Easier Than You Think.
Apple is expected to see EPS grow 24.3% and 14.5% in 2018 and 2019 (September year-end), and the stock is undervalued. I expect AAPL to rise to its March high at 182 in the short term, with additional capital gains in 2018. Buy.
Berkshire Hathaway Class B (BRK.B) – This week, Berkshire Hathaway CEO Warren Buffett revealed that a German company, Gebr. Knauf KG, had offered to buy building materials manufacturer USG Corp. (USG) on March 15 for 42 per share. Berkshire Hathaway owns 31% of USG’s shares. Buffett encouraged Knauf to follow through with the purchase of USG at a minimum price of 42.
I recommended USG in the September 2017 issue of Cabot Undervalued Stocks Advisor, within a list of homebuilding product, construction and engineering stocks that might benefit in the wake of Hurricane Harvey.
Buffett has already expressed recent interest in buying a large stake in General Electric (GE), if the share price appeals to him, and also said that he might buy an entire airline. Buffett owns shares in a handful of famous airlines, my favorites of which are Southwest Airlines (LUV) and Delta Air Lines (DAL) for their growth and value components.
Berkshire Hathaway is slated for tremendous earnings growth of 52.4% this year, followed by 8.5% EPS growth in 2019. That type of disparity in earnings growth usually brings the share price run-up to a screaming halt near the fourth quarter, when the market is ready to turn its attention toward the 2019 outlook. In addition, the stock is undervalued based on this year’s numbers, but distinctly overvalued based on next year’s numbers.
What I’m going to do is sell BRK.B near its recent high of 217. There’s room within the current trading range for short-term traders to make 10% profit. The stock could easily continue climbing after a brief pause at 217, so for those of you who want to see how high BRK.B could rise this year, my suggestion is that you use a stop-loss order to protect your downside. Sell near 217.
Discovery Communications (DISCA) – The fundamental and technical prognosis for DISCA is relatively attractive, although I hate the very high debt ratio. The number of analysts weighing in on the consensus earnings estimate keeps changing. This week there are only two analysts contributing to the 2018 earnings estimate, but seven analysts contributing to the 2019 estimate, so the latter number is more reliable. That being said, earnings per share are expected to grow 24.7% and 38.8% in 2018 and 2019. The corresponding P/Es are 9.1 and 6.6. The share price weakened with the broader market in late March, but not to an alarming extent. There’s 19% upside as DISCA retraces recent highs at 26 in the coming months. I expect the stock to then rest a while before proceeding upward. Buy.
Gentex (GNTX – yield 1.9%) manufactures innovative products for automobiles and airlines, and also serves the fire protection industry. GNTX is a mid-cap growth & income stock. Earnings per share are expected to grow 27.1% in 2018, while the P/E is just 13.8. The numbers become less attractive in 2019. We could see GNTX surpass 24 in the near future and begin a new run-up. I plan on selling the stock thereafter. Investors who would be happy with a 15% near-term capital gain should buy GNTX now. Buy.
Gilead Sciences (GILD – yield 3.1%) is expected to see a big drop in profits in 2018, followed by just 3% EPS growth in 2019. In addition, debt levels are somewhat high. I see no reason to own this stock. The price chart appears in synch with those of Gilead’s industry peers, presenting a biotech stock that’s on an upswing. I don’t like the idea of counting on the rising tide of much healthier companies to lift Gilead’s ship. My suggestion is to let GILD rise just a little more, to 81, then sell. Falling profits are not conducive to rising share prices. Sell at 81.
Intercontinental Exchange (ICE – yield 1.3%) operates regulated exchanges and clearing houses in the commodity and financial markets. ICE is a large-cap growth & income stock, fairly valued based on the expectation of 20% EPS growth in 2018, but overvalued when factoring in expectations of low-double-digit earnings growth in 2019. The stock rose to new all-time highs in January, then corrected with the broader market. Based on strong 2018 earnings growth, bullish momentum among financial stocks and increased trading activity in 2018 (which generates increased revenues for exchanges), I think ICE is capable of surpassing 76 and reaching new highs again in the coming months. I’ll likely sell the stock thereafter. Hold.
LKQ Corp. (LKQ) is a distributor of vehicle products in the U.S. and Europe. Consensus estimates show strong 2018 EPS growth of 24.5% slowing down to 10.3% growth in 2019. LKQ is overvalued based on 2019 numbers, with a 2019 P/E of 15.3. A fourth quarter 2017 run-up took LKQ to a new all-time high in January 2018. The stock has since pulled back with the broader market. There’s 13% upside as LKQ rebounds to 43 in the coming months. Hold.
Lowes Companies (LOW – yield 1.9%) – CEO Robert Niblock announced his retirement, pending the appointment of a successor. The stock reacted well, pushing the share price above a recent narrow trading range. Consensus estimates project strong earnings growth of 24.8% in 2019 (January year-end), followed by 12.4% EPS growth in 2020. The stock is undervalued based on this year’s numbers, but fairly valued based on next year’s numbers. The long-term debt-to-capitalization ratio is higher than I would prefer at 68%. The 2020 EPS figure, P/E and debt numbers are more attractive than the comparable numbers at Home Depot.
The stock appears ready to begin a new run-up, offering 12% upside as LOW rises to short-term price resistance at 97. If next year’s earnings estimates improve, I’ll encourage shareholders to continue holding LOW for a retracement of January’s high near 107. Hold.
Magna International (MGA – yield 2.4%) is a Canadian global automotive supplier. MGA has attractive fundamentals and lots of upside. Consensus estimates point toward EPS growing 13.3% and 9.9% in 2018 and 2019. The 2019 EPS number is lower than I would prefer, but with 2018 and 2019 P/Es of 8.1 and 7.4, and a 2.4% dividend yield, MGA is decidedly undervalued. I expect MGA to head back to 59, where it last traded in January, and to deliver additional capital gains thereafter. Buy.
McKesson Corporation (MCK – yield 1.0%) is neither a growth stock nor an undervalued stock. MCK traded as high as 176 in January, then suffered as healthcare stocks bore the brunt of the 2018 stock market correction. My recommendation is that current shareholders hold their MCK shares, and plan to exit when the stock gets closer to its January highs. Hold.
Nautilus (NLS) is a maker of gym and exercise equipment, and an undervalued growth stock. Its tiny market capitalization of $400 million makes the stock volatile, because even small trades will toss the share price around in an exaggerated manner. The company is theoretically a very attractive buyout target, due to strong fundamentals and small market cap.
The NLS price chart has been a disaster. I recommend that investors sell when NLS reaches 14, and reinvest in a stock with a more bullish price chart. (I won’t issue a specific sell bulletin. If NLS trades at 14 for a couple of days, I’ll remove it from the portfolio. I suggest that you sell via a sell limit order.) Again, the company’s fundamentals are fine. It’s the price action that’s throwing red flags in my path. Sell at 14.
Ross Stores (ROST – yield 1.1%) is expected to see a year of strong earnings growth, followed by moderate earnings growth in fiscal 2020 (January year-end). I don’t want to be holding the stock later this year when investors begin to notice that the stock is overvalued based on 2020 EPS projections. ROST has traded between 74 and 85 since early December. I’m currently planning to sell near 85. Hold.
STORE Capital Corp. (STOR – yield 5.0%) is a real estate investment trust (REIT). REITs don’t fit my investment model because they don’t offer reasonable and consistent opportunities for capital gains, yet they’re subject to a variety of risks such as fluctuations in interest rates and real estate values. The stock is racing toward its highs from November and December 2017. My suggestion is that growth & income investors sell STOR at 25.50 and reinvest the principal into stocks that offer both dividends and attractive earnings growth. (I won’t issue a specific sell bulletin. If STOR trades at 25.50 for a couple of days, I’ll remove it from the portfolio. I suggest that you sell via a sell limit order.) Sell at 25.50.
Stifel Financial (SF – yield 0.8%) is expected to see profits grow 28.6% and 11.3% in 2018 and 2019. The stock is fairly valued based on 2019 numbers. The stock has been weak with the broader market. I intend to sell upon a rebound to 68 due to valuation. Hold.
Target (TGT – yield 3.5%) – One Wall Street investment firm estimates that Target stands to benefit from increased customer traffic as a result of Toys R Us and Babies R Us store closures, much more so that Wal-Mart (WMT) and Bed Bath and Beyond (BBBY) might benefit. That’s because Target has a bigger emphasis on baby and toy products, and it has a much higher percentage of its stores within a five-mile radius of the stores that are closing. Expect the potential earnings boost to be modest.
Target has certainly had its woes in recent years, but the outlook for fiscal 2019 (January year-end) is actually relatively attractive. Profits are expected to grow 11.9%, and when viewed alongside the 3.5% dividend yield, the stock is currently undervalued. Unfortunately, Wall Street is expecting fiscal 2020 to deliver earnings growth of just 3.6%, and that’s not enough to cause professional investors to buy and hold the stock.
TGT experienced a 30% run-up in December and January, then pulled back with the lingering correction in the broader market. My recommendation is to hold TGT for now, then sell as it approaches its January high of 78, in favor of a more undervalued growth opportunity. Hold.
Thor Industries (THO – yield 1.3%) is a maker of recreational vehicles. THO is a very attractive and undervalued growth stock. The fundamentals are outstanding at this company and earnings estimates are rising, with EPS now expected to grow 30.6% and 18.4% in 2018 and 2019 (July year-end). The P/E ratios are low in comparison to the earnings growth rates, at 12.1 and 10.2. In addition, the long-term debt-to-capitalization ratio is very low at 4.4%.
The stock experienced an exaggerated run-up in 2017, peaked at new all-time highs in January, then fell for several months with the correction in the broader market. THO has not yet stabilized from its fall. There’s 39% upside as THO gradually returns to 156, at which time the stock will still be undervalued. Buy.
Toll Brothers (TOL – yield 0.7%), like most of its peers, is experiencing a cycle of very strong earnings growth. Profits are expected to rise 41.0% in fiscal 2018 (October year-end), then slow to 9.4% growth in 2019—both year’s earnings estimates rose last week. The price chart has been weak. There’s 21% upside as TOL heads back to its January high of 52, where I will likely sell due to full valuation. Buy.
Walt Disney Co. (DIS yield – 1.7%) – In mid-March, Disney landed on the Fresh Money Buy List at Morgan Stanley. Disney had no profit growth in fiscal 2017(September year-end), and is now expected to see profits grow 20.9% and 8.3% in 2018 and 2019. The stock is overvalued based on 2019 numbers. Disney shares have traded sideways for over three years. There’s 12% upside as DIS retraces its January high near 112. Hold.
Williams-Sonoma (WSM – yield 3.3%) – Attractive 2019 earnings growth will give way to low single-digit growth in 2020 (January year-end). The price chart indicates that WSM could rise above short-term price resistance at 55 in the near future. I intend to sell after the subsequent run-up, before the market turns its attention to next year’s lackluster earnings outlook. Buy.
