Cabot Explorer Issue: September 12, 2024

Portfolio Changes: None

From Macro Trends to Micro Opportunities

Lower inflation numbers yesterday made interest rate cuts inevitable which moved the market, led by Nvidia (NVDA), which surged 8%. I intended to recommend Nvidia at a price of 100 so I will patiently watch this bellwether stock closely.

To be a good, patient and calculating investor, one needs to do two things at once: Be aware of big macro issues and trends and focus attention on micro issues. That is, closely watch specific companies and stocks, especially smaller, micro stocks offering the biggest upside and risk demanding closer attention.

For example, through a macro lens, American stocks have been an excellent place to invest while Europe lags and Asia and emerging markets beckon.

The gap in real gross domestic product (adjusted for inflation) between the European Union and the United States widened to 30% in 2023, from 15% in 2002, mostly driven by lower productivity in Europe.

At the same time, Europe’s growth and investment have fallen behind that of the United States and China, the world’s two largest economies, which are both spending big bucks to dominate the commanding heights of the global economy, which means technology and finance.

Here, Europe lags as only four of the world’s top 50 tech companies are European. The United States has much bigger and more developed capital markets than any other country, the leading reserve currency, the strongest military, and excellent universities. It is also the most innovative country and has the largest economy in the world. On the risk side of the equation, we have high debt, large wealth gaps, and growing political instability, not to mention lagging educational performance through high school.

China’s stock market has performed poorly even though it has high projected growth (the IMF projects 4.0% over the next 10 years compared to the America’s 1.4%), it has the second largest economy in the world, a nearly comparable military in Asia, and is the world’s leading manufacturer as well as the largest exporter and trading partner.

All of this is to set the stage for today’s new recommendation of a basket of micro-cap stocks offering investors high growth. A big difference between the small stocks I followed decades ago and now is that these small companies have customers and partners all over the world. Having a basket of small-cap stocks as part of your portfolio somewhat softens the higher risk that comes with small-cap investing.

The big attraction is, of course, the chance for much higher returns.

Smaller companies, primarily because of their lack of visibility within the investment community, often experience a “valuation gap” between their stock prices and their underlying fundamentals.

This is the opportunity and for international companies and especially emerging markets, this gap can sometimes present tremendous opportunities if you do your homework.

Here are some of the characteristics of small- and micro-cap stocks – all of which present opportunities with commensurate risks.

Smaller Capitalization and Low Trading Volume

Small caps tend to be more thinly traded and, while this is a characteristic that can work both ways, it often presents a huge opportunity for shrewd investors. As the company grows its revenues and earnings over time and the public becomes more aware of its existence and future growth prospects, the stock can jump sharply as demand for a limited amount of outstanding stock increases.

Potential Discovery by Analysts

While there are dozens of analysts covering a major stock like Kraft Heinz (KHC), many small-cap stocks are hardly covered at all. When a prominent analyst does pick one up, the results can be surprising.

Opportunity for Institutional Support

When large institutional investors learn about a new company with solid growth potential and good management, they oftentimes begin building positions and this can have a marked impact on stock prices. I recall many instances of a good presentation at an investment conference resulting in a small-cap stock soaring.

Flexibility & Growth Potential

Smaller companies can seize new opportunities and change direction quickly while big companies are like aircraft carriers or cruise ships – they take a long time to change direction.

The management of these companies tends to be more entrepreneurial and less bureaucratic. There is less corporate infighting since everyone knows each other on a personal basis. Many smaller companies cannot offer mega salaries and stock options are a very powerful performance motivator.

The ability to be nimble enables a small company to seize opportunities much faster than its large-cap brothers. This means potential double-digit growth, not plodding 3-4% growth.

New Recommendation

Oberweis Micro-Cap Fund (OBMCX)

There are many small-cap and micro-cap funds and ETFs on the market, but the Oberweis Micro-Cap Fund (OBMCX) stands out for several reasons.

The fund’s sound investment process and strong management team earns it a rare Morningstar Medalist Rating of Gold.

No wonder the fund’s long-term absolute return track record is outstanding.

Over the past five years it has posted an impressive average annual return of 18.9%.

Over the past decade, it has outperformed its benchmark by an annualized (and unheard of!) 6.1 percentage points and beaten its average peer by an annualized 5.6 percentage points over the same 10-year period.

I also like that it has a rather concentrated portfolio of just 60 to 100 stocks with its top 10 stocks accounting for 29% of total assets. This is a sign of conviction and confidence.

Finally, in an investment world dominated by tech, this fund’s sector concentrations are balanced, with materials and processing at 28% and industrial and information technology both at 22% weightings.

This ETF fills a glaring omission in the Explorer ETF portfolio, so I encourage you to add this to your portfolio.

BUY A FULL POSITION

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

Centrus Energy (LEU) shares were up 9.8% yesterday after the company inked a deal with Korea Hydro & Nuclear Power (KHNP) to supply and support construction of new uranium enrichment capacity at Centrus’ American Centrifuge Plant in Piketon, Ohio. Centrus remains a Buy as new nuclear power technology becomes more acceptable with a recent Pew survey showing that 56% of U.S. adults support increasing the use of atomic energy to power the electric grid. Buy a Half

Cloudflare (NET) shares were up slightly this week as analysts detect that companies are being more careful with their software spending. Last week, Cloudflare announced it was partnering with CrowdStrike (CRWD) to connect their platforms to stop security breaches. Cloudflare estimates its market at around $176 billion this year fueled by growth in artificial intelligence (AI) and 5G cellular networks. Buy a Half

Dutch Bros (BROS) shares were up 5% this week as the company has doubled its store count and tripled its sales since 2020. It operated 912 coffee stores as of the end of June, a fraction of Starbucks’ 16,730 stores in the United States alone. Dutch Bros focuses on convenient locations which are drive-through only. Buy a Half

Novo Nordisk (NVO) shares were up 4% yesterday after it was disclosed that unlike Ozempic and Wegovy, which are typically injected under the skin, its new product Amycretin is a pill taken daily, which could be a game changer for consumers. The phase 1 trials also show some mild and moderate side effects and greater weight loss in a shorter time frame. The obesity pill could prove stiff competition for Eli Lilly and a sign to investors that Novo Nordisk might have a pipeline of next-generation drugs. Demand for Novo’s products is still high with Ozempic sales up 30% to $4.26 billion in the last quarter while Wegovy sales were up 69%. Hold a Half

PDD Holdings (PDD) shares rebounded this week as it takes dead aim, through its Temu platform, at the cross-border $785 billion e-commerce market. With its experience serving consumers in China and its massive supply chain resources, PDD Holdings is well positioned to become a substantial player in this industry though risks at home and abroad are substantial. I recommend that aggressive investors buy the stock as its return on equity is a stunning 49%. PDD has carved out a niche with its discount marketplace, which targeted shoppers in China’s lower-tier cities. From 2023 to 2026, analysts still expect PDD’s revenue to grow at a compound growth rate of 38%. Buy a Half

Sea Limited (SE) shares have slowed their rapid ascent this year but are still demonstrating relative strength as e-commerce sales growth has accelerated. Singapore-based Sea also operates digital-payments provider SeaMoney and Garena, a global online games developer.

During the second quarter, SeaMoney registered more than 4 million first-time borrowers, which was double the number it added in the same period last year. Buy a Half

Explorer Dominator Blue-Chip Recommendations – More Buy and Hold

International Business Machines (IBM) shares are up 28% this year, beating tech giants such as Apple, Microsoft., Amazon, and Alphabet. This surprising outperformance has come as IBM shifted its focus to software and artificial intelligence. The company’s new IBM mainframe computer will soon hit the market. The new Telum II will have four times the AI computing capacity of the original processor, launched in 2021. Buy a Half

Unilever (UL) shares were steady this week as the stock has generated a return four times that of the benchmark FTSE 100 index – a basket of Europe’s top 100 companies. The company offers a wide range of products in the fields of beauty, personal care, home care, and nutrition with a focus on emerging markets. Buy a Half

Visa (V) shares were unchanged this week as this card giant leverages its dominance over the U.S. and global credit and debit card market. Visa is only responsible for routing those card payments through its global network, and it charges businesses a swipe fee of about 1.5% to 3.5% for every transaction. It then splits that fee with the card issuer and retains the rest as revenue. This explains Visa’s impressive profitability with high operating margins and a return on equity of nearly 50%. Buy a Half

Watch List – past recommended stocks that I still like and keep an eye on

BYD (BYDDY), ConocoPhillips (COP), Franco-Nevada (FNV)

Explorer ETF/Fund Positions

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. Buy a Half

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

iShares MSCI India Small-Cap ETF (SMIN) is a $960 million fund that holds a basket of about 500 small-cap India stocks. It is nicely diversified with the top 10 stocks accounting for just 12% of assets. The lead sector is industrials at 25%, followed by finance at 15%, consumer goods at 14%, basic materials at 13% and healthcare at 10%. Buy a Half

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 a 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.

Centrus Energy (LEU), based in Bethesda, Maryland, supplies nuclear fuel and services for the nuclear power industry in the United States, Japan, and Europe. Centrus Energy is building an enrichment facility in Ohio and would be very likely to benefit especially if federal funding moves forward to support this and other nuclear projects. I believe Centrus stock will benefit from increasing demand for its services, and that downside risk is low while upside potential is significant.

Cloudflare (NET) is both an aggressive and dominator recommendation offering products and services in four cutting-edge fields, though cloud computing is its bread and butter.

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.

Dutch Bros (BROS) is an operator and franchisor of drive-through coffee stores. It had more than 900 stores as of the end of the second quarter, including 36 that it opened in the quarter. It’s expanding at a steady pace, expecting up to 165 new stores this year, and it envisions up to 4,000 stores over the next 10 to 15 years.

Watch List: 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 enables 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 29 consecutive years of dividend increases.

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 its increasingly popular weight-loss drugs, Ozempic and Wegovy, this well managed, highly profitable company with an excellent growth profile and potential to develop new products has limited risk.

PDD Holdings (PDD) is growing much growing faster than its competitors. Its return on equity is a stunning 49%. PDD was only founded nine years ago (as Pinduoduo), and it has carved out a niche with its discount marketplace, which targets shoppers in China’s lower-tier cities. From 2023 to 2026, analysts still expect PDD’s revenue to grow at a compound growth rate of 38%. That growth should be driven by its market share gains in China and by Temu, its cross-border marketplace that connects Chinese sellers to overseas buyers. This is a competitive market in China watched closely by regulators.

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.

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, trading at just over 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.

The next Cabot Explorer issue will be published on September 26, 2024.

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