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Cabot Benjamin Graham Value Investor Weekly Update

The stock market correction continues. It’s a normal correction that arrived after a 15-month bull run. As you hear newscasters attribute the market’s ups and downs to daily news stories, please know that the market bounces around, regardless of what topics are being highlighted en masse by the media.


The stock market correction continues. It’s a normal correction that arrived after a 15-month bull run. As you hear newscasters attribute the market’s ups and downs to daily news stories, please know that the market bounces around, regardless of what topics are being highlighted en masse by the media. “The news” is not necessarily causing stock market movement. Stock market corrections need to run their course before markets can make new highs again, so it’s good that we’re more than halfway through the correction. I’m looking forward to the rebound!


Today’s portfolio changes:

Last week’s portfolio changes:
Alphabet Cl. C (GOOG) moved from Buy to Hold.
Nautilus (NLS) rose to its target sale price of 14: Sold.
Ross Stores (ROST) moved from Hold to Sell at 84.

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Portfolio Stocks

Alphabet Cl. A (GOOG) reported first quarter diluted EPS of $13.33 when the market had expected $9.28. Results were enhanced by $3.40 due to “a new accounting standard (ASU 2016-01) that changes the way companies account for equity security investments.” Without the accounting change, Alphabet’s reported earnings handily exceeded the consensus estimate, although many one-time items made the quarter fuzzy for investors to decipher. Quarterly revenue of $31.1 billion beat the consensus estimate of $30.3 billion, and rose 23% in constant currency vs. a year ago. Fourteen investment firms changed their price targets on GOOGL this week—both up and down. Ten targets landed within the range of 1,200 – 1,300, with two higher and two lower.

Alphabet 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. I will consider GOOG to be fairly valued when it retraces its January high near 1,180, at which point I plan to sell due to full valuation. (Short-term investors who buy below 1,070 can earn a 10% capital gain as the stock returns to 1,180.) Longer-term investors should feel comfortable holding Alphabet, because earnings growth projections currently remain strong through 2020. Hold.

Apple (AAPL – yield 1.5%) manufactures a wide range of popular communication and music devices. Apple is expected to report second quarter EPS of $ 2.69, within a range of $2.59 to $2.80, on the afternoon of May 1. Morgan Stanley is expecting Apple to report weak second quarter iPhone sales, which could lead to a drop in the share price. The analyst recommends that investors buy on weakness. I concur. As long as full-year earnings estimates remain strong, my outlook for the stock remains bullish, despite any interim volatility. Forbes goes even further with dire warnings in this April 24 article, Apple Leaked Report Reveals iPhone X is Dead, citing the high cost of the iPhone X. And like the Morgan Stanley analyst, the Forbes writer ends on a rosy note, “These challenges are forcing Apple to reinvent the iPhone range and find new ways to woo customers. Consequently, recent leaks reveal the most exciting new iPhone line-up in years.”

In conjunction with the announcement of first quarter results, investors are anticipating larger-than-usual increases to the dividend and to the share repurchase authorization due to the benefits of U.S. tax reform. Last year’s dividend increase was 10.5%. One major Wall Street firm is estimating up to a 50% dividend increase.

Apple is an undervalued growth stock, expected to see EPS increase 23.9% in fiscal 2018 (September year-end), while the P/E is comparatively low at 14.5. There’s been no statistically significant change in Apple’s consensus earnings estimates in the last four weeks. AAPL has recently traded between 164 and 182. There’s 10% upside within that trading range. I expect additional capital gains in 2018. Buy AAPL now. Buy.

Berkshire Hathaway Class B (BRK.B) is expected to report first quarter 2018 results on approximately May 4. Changes in accounting rules might cause Berkshire to report a first quarter loss. Investors are encouraged to look at operating earnings for a more clear assessment of business successes. Full-year earnings estimates continue to rise, although the 2019 earnings growth rate is too low and the 2019 P/E too high for my preferences. There’s room within the 2018 trading range for short-term traders to buy now and make 10% profit as the stock returns to 217. Sell near 217.

Discovery Communications (DISCA) will report first quarter results on the morning of May 8. Consensus earnings estimates for Discovery jumped significantly in recent days. Analysts now expect full-year EPS to grow 38.4% and 31.2% in 2018 and 2019, with corresponding P/Es of 9.1 and 6.9. DISCA is a very undervalued aggressive growth stock. (I hate the very high debt ratio.)

This week Deutsche Bank raised their rating on DISCA to Buy and their price target to 34. The stock is heading back to its January and February high of 26. Once there, I expect the stock to rest a while before proceeding upward. The high debt ratio would inspire me to protect my downside with a stop-loss order, because debt adds risk to the company and its share price. Buy.

Gentex (GNTX – yield 2.0%) manufactures innovative products for automobiles and airlines, and also serves the fire protection industry. Gentex reported first quarter earnings per share of $0.40 last week, on target with analysts’ estimates. The company reiterated its guidance for full-year gross margin and capital expenditures, and for both 2018 and 2019 revenue. Despite the good earnings report, the stock fell, likely due to this statement from Gentex:
“[A] supplier production issue for certain electronic components affected the Company’s ability to meet demand for Full Display Mirrors® which resulted in a negative impact of approximately 2% on the Company’s revenue during the quarter. Since the end of the first quarter of 2018, the supplier production issue has been remediated and the Company has resumed normal shipments of the impacted products.”

Earnings estimates improved a bit for GNTX after quarterly results were announced. Full-year EPS are now expected to rise 29.5% and 9.0% in 2018 and 2019. The 2018 P/E is 13.4. Two investment firms raised & lowered their price targets on GNTX to 25.

GNTX rose past short-term price resistance last week, then fell back down to the lower portion of its 2018 trading range. I plan on selling on the next run-up, in favor of a company with better 2019 earnings growth prospects. Hold.

Gilead Sciences (GILD – yield 3.1%) will report first quarter results on the afternoon of May 1. Gilead is expected to see a big drop in full-year 2018 profits, followed by just 2.5% EPS growth in 2019. In addition, debt levels are somewhat high. I see no reason to own this stock. My suggestion is to let GILD rise back to 81, then sell. Falling profits are not conducive to rising share prices. A stop-loss order at 71.50 could be wise. Sell at 81.

Intercontinental Exchange (ICE – yield 1.3%) operates regulated exchanges and clearing houses in the commodity and financial markets. The company will report first quarter results on the morning of May 3. 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 sentiment towards financial stocks and Intercontinental’s record futures trading volumes in the first quarter of 2018, I think ICE is capable of surpassing 76 and reaching new highs again fairly soon. I’ll likely sell the stock thereafter. Hold.

LKQ Corp. (LKQ) is a distributor of vehicle products in the U.S. and Europe. LKQ is expected to report first quarter earnings per share of $0.59 on the morning of April 26, within a range of $0.57 to $0.66. Consensus estimates show strong full-year 2018 EPS growth of 23.4%, slowing down to 9.9% growth in 2019. LKQ is overvalued based on 2019 numbers. The stock is trading near its 2018 lows. Hold.

Lowes Companies (LOW – yield 2.0%) – Consensus estimates project strong earnings growth of 24.6% in 2019 (January year-end), followed by 12.2% 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%. Watch for Lowe’s to announce their annual dividend increase somewhere between Memorial Day weekend and the first week in June. Lowes increased its dividend payout by 17% to 28% in each of the last four years. The current quarterly payout is $0.41 per share.

Wells Fargo began coverage on LOW this week with an Outperform rating and a 100 price target. There’s 16% upside as LOW returns 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 2.2%) is a Canadian global automotive supplier. MGA is an undervalued mid-cap growth stock. MGA broke through short-term price resistance in April and rose to a new all-time high at 61, then pulled back to 58.5. It’s a very bullish sign that MGA is defying the stock market and reaching new highs. Buy MGA now. Buy.

McKesson Corporation (MCK – yield 0.9%) is neither a growth stock nor an undervalued stock. MCK is rising and could reach the mid-150s before pausing as it attempts to retrace its January high of 176. Hold.

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. My recommendation is that shareholders sell ROST at 84 when the stock retraces its January high. Sell at 84.

STORE Capital Corp. (STOR – yield 5.1%) 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 trading between 24 and 26, where it last traded in 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. Sell at 25.50.

Stifel Financial (SF – yield 0.8%) will report first quarter results on the afternoon of April 30. The company is expected to see full-year EPS grow 24.6% and 12.7% in 2018 and 2019, with corresponding P/Es of 12.0 and 10.6. There’s 17% upside as SF eventually retraces its 2018 high at 68. Buy.

Target (TGT – yield 3.5%) – Analysts expect EPS to grow 11.9% and 3.4% in fiscal 2019 and 2020 (January year-end), with the latter number being slow enough that it will ultimately inhibit share price growth. My recommendation is that investors sell the stock as it approaches its January high of 78, in favor of a company with multi-year, double-digit earnings growth. Sell at 78.

Thor Industries (THO – yield 1.5%) is a maker of recreational vehicles. THO is a very attractive and undervalued growth stock. The fundamentals are outstanding at this company. Consensus estimates point toward EPS growing 29.3% and 18.2% in 2018 and 2019 (July year-end). The P/E ratios are low in comparison to the earnings growth rates, at 10.8 and 9.2. 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. Patient investors can dollar-cost-average into the stock, but the stock’s not ready to rise yet. Buy.

Toll Brothers (TOL – yield 0.8%), like most of its peers, is enjoying 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 Lennar (LEN) and PulteGroup (PHM) gave bullish, better-than-expected outlooks for 2018 in recent days, so we might see Toll’s profit outlook increase as well. The price chart has been weak. There’s 21% upside as TOL heads back to its January high of 52, where I will consider selling if the 2019 earnings outlook doesn’t get bumped up. Buy.

Walt Disney Co. (DIS yield – 1.6%) – Disney had no profit growth in fiscal 2017 (September year-end), and is now expected to see profits grow 20.9% and 7.8% in 2018 and 2019. The stock is overvalued based on 2019 numbers. Disney shares have traded sideways for over three years. There’s 10% upside as DIS retraces its January high near 112. Hold.

Williams-Sonoma (WSM – yield 3.5%) – Attractive 2019 earnings growth will give way to low single-digit growth in 2020 (January year-end). I plan to sell when the stock reaches short-term price resistance at 55 in the coming months. Hold.

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