Cabot Explorer Issue: May 23, 2024

Note: I have added a new video Quick Start Guide to Cabot Explorer, in which I take you on a guided video tour through the various features of this service, including Issues, Updates, & Alerts and where to email me with questions. Newer subscribers, in particular, may find it helpful. You can find the Quick Start Guide on the right rail of the Cabot Explorer main screen.

Portfolio Changes:
Sell Global X Lithium & Battery Tech ETF (LIT)
Buy Aberdeen Asia-Pacific Income Fund (FAX)

The Power of Costco and Compounding

Nvidia (NVDA) reported yesterday that sales more than tripled to $26 billion for the quarter with net profit of $14.9 billion. Nice net margins. Nvidia’s shares have more than tripled in the last 12 months to reach a valuation of $2 trillion.

Though Nvidia and Costco (COST) both have great stocks, their business models could not be more different. Nvidia has a complex product but low capital requirements, exploding demand due to AI, and thus huge growth and profit margins. Costco’s stock has outperformed the market by a wide margin over the last decade based on a simple consistent strategy, with incremental improvements a key part of their success. It delivers modest, consistent growth with a well-executed, capital-intensive and logistics-heavy business model.

Costco has $230 billion of revenue in 2023, 125 million members worldwide with 90% renewal rates, 860 stores (adding 20-25 each year), and only 300,000 employees (Walmart has 2 million), plus annual sales of $1,800 a square foot that blows away the competition. Costco is even selling $200 million worth of small gold bars each month. This is a juggernaut that pays out to shareholders 80% of annual net income.

Its average warehouse produces an incredible $200 million of revenue a year, with top performers reaching as high as $400 million.

My takeaway is threefold. One is that this stock must be at the top of a buy list if the market pulls back. Given its size and physical bottlenecks, it can only grow its top line about 8%-10% a year but its stock still trades at a high 50X multiple of earnings.

The second is that the key question for investors is whether Costco will continue its expansion overseas. It may surprise you that it already has 108 warehouses in Canada, 40 in Mexico, 4 in Puerto Rico, 33 in Japan, 29 in the United Kingdom, 18 in South Korea, 15 in Australia, 14 in Taiwan, 6 in China, 4 in Spain, 2 in France, 1 in Iceland, 1 in New Zealand, and 1 in Sweden.

The third is tied to today’s new Explorer recommendation, and that is Costco’s success is largely attributable to a simple strategy executed consistently over time.

Just like taking advantage of the power of compounding in investing.

Going back to 1960, nearly 85% of the cumulative total return of the S&P 500 Index can be attributed to reinvested dividends and the power of compounding as illustrated in the below chart.

During the 1940s, 1960s, and the 1970s, dividends played a larger role in terms of their contribution to total returns. By contrast, dividends played a smaller role during the 1950s, 1980s, and 1990s when average annual total returns for the decades were well into double digits.

Since the 1990s, many growth companies have seemed to think that they are better off allocating their capital by reinvesting it in their businesses rather than returning it to shareholders. In addition, significant capital appreciation and stock buybacks in the last decade led many to ignore dividends and income. But the tide is turning as baby boomers look to dividends and interest income as a form of economic security to fund their retirement as well as to take advantage of the power of compounding.

There are other reasons to take dividend and interest income into consideration when picking stocks or bonds. Companies that consistently grow their dividends have historically exhibited strong fundamentals, solid business plans, and a deep commitment to their shareholders.

And though retail investors have shunned equity income funds, institutional investors have embraced them to fill in and broaden their product lines.

This brings us to today’s new recommendation.

New Recommendation

Aberdeen Asia-Pacific Income Fund (FAX): Upside with a 12% Yield

The Aberdeen Asia-Pacific Income Fund (FAX) is a close ended fixed income mutual fund launched and managed by Aberdeen Standard Investments (Asia) Limited in Singapore.

The fund was launched in 1986 and I have long admired Aberdeen as a high-quality asset manager. This fund invests in fixed income (bond) markets in Asia, Australia, and New Zealand.

About 50% of this fund’s investments are denominated in U.S. dollars and the same proportion is allocated to Asia-Pacific government bonds issued by countries such as India, Indonesia, and China as well as smaller amounts by Australia, Malaysia, and the Philippines. Yields and income are higher than in the United States, but their economies are stronger than they have been in the past. The other 50% allocation is to companies, with the lead sector being, as you would expect, finance.

The fund is trading at about a 10% discount to its net asset value. Its share price is substantially off its high and in an uptrend as well. This gives us both the potential for capital appreciation and a nice current 12% income stream that can be reinvested in whatever you please.

Buy a Half

Explorer Weekly Stock Commentary

Below is a brief update on each Explorer stock. Any changes in ratings will be highlighted. This section is all you need to read each week.

Explorer Disrupter Recommendations – need to watch more closely and have 20% trailing stop-loss in place.

Cloudflare (NET) shares were up marginally this week. This cybersecurity and sleeper AI play is a bit expensive from a valuation standpoint but remains a buy at its current price due to its upside potential. Buy a Half

Franco-Nevada (FNV) shares ended the week unchanged. It is interesting that the recent uptrend in gold prices is during a time that the stock market and economy are relatively strong. This is quite unusual, pointing to geopolitical risk as the key driver of higher gold prices. This gold-silver-platinum royalty and streaming company remains a buy. Buy a Full

Neo Performance (NOPMF) shares followed last week’s 17% gain with a more modest gain this week. First-quarter net earnings swung to profitability relative to last year. Neo manufactures the building blocks of permanent magnets and powers many modern uses of these technologies and advanced industrial materials. Neo has ample cash and very low debt levels, and the stock is an effective hedge on China/Taiwan risk, with a forward 6% dividend. Buy a Half

Novo Nordisk (NVO) shares had a bit of a volatile week after Hims & Hers Health (HIMS) announced a plan to sell legal copies of Novo Nordisk weight-loss drug Wegovy. On the good news front, last week a study found Novo Nordisk’s blockbuster obesity drug cut patients’ risk of heart attacks and strokes. Morgan Stanley researchers last year projected that over the next 10 years, 7% of the U.S. population could be taking these medications. Hold a Half

PayPal (PYPL) shares were down a bit again this week and this stock is testing our patience. Its new CEO, Alex Chriss, is looking harder at Venmo, its peer-to-peer mobile app. More important is PayPal is leveraging its powerful brand name and making the shopping experience easier, faster, and with an overall better platform for consumers, while helping merchants retain customers and generate repeat sales. This stock is relatively inexpensive, but it needs more impressive growth numbers to develop a sustained uptrend. Hold a Half

Sea Limited (SE) shares tacked on five points this week to reach 74, buoyed by several positive trends. Sea rolled out an “on-time guarantee” and delivered 70% of packages within three days in Southeast Asia. Investing in live streaming about a year ago led to Shopee’s e-commerce platform becoming the largest live-streaming e-commerce platform in Indonesia, which is the largest market in Southeast Asia. Finally, the company’s digital entertainment segment returned to growth last quarter. Buy a Half

Super Micro Computer (SMCI) shares were steady this week after last week’s nice 16% gain. Yesterday’s announcement of Nvidia’s quarterly sales tripling should provide further support for this stock. The consensus on Wall Street projects that Super Micro’s revenue will rise by 122% to $20.6 billion in 2024 so expectations are high. Hold a Half

Explorer Dominator Blue-Chip Recommendations – More Buy and Hold

International Business Machines (IBM) shares added five points this week to reach 174 following several updates on the AI front. The company’s Watsonx platform supports clients that need to train, tune, and deploy AI applications and regulations. IBM has a book of business related to Watsonx and AI of at least $1 billion, and this is growing on both the software and consulting sides of their business. Buy a Half

Unilever (UL) shares traded sideways this week as the company pursues the sale of its ice cream businesses and buys back shares. About 3.4 billion people use its products daily and 59% of its sales are from emerging markets. This consumer conglomerate has 14 brands with sales exceeding $1 billion and 30 “power brands” that account for almost 75% of Unilever’s total sales. Buy a Half

Visa (V) shares retraced five points on no significant news. This company is remarkable. $30 billion-plus of annual revenue, huge gross margins, with 27,000 employees worldwide. 707 million transactions per day with an error rate of 0.0001%. It has 16,000 banks in its network as well as six data centers. Buy a Half

Watch List

• BYD (BYDDY)
• ConocoPhillips (COP)

Explorer ETF/Fund Positions

Global X Lithium & Battery Tech ETF (LIT) offers solid exposure to lithium companies, but a price uptrend looks a way off so I’m moving this to sell. Move From Buy a Half to Sell

Grayscale Bitcoin Trust (GBTC) offers investors a way to track very closely to the day-to-day or “spot” movement of bitcoin prices. For aggressive investors comfortable with volatility. Buy a Small Allocation

JPMorgan Equity Premium Income ETF (JEPI) offers double-digit yield coming from both option premiums and dividends using a value-focused strategy. Buy a Full.

Morgan Stanley China A Share Fund (CAF) offers exposure to a basket of the largest Chinese-listed stocks. Buy a Half

WisdomTree Emerging Markets High Dividend Fund (DEM) offers a high dividend yield and some of the highest quality emerging market stocks. Buy a Half

WisdomTree’s Japan Hedged Equity ETF (DXJ) offers exposure to broad basket of dividend-rich Japanese stocks hedging for yen currency fluctuations. Buy a Full

Model Portfolio

ETFs

Explorer Stocks Summary

Brief company summaries that will not change week to week.

Watch List: BYD (BYDDY) switched to producing only all-electric battery vehicles (BEVs) and plug-in hybrid electric vehicles (PHEVs). The company also manufactures and supplies EV batteries, including to Tesla, and makes its own chips. This is vertical integration that would make Henry Ford proud. BYD is in a strong position to be one of, if not the leader of the EV revolution in terms of size, scale, and growth.

Cloudflare (NET) is both an aggressive and dominator recommendation offering products and services in four cutting-edge fields: cloud computing, AI, cybersecurity, and edge computing. its global reach is breathtaking as 20% of all web traffic runs through Cloudflare’s network and over 95% of internet users from 180 countries worldwide access the company’s services each day. And it reaches these users within 50 milliseconds. The firm’s client list includes more than 30% of Fortune 1000 companies and the ability to efficiently move and connect data – from where it is located to where it is needed (edge computing) – is a massive business opportunity in which Cloudflare already excels.

Watch List: ConocoPhillips (COP) is a global energy industry giant and one of the largest independent exploration and production (E&P) companies in the world, as measured by production levels and proved reserves. The company, founded in 1917 and based in Houston, has operations in 13 countries, although almost half the company’s production is derived from U.S. sources.

Franco-Nevada (FNV) is a company with more than half of its revenue coming from gold, but it also offers exposure to platinum, silver, and oil and gas. Franco-Nevada’s focus on royalties and streaming reduces risk and enables it to sidestep the huge capital costs that impact traditional miners. It enjoys cash flow and profits as its mining partners finance and complete exploration and expansion projects. That cash flow allows it to invest in new deals, pay a dividend, and operate debt free. Franco-Nevada has increased its dividend each year since its IPO in 2008.

International Business Machines (IBM) is a blue-chip artificial intelligence (AI) and India play with a nice dividend yield. Known as “Big Blue,” IBM now primarily helps businesses and governments manage their information technology in the cloud era. The stock sells at a discount to the S&P 500 multiple and the information technology sector’s forward earnings multiple. IBM has paid a dividend every quarter since 1916 and has had 28 consecutive years of dividend increases.

Neo Performance (NOPMF) manufactures the building blocks of permanent magnets and powers many modern of these technologies and advanced industrial materials. These include magnetic powders and magnets, specialty chemicals, metals, and alloys – all using rare earths and minerals critical to permanent magnets. Neo has a global platform that includes nine manufacturing facilities located in China, the United States, Germany, Canada, Estonia, and Thailand, as well as one dedicated research and development center in Singapore.

Neo stock is down 13% this year as rare earth stocks have pulled back due to weak prices, but the stock trades at just 17 times forward earnings and 49% of book value. Neo also has ample cash and very low debt levels. The stock offers us an excellent hedge on China/Taiwan risk, a forward 6% dividend yield, and incentives are aligned with about 20% of the outstanding stock held by management.

Novo Nordisk (NVO) specializes in treatments for diabetes, hemophilia, and obesity. The company supplies half of the world’s insulin, and its diabetes care products are used by over 34 million people today. Novo highlights that more than 750 million people are currently living with obesity and that this is up a multiple of 3X since 1975. In summary, based on sizable and growing demand for this weight-loss drug, this well managed, highly profitable company with an excellent growth profile and potential to develop new products has limited risk.

PayPal (PYPL) is a digital payment giant. With 430 million active accounts generating over $1.5 trillion in payment volume annually, PayPal retains a strong leadership position in the e-commerce payment ecosystem. PayPal has been cutting costs and expanding margins and earnings growth. In addition, PayPal’s new CEO is spearheading an innovation drive doubling down on growth efforts and boosting crypto capabilities.

Sea Limited (SE) has three core businesses: 1) digital gaming/entertainment, 2) e-commerce, and 3) digital payments and financial services, known as Garena, Shopee, and SeaMoney, respectively. Garena is a leading global online games developer and publisher. Shopee is the largest e-commerce platform in Southeast Asia and Taiwan. SeaMoney is a leading digital payments and financial services provider in Southeast Asia. Some of you may recall this stock when it was an Explorer recommendation in the fall of 2019 at around $30 and became more than a 10-bagger to its 2021 high.

Super Micro Computer (SMCI), commonly known as Super Micro, manufactures enterprise computer server hardware for cloud computing, artificial intelligence, data storage and telecommunications. Super Micro stock looks relatively inexpensive right now for the growth that it has been delivering. The company trades at just two times sales. Super Micro has two larger rivals, Dell (DELL) and Hewlett Packard (HPE), but it is forecast to grow five to 10 times faster. Furthermore, both Dell and HPE have relatively high debt whereas Super Micro has a net positive cash position. This is an aggressive pick in a sector experiencing extraordinary growth.

Unilever (UL) is a dominant consumer goods giant with a trove of 400 recognizable brands in its diversified portfolio – from Vaseline to Dove – that it sells in over 190 countries. However, 30 “power brands” account for almost 75% of Unilever’s total sales. It is a steady, stable stock for an uncertain environment and for a change, its stock is selling at a rare discount – down about 25% from all-time highs and at roughly two times sales. Two other reasons I like Unilever are that 78% of its sales are outside North America and almost 60% are from emerging markets that offer higher consumer sales potential due to better demographics.

Visa (V) doesn’t extend credit but provides the plumbing for financial payments and communications throughout the world. Visa’s financial infrastructure also underpins much of the world’s commerce. The duopoly between Visa and Mastercard is often referred to as one of the best businesses in the world, with insurmountable moats, low operating costs, and plenty of opportunities for unlocking additional value. Visa currently trades at a discount to its archrival MasterCard. This leaves it much better poised to outperform the latter going forward.

The next Cabot Explorer issue will be published on June 6, 2024.

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