Market performance for the rest of the year will depend upon a full recovery brought on by the vaccines the removal of lockdowns and restrictions. If that doesn’t happen, look out. But I’m confident it will.
Of course, the pricey market indexes don’t apply to many individual stocks. Some stocks are very overvalued while others remain undervalued. At this point, the more conservative play is to target stocks with cheap valuations to buy, especially while many of those bargain stocks also have newfound momentum.
In this issue, I highlight a blue-chip energy stock. It sells at a dirt-cheap valuation while paying a high and safe dividend. It also has strong momentum ahead of what is likely to be a year of vastly improved profits.
Cabot Dividend Investor 221
The Market Just Keeps on Going
The bull market keeps raging. All three major indexes just made still new all-time highs. The S&P 500 is up about 20% since the end of October and 78% since the low of last March. How long can this keep going?
The short answer is that it will likely continue higher over the course of the year, albeit at a much slower rate. Of course, a pullback or correction would be entirely normal and healthy after such a steep run higher. And it wouldn’t be surprising in the coming weeks and months. But the year looks solid.
A common opinion is that the market is way overvalued right now.
At first glance, it certainly is. The S&P 500 is currently at an average price-to-earnings ratio of 32. That’s way high. But that’s based on trailing earnings, which include an economic crash from the pandemic lockdowns. The market is forward looking. And the future paints a different picture.
On a forward earnings basis, which includes this year’s expected earnings, the price-to-earnings ratio falls to about 22 times, and the average ratio over the past 30 years is about 20. That reflects about a 6% overvaluation from historical norms. But that number could be inflated.
So far this quarter, earnings are coming in miles above expectations. The economy and corporate earnings have far exceeded predictions at every step of the recovery so far. It would be consistent with recent results for current expectations to be low, and the forward market PE to be less than the projected 22 times.
Everything is relative and a higher than average PE ratio might be justified. Interest rates are ridiculously low. The benchmark ten-year Treasury yield is at a measly 1.15%. Money has no place else to go but stocks to fetch a decent return. Sure, investors can always get spooked at some point. But fear always wanes. And when it does investors will fall back into the arms of the stock market. Plus, there will be trillions in stimulus floating around.
That said, the future is always uncertain. The year 2020 proved that point. Let’s forget the numbers for a second and keep it simple. Market performance all hinges upon a full recovery later this year brought on by vaccines, the removal of lockdowns and restrictions. If that doesn’t happen, look out. But I’m confident it will.
Of course, market index valuations don’t apply to many individual stocks. Some stocks are very overvalued while others remain undervalued. At this point, the more conservative play is to target stocks with cheap valuations to buy, especially while many of those bargain stocks also have newfound momentum.
In this issue, I highlight a blue chip energy stock. It sells at a dirt-cheap valuation while paying a high and safe dividend. It also has strong momentum ahead of what is likely to be a year of vastly improved profits
What to Do Now
It seems prudent to be cautious in the near term, but still respectful of the full recovery that likely lies just ahead.
Despite the positive outlook for the rest of the year, the market has moved sharply higher very fast. A pullback is probably overdue. And nobody knows for sure what the future will bring. For those reasons, we took profits off the table over the past months.
We sold positions in Crown Castle International (CCI), Alexandria Real Estate Equities (ARE), and B&G Foods (BGS). We also took partial profits in high-flying positions Innovative Industrial Properties (IIPR), AbbVie Inc. (ABBV), and Eli Lilly (LLY).
Of course, BGS was an unusual situation. The price was lifted far beyond what was justified because of near-term trading shenanigans. We took advantage and sold the position for a 67% total return in less than seven months. The stock has since crashed back down.
We are still holding at least partial positions in several strong stocks. The market could still continue to run higher for a while. If the market wants to give still higher prices, let’s let it. The stocks targeted as buys are all selling at relatively cheap valuations and should have a strong year regardless of the market gyrations.
Featured SToCK
Buy Chevron Corporation (NYSE: CVX)
Yield 5.64%
Chevron (CVX) is one of the world’s largest fossil fuel pushers. The reason for the purchase is simple. Right now, it is a play on the vaccine and full recovery, which is a good bet. The stock has momentum and a long way to go to get to pre-pandemic prices. CVX has significant upside in just recovering from this pandemic.
The fossil fuel industry isn’t dead yet. Sure, alternative energy is the fast-growing energy source of the future. But fossil fuels aren’t done by a darn sight. The U.S. still uses fossil fuels for 80% of its energy needs. Oil and gas won’t go out of style anytime soon.
Energy stocks are poised to benefit from the full recovery next year while still offering great value and high dividend yields. Now the sector finally has some momentum too. And Chevron is the best of the best.
Chevron is one of the world’s largest integrated energy companies with operations spanning the globe. The company is involved in every facet of the energy industry but it is heavily skewed toward the upstream segment, oil and gas production and exploration. It has a huge and growing presence in the Permian basin, the largest shale oil producing region in the U.S. and the fastest growing oil region in the world.
I like CVX because it’s better than the other large oil companies. It started the pandemic in much better shape and is weathering the storm better.
The company has done a stellar job of getting leaner and meaner over the last several years. Chevron’s cost per dollar of BOE produced has fallen from $18 in 2014 to under $10 today. Chevron has lower costs and higher margins than its peers. The oil giant also hit this recession right. It completed several large projects in the past several years and had already wound down capital expenditures.
Beyond the planned reductions, Chevron also cut its planned expenditures in 2020 by 35%. While profits are still below pre-pandemic levels, they are much improved from the dark days of the recession in the second quarter. And things are rebounding fast.
Chevron has a superior balance sheet and the ability to turn things around quickly when the economy improves. But don’t take my word for it. The market agrees. CVX went down less than the other oil majors in the bear market and has responded better to the vaccine news. It has significantly outperformed its peers over the past year.
If the full recovery unfolds this year as expected, many other energy stocks have more upside potential than CVX. In fact, CVX probably has a lot less potential upside than the other oil majors. But if things don’t go as expected, CVX has less downside. That makes it a more conservative play.
Then there’s the dividend. It currently yields a spectacular 5.64%. The dividend should be safe as well. Chevron has raised the payout every year for the last 32 years, including through the financial crisis and the oil price crash from 2014 to 2016. The company’s Chief Financial Officer also said that maintaining the dividend through the pandemic is the company’s “number one financial priority.”
After wallowing in oblivion during the market recovery, the stock sprang to life after the vaccine announcements. It soared over 40% between late October and late November. It has since leveled off and bounced around, which is normal after such a big move. But oil prices have moved to a 13 month high and the sector appears to be on the move again.
You haven’t missed the boat. Despite the recent rally, CVX is still down about 30% from pre-pandemic levels in 2019, and things weren’t great then. I believe in a full recovery in this year, and CVX will surely benefit. The stock still has a long way to go to get back to pre-pandemic levels and the market has given us a taste of what likely lies ahead.
Chevron Corporation (CVX)
Security type: Common stock
Category: Energy
Price: $89.95
52-week range: $51.60 - $112.60
Yield: 5.6%
Profile: Chevron is one of the world’s largest integrated energy companies with operations spanning every facet of the energy industry, but heavily skewed toward exploration and production.
Positives
- Energy sector profits are likely to rebound sharply amidst a full recovery.
- The stock is still cheaply valued with a high and safe dividend.
- CVX offers value and momentum in an expensive market.
Risks
- The virus is unpredictable and there is no guarantee that a full recovery unfolds as expected.
- Fossil fuels are a dying industry and problems remain even after the pandemic.
Portfolio at a Glance
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Portfolio Updates
January 14th
Purchased Broadcom Inc. (AVGO) $455
January 20th
Sold 1/3 Eli Lilly (LLY) $201.26 - Total return 33.28%
Sold 1/3 Innovative Industrial Properties (IIPR) $195.62 – Total return 178.62%
January 27th
Sold B&G Foods (BGS) $41.05 - Total return 66.75%
Sold 1/3 AbbVie Inc. (ABBV) $102.79 - Total return 48.35%
Digital Realty Trust (DLR) – raised rating from “HOLD” to “BUY”
High Yield Tier
The investments in our High Yield Tier have been chosen for their high current payouts. These investments will often be riskier or have less capital appreciation potential than those in our other two tiers, but they’re appropriate for investors who want to generate maximum income from their portfolios right now.
Brookfield Infrastructure Partners (BIP – yield 3.6%) – This infrastructure partnership proved resilient during the pandemic as funds from operations grew 2.3% for 2020 and 11.3% in the fourth quarter. The stock continues on a slow and steady uptrend with things looking up for this year.
Performance of its transportation assets declined last year as ports and tolls roads were affected by the lockdowns. Its midstream energy assets underperformed as well. These assets should rebound strongly as the economy opens up. Brookfield invested $1 billion in new assets at the end of last year in Indian telecom towers and U.S. LNG export facilities as well. Those assets, along with a lot more over the course of the year, should also boost earnings. BUY.
Enterprise Product Partners (EPD – yield 8.6%) – That distribution yield is for real. Even in a tough year, Enterprise covered the distribution by 1.6 times with distributable cash flow. The stock is also dirt cheap, nearly 30% below the pre-pandemic high and almost 50% below the all-time high. The stock has been bouncing up and down since mid-December. But the next major move is likely to be higher.
The main event is still a full recovery ushered in by the vaccines. Business is already rebounding and should get much better as the economy opens up. Last year was lousy but Enterprise still proved resilient. I consider this foolish drop in price a buying opportunity. The stock also has momentum as it has trended sharply higher since the beginning of November. BUY.
STAG Industrial (STAG – 4.6%) – This monthly paying industrial REIT significantly outperformed the REIT index last year through the pandemic but has underperformed since the vaccine announcement in November. The REIT sector picked up quite a bit as the market looked to a full recovery later in 2021. While STAG’s peers made up for lost time, STAG was seen more as a pandemic beneficiary because of its online shopping warehouses. But the recent performance disparity should level off as industrial properties will benefit in a full recovery as well. HOLD.
Verizon Communications (VZ – 4.6%) – The wireless giant has been the worst performer in the portfolio. The market has been spectacular while this loser has been trending lower since the beginning of December. That said, there are a few things to like about the stock right now. It’s a strong down-market performer while the market is looking toppish. It’s also near the low point of its trading range and should rebound from here if it’s consistent with past trading patterns. Plus, the stock should benefit as 5G becomes a bigger story in the post-pandemic market. HOLD.
Dividend Growth Tier
To be chosen for the Dividend Growth tier, investments must have a strong history of dividend increases and indicate both good potential for and high prioritization of continued dividend growth.
AbbVie (ABBV – 5.0%) – This is a great pharmaceutical company for the longer haul. It has a fantastic pipeline and it’s still cheaply valued. But I’m not quite sure what to make of the stock in the near term. It has been on a sharp uptrend since the summer of 2019. However, it tends to forge new highs and then pull back for a while, and it recently made a new 52-week high.
It would be very consistent with recent trading patterns for the stock to languish for a couple of months before the next surge to a new high. That’s part of the reason we took a profit in one third of the position a couple of weeks ago. Of course, the short-term gyrations won’t matter that much for long-term investors. And it could break out to a new level. HOLD.
Altria (MO – 8.1%) – I still think this is a better stock than it gets credit for. For 2020, revenue was up 4.2% and adjusted earnings grew 3.6% from 2019. And that was through the pandemic recession. Cigarette profits were up over 10% for the year. It continues to grow earnings and can handily afford the huge dividend. The future is what concerns investors as smoking volumes continue to shrink and it doesn’t yet have a reliable offset. But there are several good prospects. MO is a great income stock for now and maybe something better down the road. BUY.
Broadcom Inc. (AVGO – yield 3.1%) – The technology giant doesn’t announce earnings until March, but other company results are indicating a strong semiconductor market. Last quarter, wireless revenue soared 43%, primarily because of the launch of the new Apple (AAPL) 5G phones, which require more filters and other networking technology. That boost should continue in the quarters ahead.
Longer term, Broadcom will see greater demand as its chips will be an enabling technology behind powerful emerging trends like the internet of things, self-driving cars and artificial intelligence. The uptrend in the stock is still rock solid and showing no kinks in the armor. It made a new all time high in February. BUY.
Digital Realty Trust (DLR – yield 3.1%) – This data center REIT made a strong bounce from 130 per share in mid January to the current 146. The stock tends to trade choppy and whenever it falls below the moving averages it tends to rebound strongly. The rebound appears to be underway and should have more to go. It’s a solid REIT in a growth business that doesn’t stay cheap for very long. It moves independently of the overall market which can be annoying when the market is killing it. But it’s a good stock to have in the portfolio with the market looking high. BUY.
Eli Lilly and Company (LLY - yield 1.7%) – The big pharmaceutical company reported fantastic earnings. Revenue grew 22% from last year’s quarter and earnings soared 41%, helped by sales of the new Covid antibody treatment. The stock initially soared to a new all-time high but has since pulled back as investors took profits on the news.
This is a best-in-class company with an amazing pipeline. It should continue to thrive longer term. But the stock has soared 67% since the beginning of November. That’s a massive, short-term move for a big pharma stock and a pullback was inevitable. We took some profits a few weeks ago not far from the high. The news has been great at this company and it’s a low-beta stock that can be held in any market. HOLD.
Innovative Industrial Properties (IIPR – yield 2.4%) – After bouncing around since late December this marijuana REIT is on the move again. It just broke out to another all-time high. IIPR has now returned over 200% in about 14 months since being added to the portfolio in December of 2019. That’s a winner. How much higher can it go? It’s hard to say. It’s in uncharted territory. We locked in a huge profit and we’ll see how much more can be had from the remaining position. HOLD.
Qualcomm Inc. (QCOM – yield 1.6%) – The chipmaker had a rough day last week. It fell over 9% last Wednesday after fourth quarter earnings failed to impress the Street. It beat earnings estimates with EPS growth of 119% from the year ago quarter but revenue fell short because of industry-wide supply shortages in 5G smart phones. It also said that these supply shortages would persist through next quarter as well. Citigroup downgraded the stock from “BUY” to “NEUTRAL.”
The supply issues will get worked out and the sales will be there. But after a stock runs like this it needs earnings that dazzle to keep the party going. This wasn’t good enough. But the main story is still intact. Qualcomm will reap huge benefits from 5G smart phone royalties in the quarters ahead and benefit longer term as 5G enabled technologies proliferate. HOLD.
Realty Income (O – 4.6%) – This is a good down-market stock that sells at a historically very cheap valuation and pays a strong and reliable dividend. Its retail properties tend to be in supermarkets, pharmacies and discount stores which held up well in the pandemic. The REIT grew earnings in the first nine months of the year despite the lockdowns. O really doesn’t deserve to be as cheap as it is. But the market still isn’t warming to this REIT yet. It could get a boost from fourth quarter earnings later this month. BUY.
U.S. Bancorp (USB – 3.8%) – The stock pulled back after rising to a post-pandemic high of 50 per share last month. The stock tends to bounce around but it is still in an uptrend that began at the end of October. It still sells at a cheap valuation ahead of what seems certain to be a much better year for profits as the economy recovers from the pandemic. A near-term dip like this is a good buying opportunity. BUY.
Valero Energy Corp. (VLO yield 6.4%) – The refiner stock is back. Energy stocks have been on the move again as oil prices hit a 13-month high and the sector posted six straight days of gains. VLO was up 5% yesterday alone and made a new post-pandemic high. It’s up over 15% in February so far. The energy sector rally had run out of gas since December after a huge move. This looks like it might be the early stages of a surge higher in the sector as investors are again embracing this cyclical sector ahead of a full recovery later in the year. BUY.
Safe Income Tier
The Safe Income tier of our portfolio holds long-term positions in high-quality stocks and other investments that generate steady income with minimal volatility and low risk. These positions are appropriate for all investors, but are meant to be held for the long term, primarily for income—don’t buy these thinking you’ll double your money in a year.
Invesco BulletShares 2021 Corporate Bond ETF (BSCL – yield 2.1%) – This short-term bond fund is a safe and steady port in a market that is always uncertain. It serves a purpose of diversifying a portfolio from the stock market but doesn’t have the interest rate risk of longer-term bonds or the credit risk of high yield. The 2.1% yield is nothing to write home about, but in this low interest rate world it’s actually not bad for a safe investment. BUY.
Invesco Preferred ETF (PGX – yield 5.0%) – This preferred stock ETF provides diversification as preferred stock performance is historically not correlated to the stock and bond markets. It’s a great place to generate a solid yield while rounding out your portfolio. There probably isn’t much upside left but a 5% yield in a steady investment in another asset class serves a purpose. HOLD.
NextEra Energy (NEE – yield 1.7%) – On the one hand, this combination regulated and alternative energy utility isn’t cheap. It has blown away both the returns of the utility sector and the overall market in every measurable period over the last ten years, including YTD. The valuations are high relative to the five-year averages.
On the other hand, the uptrend and chart is a thing of beauty. And I don’t see any reason why this stock won’t continue its charmed existence. Alternative energy is a big hit with investors and the intrigue is likely to grow as the new Administration puts more focus on it. HOLD.
Xcel Energy (XEL – yield 2.8%) – This smaller, more volatile alternative and lesser-known alternative energy utility has a similar longer-term uptrend as NEE, but it’s taken some lumps lately. XEL is also a great way for conservative investors to play the growing clean energy phenomenon. But it has more attractive valuations than NEE.
XEL is near the low point in a pattern that moves up and down on a longer-term uptrend. It’s been struggling of late as investors focus on other things. It is well positioned as a safe stock in a high market and an alternative energy leader with a much more climate-change-oriented Administration. BUY.
Dividend Calendar
Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Dividend Investor for an explanation of how dates estimated.
The next Cabot Dividend Investor issue will be published on March 10, 2021.
Cabot Wealth Network
Publishing independent investment advice since 1970.
President & CEO: Ed Coburn
Chairman & Chief Investment Strategist: Timothy Lutts
176 North Street, PO Box 2049, Salem, MA 01970 USA
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