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Cabot Benjamin Graham Value Investor 278

This month’s Cabot Value Model contains a diversified list of high-quality buy recommendations. Many of these stocks have been neglected by investors in 2017 and are now poised to rise dramatically. Buying blue-chip companies is prudent when the stock market is noticeably overvalued!

Cabot Benjamin Graham Value Investor 278

Benjamin Graham is called The Father of Value Investing. His influence has inspired many successful investors, including Warren Buffett.

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Harvey’s Impact

The suffering of hundreds of thousands of people in Texas and Louisiana impacted by Hurricane Harvey is felt across the country. We hope Harvey’s victims will recover quickly.

Will the stock market rise or fall as a result? The economic consequences of the hurricane and related disastrous flooding will climb into the billions. According to AccuWeather, the full cost of the storm will approach $160 billion. Harvey is expected to cost about the same as the combined costs of Hurricanes Katrina and Sandy. The cost is so large that the U.S. GDP growth will be reduced by 0.5% to 1.0% in the current quarter.

How will investors react during the next few days, weeks or months? Ned Davis Research completed a study of the stock market’s reaction to the six costliest hurricanes to hit the U.S. (Andrew, Ike, Ivan, Katrina, Sandy and Wilma) and measured the impact on stocks.

Hurricane Ike hit during the market meltdown in 2008, so we’ll disregard Ike’s impact. However, the stock market advanced on average after the other five hurricanes blew through. The Standard & Poor’s 500 Index advanced an average of 1.2% during the first following month, rose 5.4% after three months, climbed 8.1% after six months, and surged 13.3% after 12 months. Remarkably, stocks performed far better after major hurricanes than during most other time periods!

I don’t recommend rushing to buy stocks, however. Congress will need to raise the nation’s debt ceiling and keep the government running when funding runs out at the end of September. The autumn season could become quite interesting. I’m still bullish!
“Price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.” — Benjamin Graham

CABOT VALUE MODEL

The Cabot Value Model applies A-List Dividend and Modern Value Model analyses.

The stock choices using the A-List Dividend analysis meet the following criteria:
(1) Dividend increases every year for 25 years or 10% dividend increases every year for 10 years
(2) Standard & Poor’s Quality Rating of A+, A, or A-
(3) Dividend yield is 1.0% or higher
(4) Dividend payout ratio is less than 50%

The Modern Value analysis uses a system initially developed by Benjamin Graham and Dr. Wilson Payne in 1946, and later modernized and enhanced by J. Royden Ward. The analysis uncovers undervalued stocks of well-known, high-quality companies which have recorded steady earnings growth. Ward’s Modern Value analysis is similar to the approach used by Warren Buffett.

When the market is low and undervalued, the Cabot Value Model will hold 75% moderately aggressive stocks and 25% conservative, counter-cyclical stocks, bonds or ETFs. When the market is high and overvalued, the Model will hold 25% moderately aggressive stocks and 75% conservative, counter-cyclical stocks, bonds or ETFs.

Buy Recommendations

The Cabot Value Model contains 16 securities this month with three new stocks: Apple (AAPL), Home Depot (HD) and Ross Stores (ROST). Three stocks transition out of the Model: Disney (DIS), FleetCor Technologies (FLT) and Lowe’s (LOW).

Disney, FleetCor and Lowe’s are now listed in the table of Hold and Sell Recommendations, which shows my Hold/Sell Opinions for these securities and previous recommendations that have transitioned out of the Model. My Hold recommendations remain excellent investments. You should continue to hold your stocks and ETFs until your selection reaches its Min Sell Price, at which time I will issue a sell alert. I will also issue a sell alert when a disappointing performance or adverse condition affects any company or ETF.

Currently, only one stock in the Cabot Value Model is priced below its Max Buy Price. Before buying Cabot Value Model stocks, you should wait until the price of the stock decreases to or dips below its Max Buy Price.

Defensive Securities: This month’s allocation for my Model remains at Level 5, which calls for a mix of four stocks and 12 defensive positions. The defensive or protective portion of the Model is composed of stocks, ETFs, bonds and cash and is fulfilled by AT&T, BRKB, FDX, GOOG, HD, ICE, IHDG, NKE, ROST, SBUX, TROW and UNH.

My objective for portfolio allocation is to increase the defensive holdings in the Model when the market rises and becomes overvalued, and decrease the defensive holdings in the Model when the market declines and becomes undervalued. I believe my strategy of increasing or decreasing the number of defensive positions will help you reduce your risk and enhance your profits.

The Dow Jones Industrial Average, at 21,865, is slightly below my peak Minimum Sell Price target of 21,890 indicating that the stock market is overvalued. My current allocation of four stocks and 12 defensive positions for Level 5 will not change if the stock market climbs higher. If the Dow falls to 20,225, my allocation mix will change to six stocks and 10 defensive positions, or Level 4.

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Apple (AAPL) Industry: Information Technology–Hardware & Peripherals; Low Risk; 1.6% Yield; Modern Value Analysis

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Apple (AAPL: Current Price 162.91; Max Buy Price 164.06) makes and sells smartphones (iPhones), tablets (iPads), computers (Macs), media devices (iPods and Apple TVs) and related accessories and services. In addition, the company has been venturing into new products, including Apple Watch, Apple Pay, Homekit, Healthkit, Apple Music and CareKit.

Demand for iPhones and other Apple products has surged in 2017 bolstered by higher demand for premium smartphones. The much-anticipated launch of the 10-year anniversary iPhone, celebrating 10 years since the first iPhone was introduced by Steve Jobs, is generating a lot of excitement ahead of its scheduled launch on September 12.

Apple surprised investors with stellar growth in the quarter ended July 1. Sales rose 7% and EPS surged 18%. iPhone sales remained steady ahead of the company’s new phone launch. Surprisingly, iPad and Mac sales perked up after several quarters of lackluster growth.

Revenue from Apple services—the App Store, iTunes, Apple Pay and iCloud—soared 22% during the quarter, and is poised to post rapid growth in future quarters. Apple’s much anticipated new iPhone could provide an additional boost to sales and earnings after the launch on September 12.

International sales make up 64% of total sales and have been hurt by weak demand in China, but sales in Japan and Apple’s foray into India are showing promise.

At 19.6 times latest EPS with an expected five-year EPS growth rate of 10.0%, AAPL shares are undervalued. The balance sheet is very strong with low debt and lots of cash. The current dividend yields 1.6%, after a healthy increase in April. I expect AAPL shares to advance 26% to my Min Sell Price of 204.48 within 12 to 18 months. Buy at 164.06 or below.

Berkshire Hathaway (BRKB) Industry: Financial–Insurance; Very Low Risk; No Dividend; Modern Value Analysis

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Berkshire Hathaway (BRK.B: Current Price 178.62; Max Buy Price 177.44) is a complex holding company with renowned value investor Warren Buffett at the helm as chairman and chief executive officer. Berkshire directly owns 100% of 62 businesses. In addition, several insurance companies owned by BRKB hold parts of 52 businesses; these businesses were attained primarily through purchases of marketable common stocks.

Any excess capital within Berkshire’s insurance companies is used to buy stocks. Berkshire’s businesses and stock investments make up a well-diversified array of investments, with a significant over-weighting in the insurance sector.

Some of the more-recognizable companies that Berkshire directly owns include Benjamin Moore & Co., Burlington Northern Santa Fe, Clayton Homes, Dairy Queen, Duracell, Fruit of the Loom, GEICO, General Re, H.H. Brown Shoe Group, Helzberg Diamonds, Johns Manville, Jordan’s Furniture, Lubrizol, NetJets, Precision Castparts, See’s Candies, Shaw Industries and The Pampered Chef. All businesses are managed on a decentralized basis with minimal involvement by Berkshire headquarters.

The 10 largest common stock holdings held by Berkshire’s insurance subsidiaries are Kraft Heinz, Wells Fargo, Apple, Coca-Cola, Bank of America, American Express, IBM, Phillips 66, U.S. Bancorp and Charter Communications. Stock holdings are managed by a team of investment professionals at Berkshire who use a buy low, hold forever approach.

Berkshire’s large Bank of America holding was recently acquired by exercising warrants to buy 700 million shares at $7.14 per share. The shares are now worth $23.58 per share.

Earnings per share are expected to be down for the 2017 year due to lower earnings from the directly-owned reinsurance companies (higher catastrophe claims) and BNSF railroad (lower coal shipments). However, earnings are a poor measure of Berkshire Hathaway’s progress because of Warren Buffett’s long-term investment approach.

Book value is a better yardstick to measure the company’s growth, although according to Mr. Buffett, book value “far understates” Berkshire’s intrinsic value, because many of Berkshire’s directly-owned businesses are worth much more than their carrying value. Stated book value is currently $121.30 per share, an increase of 9% from a year-ago. Book value is expected to rise 5% to 10% during the next 12 months and beyond.

At 1.47 times conservatively stated book value, BRK.B shares are undervalued. The company has built up a cash hoard of almost $100 billion, which provides flexibility to take advantage of investment opportunities quickly. I expect BRKB shares to climb 25% to reach my Min Sell Price of 222.84 within one year. Buy at 177.44 or below.

Home Depot (HD) Industry: Retail–Home Improvement Retail; Very Low Risk; 2.7% Yield; A-List Dividend Analysis

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Home Depot: (HD: Current Price 149.84; Max Buy Price 153.38) is the largest home improvement retailer in the U.S. The company sells building materials, home improvement products, and lawn and garden products, and provides various services. Home Depot serves do-it-yourself homeowners as well as professional builders, contractors and repair people. The company operates 2,281 retail warehouse-type stores in the U.S., Canada and Mexico.

The shortage of new U.S. housing is forcing homeowners to repair and upgrade their existing homes. Low mortgage interest rates will help the home improvement boom expand in 2017 and 2018.

Home Depot exceeded second-quarter sales and earnings expectations. Sales for the quarter ended July 30 climbed 6% and EPS advanced 14%. Same-store sales rose an impressive 6.3%, as sales to professionals outpaced sales to do-it-yourself shoppers.

Home Depot will add rooftop solar farms to 50 Home Depot stores in five states. The move will cut the electricity demand for the stores by one third or more.

Sales will probably climb 7% and EPS will increase 14% to $7.95 during the next 12 months ending July 31, 2018. Home Depot will benefit from demand for wood and other supplies from homeowners in the Houston region that has been battered by hurricane Harvey. The rebuilding effort will likely take many months to complete.

At 21.5 times current EPS and with a dividend yield of 2.7%, HD sells at a reasonable price. Home Depot is a blue-chip company with a proven track record and exceptional management. I expect HD shares to rise 23% and reach my Min Sell Price of 183.60 within one year. Buy at 153.38 or below.

Ross Stores (ROST) Industry: Retail–Apparel; Very Low Risk; 1.1% Yield; A-List Dividend Analysis

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Ross Stores (ROST: Current Price 58.69; Max Buy Price 60.23) operates off-price retail apparel and home accessories stores. Products include in-season branded and designer apparel, accessories, footwear and home fashions through the Dress for Less and dd’s DISCOUNTS brands. The company was founded in 1957 and is headquartered in Dublin, California.

The company’s Ross format primarily targets middle income households and dd’s DISCOUNTS stores target lower-income households. Prices offered at Ross are generally 20% to 60% below the regular prices of most department and specialty stores while the dd’s DISCOUNTS stores offer products at steeper discounts. As of July 29, Ross Stores operated 1,589 outlets including 1,384 namesake stores and 205 dd’s DISCOUNTS stores.

Many retail stocks have been pummeled during the past year or so, mainly because there are too many stores offering the same products, and customers now prefer to shop online and avoid the trip to the mall. Stores offering bargain-priced high-quality goods, though, are coping quite well in the current retail slump.

Ross has increased sales, earnings and dividends in every year during the past 12 years, and has surpassed earnings estimates in 12 of the past 13 quarters. The company’s pristine record would normally deserve a premium stock price but in 2017, Ross shares have declined along with most other apparel retailers.

Ross surprised investors with another sales and earnings beat for the quarter ended July 31. Same-store sales rose 4% after rising 3% in the previous quarter, which sent ROST shares higher by 11%. The current price, though, is still a bargain and offers value investors an unusual opportunity to buy a blue-chip growth stock at a very reasonable price.

At 19.3 times current EPS, ROST shares are now attractive. Sales and earnings growth will likely exceed 10% in 2017 and 2018, bolstered by aggressive store expansion and increasing market share. The balance sheet is solid, with low debt and over $1 billion cash to fund further expansion. I expect ROST shares to climb 24% to reach my Min Sell Price of 72.98 within one year. Buy at 60.23 or below.

UnitedHealth Group (UNH) Industry: HealthCare–Managed HealthCare; Very Low Risk; 1.5% Yield; A-List Dividend Analysis

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UnitedHealth (UNH: Current Price 196.73; Max Buy Price 197.57) is a diversified health care company. With revenues of $185 billion, the company ranks as one of the largest health care providers in the U.S. UnitedHealth offers a comprehensive array of health benefit plans and services for individuals, including Medicare beneficiaries, and for employers of all sizes.

UnitedHealth also provides network-based health services to Medicaid recipients and to participants in other government-sponsored healthcare programs. In addition, through its OptumHealth division, UnitedHealth provides behavior and clinical care and financial services.

Another Optum segment sells software and data management services and provides consulting and pharmaceutical research services to help clients develop pharmaceutical products. Lastly, OptumRx offers pharmacy benefit management services, including retail network pharmacy management and mail order pharmacy services. Optum generated 45% of UNH’s total sales and is growing rapidly.

UnitedHealth abandoned all but three public health insurance exchange markets at the beginning of 2017. UnitedHealth’s losses from Affordable Care Act subscribers in 2016 have dwindled in 2017. The company is well-prepared to meet any changes in the U.S. healthcare system brought about by the new Republican administration and Congress.

UnitedHealth will acquire the Advisory Board’s health operation, paying $1.3 billion including the assumption of debt. The Advisory Board, well-known in the hospital industry, generated $803 million in revenue in 2016. UnitedHealth has grown rapidly after acquiring several companies. The company will acquire Surgical Care Affiliates for $2.3 billion, adding a major surgical company to its growing roster of doctor groups and clinics. The purchase will add $1.5 billion in sales to UNH’s $7.6 billion current total.

UnitedHealth has produced rapidly growing sales, earnings, and dividends at a steady pace since the company was founded in 1977. Sales will climb 9% and EPS will advance 11% during the next 12-month period. At 20.5 times current EPS, UNH shares are reasonable. UnitedHealth has increased its dividend at a 40% annual pace during the past five years. I expect UNH shares to climb 25% to reach my Min Sell Price of 246.37 within 12 to 18 months. Buy at 197.57 or below.


Hold and Sell Recommendations

The following table includes my Hold and Sell Opinions for securities appearing in previous Cabot Value issues. These stocks have transitioned out of the Model, but remain excellent investments. You should continue to hold the stocks and ETFs you purchased until your selection reaches its Min Sell Price, at which time I will issue a sell alert. I will also issue a sell alert when a disappointing performance or adverse condition affects any company or ETF. The stocks recommended to be sold in prior issues are not included in the table.

Buy recommendations (including Risk Ratings) for the September 2017 Model can be found in the Current Buy Recommendations.

Sell Changes Since Last Issue:

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Cisco Systems (CSCO 31.48) disappointed investors again. Sales slipped 4% and EPS dipped 3%. Management provided a tepid outlook for the current quarter and next 12 months. Cisco’s transition from hardware to software and subscription products and services is a move in the right direction, but the change is taking too long.

In addition, the company is losing market share in switches, its primary product line, which produced 9% negative growth in the latest quarter. Sales and earnings growth will likely be less than 5% during the next 12 months, which is too slow for most investors.

I first recommended buying CSCO at 22.76 in the October 2013 Cabot Value Model using the Modern Value system. The stock has gained 36.4% during the past 46 months compared to a gain of 46.0% for the Standard & Poor’s 500 Index. Sell.

Buy and Hold Changes Since Last Issue:
Apple (AAPL) Hold to Buy. Second-quarter sales and earnings surprised investors. Launch of the new iPhone on September 12 should provide another boost to AAPL’s stock price.

Disney (DIS) Buy to Hold. Reported disappointing second-quarter sales and earnings, plagued by slow ad sales at sports network ESPN.

FleetCor Technologies (FLT) Buy to Hold. Recent negative publicity concerning CEO Ronald Clarke’s excessive pay package is hurting the stock. I’ll wait until the story fades before reinstating FleetCor in the Cabot Value Model as a Buy.

Home Depot (HD) Hold to Buy. Reported excellent second-quarter sales and earnings, but the stock declined. The resulting lower price presents an excellent buying opportunity.

Lowe’s (LOW) Buy to Hold. Higher labor costs could dampen earnings during the next few quarters.
Model Performance

Performance calculations for the Cabot Value Model include all Buy-rated and all Hold-rated stocks.

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The Cabot Value Model declined 0.92% in August, compared to a decrease of 0.12% for the Dow Jones Industrial Average. The Model gained 7.78% during the first eight months of 2017 compared to an increase of 10.64% for the Dow. Value stocks continue to underperform in 2017.

Fifteen years ago, the Model was first published in my Cabot Benjamin Graham Value Investor. During the ensuing 15 years, the Model has increased 253.7% compared to increases of 145.8% for the Dow and 161.3% for the Standard & Poor’s 500 Index. All performance numbers do not include dividends.

Finally, the Cabot Value Model, used extensively by investment advisors since 1995 and by individual subscribers since 2002, has outperformed the Dow Jones Industrial Average by a wide margin during the past 21 years. Since inception on 12/31/95, the Cabot Value Model has provided an impressive return of 1,122.4% compared to a return of 735.2% for Warren Buffett’s Berkshire Hathaway! During the same 21-year period, the Dow has gained just 327.3%.

The Cabot Value Model performance includes the performance results of the Modern Value Model for the period from 12/31/95 to 11/30/02. Performance for the period from 11/30/02 to 3/3/14 was derived from the average monthly performance of the Classic Value Model and Modern Value Model, weighted equally.
Beginning March 3, 2014, the Cabot Value Model includes buy recommendations derived from the Modern Value and the A-List Dividend analyses. Performance calculations for the Cabot Value Model now include all Buy-rated and all Hold-rated stocks. Prior to March 3, 2014, performance calculations included only stocks contained in the Model.

Top 275 Value Stocks

Following are the highest rated Top 275 Value Stocks in the Benjamin Graham database. Use the Top 275 to look up data and ratings for stocks you already own or in which you have an interest. The table is also available on the Google cloud as an interactive, real-time worksheet. The maximum rating for Quality, Value, Growth and Technical is 5.00, which is best. The maximum Total Rating is 10.00, also the best.

Explanation of terminology for the Roy’s Opinion column:
Buy-V: Cabot Value Model stocks recommended to be purchased.
Buy-E: Cabot Enterprising Model stocks recommended to be purchased.
Potential Buy: Stocks with the possibility to be recommended. Their current prices are below their Maximum Buy Prices.
Hold-V: Cabot Value Model stocks recommended to be held until Roy issues a sell alert or the stock reaches its Minimum Sell Price.
Hold-E: Cabot Enterprising Model stocks recommended to be held until Roy issues a sell alert or the stock reaches its Minimum
Sell Price.
Sell: Stocks recommended to be sold.
Neutral: Interesting stocks in Roy’s database but not sufficiently researched to form an opinion.

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Send questions or comments to roy@cabotwealth.com.
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Cabot Benjamin Graham Value Investor is published by Cabot Wealth Network, independent publisher of investment advice since 1970. Neither Cabot Wealth Network nor our employees are compensated by the companies we recommend. Sources of information are believed to be reliable, but are in no way guaranteed to be complete or without error. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on the information assume all risks. © Cabot Wealth Network. Copying and/or electronic transmission of this report is a violation of U.S. copyright law. For the protection of our subscribers, if copyright laws are violated, the subscription will be terminated. To subscribe or for information on our privacy policy, call 978-745-5532, visit https://cabotwealth.com// or write to support@cabotwealth.com

THE NEXT CABOT BENJAMIN GRAHAM VALUE INVESTOR WILL BE PUBLISHED OCTOBER 5, 2017

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