Today’s featured stocks include a new addition to the Growth Portfolio. You’ll also find comparisons between our featured stocks and their peers in the integrated oil, asset management and semiconductor industries.
Cabot Undervalued Stocks 517
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Overdue for a 20+% Year!
The 2017 U.S. stock markets continue to perform well. I hope you’re enjoying the price action! The NASDAQ has been reaching new highs since late April, the S&P 500 appears ready to reach new highs this week, and the Dow Jones Industrial Average will probably bring up the rear shortly thereafter.
If you ask 10 different people about the stock market, you’ll get 10 different opinions, mostly composed of “the market’s overvalued” and “head for the hills!” Hogwash!
The fact is that the S&P 500 index tends to rise 20% or higher approximately two to four years out of every decade. It’s only happened once this decade, in 2013. We’re overdue for a 20%+ year, and it’s happening now.
Also, I tend to have fairly good instincts when we’re reaching major highs and lows in the market averages. I’ll give you as much warning as possible when I perceive those things happening, but right now, I foresee nothing alarming on the horizon.
Today’s featured stocks are really featured industries. I want to give you a broader view of how some of my favorite stocks look compared to their industry peers. Thus, the features on Cavium (a new addition to the Growth Portfolio), ExxonMobil and Legg Mason are really broader discussions about semiconductor, integrated oil and asset management stocks. I try to find the best companies within industry groups, using profits and valuation as my measuring sticks, on the theory that fantastic numbers will also appeal to institutional portfolio managers. We need their buy-in to push the share prices up!
Feel free to send questions and comments to Crista@cabotwealth.com.
Portfolio Notes
Make sure to review the daily Special Bulletins from April 25 to 28 in which I mentioned news, rating changes and/or price action on Blackstone Group (BX), Chipotle Mexican Grill (CMG), Dollar Tree (DLTR), ExxonMobil (XOM), H&R Block (HRB), Johnson Controls (JCI), Legg Mason (LM), PulteGroup (PHM), Royal Caribbean (RCL), Thermon Group (THR), Total S.A. (TOT), Vertex Pharmaceuticals (VRTX), Whirlpool (WHR) and XL Group (XL).
In recent news, ExxonMobil (XOM), Goldman Sachs (GS), Legg Mason (LM) and Whirlpool (WHR) increased their dividend payouts in late April.
Buy-Rated Stocks Most Likely To Rise More Than 5% Near-Term:
Cavium (CAVM)
ExxonMobil (XOM)
Martin Marietta Materials (MLM)
PulteGroup (PHM)
Tesoro (TSO)
Thermon Group (THR)
TiVo (TIVO)
Vulcan Materials (VMC)
XL Group (XL)
Today’s Portfolio Changes:
American International Group (AIG) moves from Hold to Strong Buy.
Last Week’s Portfolio Changes:
Dollar Tree (DLTR) moved from Buy to Hold.
Whirlpool (WHR) moved from Strong Buy to Buy.
Growth Portfolio
Growth Portfolio stocks have bullish charts, strong projected earnings growth, little or no dividends, low-to-moderate P/Es (price/earnings ratios) and low-to-moderate debt levels.
Featured Stock: Cavium (CAVM)
Cavium, Inc. is a manufacturer of semiconductor processor chips and related products, based in San Jose, California. The company is expected to achieve 50%+ revenue growth this year, both organically through new customer wins, and from its 2016 acquisition of QLogic. Margins are expected to remain strong for several years due to cost cutting and better product mix.
As is common when companies undergo major changes—in this case, a big acquisition and a transition from annual net losses to solid profitability—Wall Street analysts are usually conservative on their future earnings estimates until they see several quarters of financial results. In that light, Cavium surpassed the market’s first quarter expectations for both revenue and EPS, and the company also guided Wall Street higher for second quarter revenue and EPS (December year-end). Analysts now expect EPS to grow 80.1% and 27.1% in 2017 and 2018. The corresponding P/Es are 24.9 and 19.6.
CAVM is one of the only undervalued stocks in its semiconductor peer group. That’s important because semiconductor stocks have been popular this year. Institutional fund managers are going to want to have industry representation within their portfolios; but at the same time, they’re going to be wary of companies like Applied Materials and Broadcom that are projected for much slower EPS growth next year.
Cavium’s long-term debt-to-capitalization ratio soared to 47.5% in 2016 in conjunction with the QLogic acquisition. That number is not extreme, but it’s a tad higher than I prefer, which is why I give CAVM a Buy rating today, rather than a Strong Buy. I’m pleased with all the other numbers and the price chart.
We’ve made money this year on several semiconductor stocks:
Applied Materials (AMAT) delivered a total return of 37.88% during the 6.4 months that it was in our portfolios. I sold AMAT on February 13 because the stock was quite overvalued based on 2018 projected EPS (October year-end). AMAT currently has an expected 2018 EPS growth rate of 6.8%, with a P/E of 14.6 and a 1.0% dividend yield. The stock remains overvalued.
ASML Holding (ASML) delivered a total return of 12.49% during the 1.6 months that it was in our portfolios. I sold ASML on February 22 after it rapidly rose, becoming quite fully valued. The stock is now a little overvalued.
I recommended yet another semiconductor stock, Broadcom (AVGO), in Cabot’s free publication, Wall Street’s Best Daily, on November 11, when the price was 168.32. The stock has since risen 31.8% to 221.82. And by the way, if you own AVGO, please know that its EPS and P/E situation is almost exactly the same as AMAT’s. The stock is overvalued. Consider using a stop-loss order to protect your downside.
CAVM is a mid-cap aggressive growth stock. The share price repeatedly rose to the low 70s in 2015, fell in the first half of 2016, then began its rebound. I expect the stock to surpass 74 this year, spurred by surprisingly strong earnings growth and favorable market sentiment toward semiconductor stocks. Buy CAVM now. Buy.
Updates on Growth Portfolio Stocks
Adobe Systems (ADBE) is a fairly valued software company with aggressive earnings growth. ADBE continues to rise. Cautious investors and traders should use stop-loss orders, because this run-up will eventually come to a halt when ADBE is ready to rest. Hold.
American International Group (AIG – yield 2.1%) is a very undervalued diversified insurance company with strong projected earnings growth. The market is expecting first quarter EPS of $1.08 to be reported on the afternoon of May 3. 70% of companies in AIG’s property & casualty peer group reported earnings beats in recent weeks. AIG declares sporadic dividend increases, with a decent possibility of doing so in early May.
The stock came down since mid-February, from 67 to 59. I’m returning AIG to a Strong Buy because the stock is low within its trading range, the fundamentals are extremely attractive and an upside earnings surprise—which is statistically likely to happen—will prompt an upturn in the share price. Strong Buy.
Dollar Tree (DLTR) remains the premiere stock in its discount retail peer group, with expectations of double-digit earnings growth. However, many of its numbers don’t quite meet my normal standards, including 2019 EPS growth (January year-end), 2019 P/E and long-term debt ratio. The stock broke out of a four-month trading range in late April, and could rise all the way to November’s high near 90 before stopping. My intention is to sell the stock at 90 to clear the path for a more undervalued growth stock to join the portfolio. Hold.
Goldman Sachs Group (GS – yield 1.3%) is a premiere Wall Street investment bank. The stock is undervalued, the earnings outlook is good and the share price is low within its trading range. I expect GS to retrace its March highs above 250 this year, at which point I might sell in favor of a more attractive growth stock opportunity. Buy.
Johnson Controls (JCI – yield 2.4%) is a multi-industry company with the following business mix: fire & security services, residential and commercial HVAC/R (heating, ventilation, air conditioning and refrigeration), automotive batteries and building equipment. An undervalued growth stock, I expect JCI to rise to 45.5 in 2017. Strong Buy.
Martin Marietta Materials (MLM – yield 0.8%) will report first-quarter results on the morning of May 2. MLM is an aggressive growth stock that’s undervalued based on 2018 numbers. MLM could break past short-term upside resistance at 242 this year. Strong Buy.
PulteGroup (PHM – yield 1.6%) is a single-family U.S. homebuilder. Read about Pulte’s strong first-quarter results in the April 25 Special Bulletin. This year’s consensus EPS estimate has been slowly rising for three months. Analysts expect EPS to rise 41.5% and 17.8% in 2017 and 2018. The corresponding P/Es are very low at 10.1 and 8.6. I expect the current pullback among housing stocks to be brief. Buy PHM now. We could see it rise to the upper 20s this year. Strong Buy.
Quanta Services (PWR) will announce first-quarter results on the morning of May 4. PWR is an undervalued aggressive growth stock. Given a neutral to bullish stock market, I expect PWR to rebound to 38 this spring. Strong Buy.
Vulcan Materials (VMC – yield 0.8%) is an aggressively growing supplier of construction aggregates, asphalt and concrete. The company will report first quarter results on the morning of May 10. The stock had a big price correction this past winter, and subsequently began its rebound in late March. VMC could break past 124 in early May, on its way to upside price resistance at 135. Strong Buy.
XL Group (XL – yield 2.1%) is a very undervalued, aggressive growth insurer and reinsurer. Read about XL Group’s first-quarter results in the April 27 Special Bulletin. The quarter’s EPS came in about five cents per share above the consensus estimate, and analysts subsequently raised the full-year 2017 EPS estimate by five cents. That seems ridiculously cautious to me, because the margin improvement that led to the first-quarter earnings beat is not likely to disappear during the next three quarters. I think what’s happening is that EPS are already expected to grow 98.8% in 2017, and Wall Street analysts are loath to stick their necks out any further. Well, all the numbers will shake out in due time. Meanwhile, the 2017 P/E is 12.9. Contemplate those numbers. I find the disparity between the EPS growth rate and the P/E rather astonishing.
The stock began a new run-up in recent days. Buy XL now. Strong Buy.
Growth & Income Portfolio
Growth & Income Portfolio stocks have bullish charts, good projected earnings growth, dividends of 1.5% and higher, low-to-moderate P/Es (price/earnings ratios), and low-to-moderate debt levels.
Featured Stock: ExxonMobil (XOM - yield 3.8%)
ExxonMobil is the largest U.S. integrated oil company. Read about ExxonMobil’s strong first-quarter results and modest dividend increase in the April 28 Special Bulletin.
Analysts will likely raise earnings estimates for XOM in the coming days. Currently, consensus estimates project ExxonMobil to grow EPS at rates of 64.1% and 19.5% in 2017 and 2018 (December year-end). The corresponding P/Es are 21.0 and 17.6. After factoring in the big, growing dividend and the very low debt levels, XOM is an extremely undervalued stock.
I’ve been recommending integrated oil company stocks since November, when I added Total S.A. (TOT) to the Cabot Undervalued Stocks Advisor portfolios, quickly followed by BP plc (BP) and ExxonMobil. But the truth is, the industry is rife with excellent companies that meet all of my investment criteria: EPS growth at 15%+ per year, P/Es lower than EPS growth rates, attractive dividends and low-to-moderate debt levels.
Take a look at BP, TOT, XOM and some of their industry peers in this chart:
In order to make the chart more useful, here are some details that investors should be aware of:
BP, RDS.A, STO and TOT are foreign stocks. Investors will lose some of their dividend yield to foreign taxes, which are generally withheld by brokerage firms (as opposed to being reported on investors’ federal income tax returns).
The very large numbers in the column representing current year EPS growth rates are simply a reflection of profits rebounding after a bad year throughout the industry.
OXY took a net loss in 2016 and is expected to earn $0.94 per share in 2017.
STO took a net loss in 2016 and is expected to earn $0.98 per share in 2017.
The dividend payouts on STO and TOT vary each quarter.
I left Asian and Middle Eastern companies off the list because they do not meet my investment criteria.
The only stock on the list that I’d express caution about is Occidental Petroleum (OXY). That’s because its P/Es are so much higher than its competitors’ P/Es that investors are not likely to buy OXY when there are other attractive oil companies to choose from that have lower valuations. And since it’s investors’ buying activity that pushes share prices upward, it helps to be aware of how good your stock selections look compared to their industry peers.
After a quick run-up to 92 in December, XOM’s price receded to 81 in February, and has since been trading sideways. Given a stable or bullish stock market, I expect XOM to rebound to 92 (or higher) this year. Buy XOM now. Strong Buy.
Updates on Growth & Income Portfolio Stocks
BP plc (BP – yield 6.9%) is a very undervalued integrated oil company that’s based in London. The company is expected to deliver strong first quarter results on May 2, enhanced by higher oil prices in the quarter and a new 10% stake in an Abu Dhabi project. I expect BP to surpass 38 this year as the price of oil continues to ratchet upwards. Strong Buy.
Blackstone Group LP (BX – variable payouts) is an alternative asset manager. First-quarter assets under management (AUM) rose to a record $368.2 billion. EPS are expected to rise 44.5% in 2017 and 9.7% in 2018. When EPS are viewed in conjunction with the large dividend, the stock is decidedly undervalued. BX began a new run-up last week. I can’t make a good estimate on the upside potential, but I expect BX to deliver a 15% to 30% total return in the coming year, barring a major stock market correction. Strong Buy.
GameStop (GME – yield 6.7%) is a retailer of games, collectibles and technology, with additional ventures in the entertainment field. Each new shipment of the Nintendo Switch game console has sold out within hours of arrival at retail locations. GameStop announced another pending Switch shipment last week and is retailing the new Mario Kart 8 deluxe game. The stock has been moving rapidly between 20 and 26 since October 2016. Hold.
H&R Block (HRB – yield 3.5%) is a nationwide tax preparation company. Block effectively recaptured some market share during the recent tax season, achieving higher pricing and margins. Therefore, consensus earnings estimates have been rising for several months, now reflecting expected 10.1% EPS growth in Block’s fiscal 2017 (April year-end). HRB’s current rise will likely come to a halt at 27, where it traded in March 2016. The stock is fairly valued based on 2017 numbers, but quite overvalued based on 2018 numbers. Therefore, unless 2018 earnings estimates change drastically, I will be selling the stock near 27 in favor of a more undervalued growth & income stock. Hold.
Royal Caribbean Cruises (RCL – yield 1.8%) Read about Royal Caribbean’s strong first-quarter results, new share buyback and debt rating upgrade in the April 28 Special Bulletin. I’m concerned that Royal Caribbean’s surprisingly large increases in actual first half 2017 EPS did not cause company management to increase full-year EPS guidance by a similar amount. That could mean that second half 2017 numbers will be coming in lower than the market has been led to believe. The stock rose to new highs last week, and the price chart remains bullish. I’m inclined to sell after the current run-up, before second half 2017 numbers have a chance to bother the share price. Hold.
TiVo (TIVO – yield 3.6%) is a digital entertainment company that provides technology licensing and related services, which enable people to access online and televised entertainment. The company will report first-quarter results on the afternoon of May 3. The stock is an extremely undervalued small-cap stock. TIVO could rise to 22.50 this year. Buy TIVO now. Strong Buy.
Whirlpool (WHR – yield 2.4%) is a global manufacturer of home appliances. Read about Whirlpool’s first-quarter results in the April 25 Special Bulletin. New consensus estimates project EPS to grow 8.5% and 14.1% in 2017 and 2018. The corresponding P/Es are 12.2 and 10.7. The stock is overvalued based on this year’s numbers, but undervalued based on 2018 numbers. (If I had to pick, I’d prefer 2018 numbers to be undervalued vs. 2017 numbers, simply because the stock’s capital gain potential stretches out farther into the future.)
The “Fast Money” traders on CNBC opened their April 28 segment with a buy recommendation on WHR. WHR has risen to a range of 185 to 190 four times since April 2016. The price chart seems to be indicating that the stock is ready to break past 190 quite soon. WHR could then rise to early-2015 highs of 205 before resting again. Buy.
Buy Low Opportunites Portfolio
Buy Low Opportunities Portfolio stocks have neutral charts, strong projected earnings growth, low-to-moderate price/earnings ratios (P/Es) and low-to-moderate debt levels. (Dividends are not a portfolio requirement, but some of the stocks will have dividends.) Investors should be willing to wait patiently for these stocks to climb.
Sometimes a stock in the Buy Low Opportunities Portfolio produces good capital gains and the share price is no longer low, yet the stock remains an attractive investment. Those stocks will then be moved into the Growth Portfolio or the Growth & Income Portfolio.
Featured Stock: Legg Mason (LM – yield 3.0%)
Legg Mason (LM – yield 3.0%) is a seriously undervalued asset management and financial services company with aggressive earnings growth. Read about Legg Mason’s strong fourth-quarter results (March year-end) in the April 27 Special Bulletin.
Here are the pertinent full-year earnings results and projections:
After recording a net loss in fiscal 2016 (March year-end), Legg Mason reported full-year 2017 EPS of $2.19 when the market was expecting $2.07.
Consensus estimates project the company to earn $2.80 and $3.49 per share in fiscal 2018 and 2019, representing aggressive earnings growth of 27.9% and 24.6%.
The 2018 and 2019 price/earnings ratios (P/Es) are 13.3 and 10.7, reflecting extreme undervaluation vs. earnings growth rates. The fiscal 2017 P/E range was 11 to 18.
The company increased the quarterly dividend by 27% on April 27, from $0.22 to $0.28 per share.
How does Legg Mason stack up against its peers in the mutual fund asset management industry? As you can see in the chart below, Legg Mason is expected to report over 20% EPS growth in each of its next two fiscal years.
The only other company on the list that is expected to achieve relatively similar aggressive earnings growth is Ameriprise Financial (AMP). (You can read more about AMP in my March 17 stock recommendation in Cabot’s free publication, Wall Street’s Best Daily. And for those of you who bought AMP, the company increased the quarterly dividend last week, from $0.75 to $0.83 per share.)
In addition to outstanding earnings growth, Legg Mason shares offer the biggest disparity between earnings growth rates and price/earnings ratios (P/Es), making LM the most undervalued stock within its peer group. Lastly, LM has one of the highest dividend yields of these ten stocks, at 3.0%.
So whether you’re reviewing mutual fund asset management company stocks for growth, value or dividend yield, Legg Mason comes out on top as a premiere investment choice.
Legg Mason took a net loss in fiscal 2016 (March year-end). You can see on the five-year chart that the stock declined during the company’s 2016 fiscal year, as investors anticipated the loss and sold the stock. Then the share price stabilized, as the market began to understand that the loss was a one-time event and did not represent a chronic problem. Therefore, I added LM to the Buy Low Opportunities Portfolio in October 2016, in anticipation of the rebound in profitability and the concurrent rebound in the share price.
The stock has lots of room to deliver additional capital gains to investors. Professional investment managers who are comparing LM to its peer group are seeing the same numbers that I reported here today. As they select stocks within the asset management industry, many of them buy LM, and each purchase is going to drive the share price up further.
LM broke out of a trading range in mid-April, then pulled back a bit. The stock could reach medium-term price resistance at 44-45 relatively quickly, at which point it will still be undervalued. Buy LM now. Strong Buy.
Updates on Buy Low Opportunities Portfolio Stocks
Archer Daniels Midland (ADM, yield 2.8%) will report first quarter results on the morning of May 2. Earnings growth is expected to be strong in 2017, but the stock is somewhat overvalued based on slowing 2018 EPS growth. The trading range has been consistently moving higher since the November elections, with a ceiling at 47. I will likely sell ADM when it reaches 47 if the 2018 earnings projections don’t improve. Hold.
Boise Cascade (BCC) is a very undervalued, aggressive growth wood products manufacturer and building materials distributor. The company will report first-quarter results on the morning of May 3. BCC has been rising, with upside price resistance at 32.50 and 39. Strong Buy.
Chipotle Mexican Grill (CMG) Read about Chipotle’s outstanding first-quarter results in the April 26 Special Bulletin. Analysts expect EPS to increase from $0.77 in 2016 to $8.45 in 2017 and $12.19 in 2018. The stock remains undervalued. CMG is up 31% from its November lows. I expect the current rise in the share price to come to a halt at 530, where CMG last traded in March 2016. Hold.
Mattel (MAT – yield 6.8%) is a global toy manufacturer. Consensus earnings projections have come way down for Mattel since I added the stock to the portfolio in late December 2016. At this point, Wall Street consensus estimates point toward EPS growth rates of 15.1% and 23.0% in 2017 and 2018, with corresponding P/Es of 18.4 and 14.9. The earnings growth rates, plus the dividend yield, are much higher than the P/Es, and I’m therefore not worried about prospects for the share price. Need a little more hope? MAT was featured last week in CNBC’s 2017 Stock Draft, and an insider bought a million dollars worth of MAT on April 24.
The downturn in the share price presents an extraordinary opportunity for dividend investors. Growth stock investors, however, should wait for the stock to trade in the low 20s for a while before a rebound can commence. Buy.
Schnitzer Steel Industries (SCHN, yield 4.0%) is a scrap metal recycling company. The company is expected to grow EPS by 125% in 2017, while the P/E is just 17.1. The steel industry is faring well, with higher pricing, low inventories, and shipments rising in March for the third consecutive month.
Note that United States Steel (X) reported a surprisingly bad quarter last week due to ongoing company-specific problems which will not affect industry peers, other than perhaps giving peers a competitive edge. U.S. Steel reported a first-quarter loss of ($0.83) per share when analysts were expecting a $0.32 profit. The company did not keep their blast furnaces modernized during recent lean years, and is now planning to spend the money to bring their equipment up to date. That process will take three to four years, and will necessarily limit production volumes. The stock did not react well: investors pushed the share price down 26% on April 26.
SCHN seems to be stabilizing after a recent drop, but it’s not yet ready to rebound. Patient investors can buy low here. Buy.
Tesoro (TSO – yield 2.7%) is an undervalued aggressive growth stock in the oil refining and marketing industry. The company will report first quarter results on the afternoon of May 8. TSO exhibited a shakeout pattern on its price chart in the second half of April; a bullish sign indicating that an upturn in the share price is imminent. Buy TSO now. Strong Buy.
Thermon Group Holdings (THR) is an aggressive growth stock in the electrical equipment industry. A breakout past 21 will be quite bullish, with additional price resistance at 25. Strong Buy.
Total SA (TOT – yield varies, approx. 4.4%) is an international oil and gas company that’s based in France. Read about Total’s strong first-quarter results in the April 28 Special Bulletin. TOT is a greatly undervalued, aggressive growth stock. The share price rose past its recent trading range in early April, and continues to ratchet upwards. I expect the stock to produce very attractive returns for investors going forward. Buy TOT now. Strong Buy.
Universal Electronics (UEIC) is a consumer electronics company. The company will report first quarter results on the afternoon of May 4. UEIC is rising toward its February high of 74, where I will likely sell because the stock is overvalued based on 2018 numbers. However, a strong earnings beat could change all the numbers, so I will reassess after the earnings report. Hold.
Vertex Pharmaceuticals (VRTX) is a large-cap, aggressive growth biotech company that corners the market in treatments for cystic fibrosis. Read about Vertex’s strong first quarter results in the April 28 Special Bulletin. Consensus estimates project EPS to grow 90.6% and 79.6% in 2017 and 2018 (December year-end), with corresponding P/Es of 73.0 and 40.7. The stock remains undervalued.
VRTX has risen from 72 in mid-December, without so much as a 10% price correction. Statistically, we’re due for a pullback, at which time I’ll encourage investors to buy the stock. The best-case scenario this year is that VRTX could rise all the way to its 2015 high around 140, at which time I plan to sell. Hold.
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Send questions or comments to crista@cabotwealth.com.
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